State regulators question RIAs' use of mandatory arbitration

'How can that be in the best interests of the client?' one asks

Oct 7, 2013 @ 3:38 pm

By Mark Schoeff Jr.

Brokers often are criticized for demanding that the contracts they sign with customers contain mandatory arbitration clauses, but registered investment advisers increasingly are doing the same thing, even though they hold themselves out as always working in the clients' best interests.

Regulators at the North American Securities Administrators Association's annual conference in Salt Lake City said on Monday that more RIAs are inserting the clauses in customer contracts and questioned the practice, since these advisers are supposed to be acting as fiduciaries.

“How can a mandatory arbitration clause fit that definition? How can that be in the best interests of the client?” said Steven Thomas, director of Lexington Compliance, a division of RIA in a Box LLC.

“We are seeing a proliferation of these agreements,” said John Cronin, securities director for the Vermont Department of Financial Regulation.

States are in a bind when it comes to policing adviser use of mandatory arbitration, he said. Vermont used to make advisers remove such clauses from their agreements; it now permits them.

Mr. Cronin's department concluded that the state would be vulnerable to lawsuits over the issue because federal courts — especially the Supreme Court — have upheld arbitration in a number of cases in recent years.

“Based on resources, you have to pick your battles,” Mr. Cronin said.

Virginia is still fighting on the adviser arbitration front.

“We make [advisers] take it out,” said Debra Bollinger, senior counsel at the Virginia State Corporation Commission. “It's probably going to end up in a lawsuit.”

State regulators have been pushing the Securities and Exchange Commission to prohibit mandatory arbitration in brokerage and adviser customer agreements, asserting that investors deserve the right to take their claims to court. Currently, the Financial Industry Regulatory Authority Inc. conducts arbitration proceedings.

A provision of the Dodd-Frank financial reform law gives the SEC the authority to end mandatory arbitration. But the commission has not indicated whether it will propose such a rule.

“This needs a one-stop fix,” Mr. Cronin said. “The best solution is for the SEC to act on the authority given to it under Dodd-Frank.”

In Monday's panel, Ira Hammerman, senior managing director and general counsel at the Securities Industry and Financial Markets Association, argued that Finra arbitration offers investors a fast, efficient and relatively inexpensive way to pursue their claims, citing statistics showing that arbitration cases usually reach a conclusion in 14 months.

“There's no way you can do that in the federal court system, given the demand on judges,” he said. “Customers get their proverbial day in court a lot faster through arbitration.”

Those advantages would be lost if customers were allowed to opt out of arbitration, Mr. Hammerman said, because it would undermine industry support for the Finra system.

“Choice for its own sake doesn't always result in a benefit,” he said. “The whole system of arbitration will eventually break down.”

Robert Banks Jr., owner of Banks Law Office PC, said that the Finra process — in which customers obtain an award about 40% of the time — is generally fair and has been improved over the years. The latest regulatory change makes the all-public arbitration panel the default choice for hearing cases, a move that likely will reduce participation by industry representatives.

But Mr. Banks supports giving customers venue flexibility.

“I don't see this as a ground-shattering move,” he said. “We are going to have Finra arbitration no matter what. Investor choice is pretty hard to argue against.”


What do you think?

View comments

Upcoming event

Sep 10


Denver Women Adviser Summit

The InvestmentNews Women Adviser Summit, a one-day workshop now held in six cities due to popular demand, is uniquely designed for the sophisticated female adviser who wants to take her personal and professional self to the next level.... Learn more

Most watched


Young professionals see lots of opportunity to reinvent the advice experience

Members of the 2019 InvestmentNews class of 40 Under 40 have strategies to overcome the challenges of being young in a mature industry.


Young advisers envision a radically different business in five years

Fintech and sustainable investing are two factors being watched closely by some of the 2019 class of InvestmentNews' 40 Under 40.

Latest news & opinion

New Jersey fiduciary rule: Pressure leads to public hearing, comment deadline extension

Industry push results in chance to air grievances on July 17 and another month to present objections.

InvestmentNews' 2019 class of 40 Under 40

Our 40 Under 40 project, now in its sixth year, highlights young talent in the financial advice industry. These individuals illustrate the tremendous potential of those coming up in the profession. These stories will surprise, entertain, educate and inspire.

Galvin to propose fiduciary rule for Massachusetts brokers

The secretary of the commonwealth is proposing a fiduciary standard in response to an SEC investment-advice rule he views as too weak.

Summer reading recommendations from financial advisers

Here are some books that will keep you informed and entertained during summer's downtime

4 strategies for Roth conversions

There's never been a better time to do a Roth conversion, and here are several ways to go about it.


Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting It'll help us continue to serve you.

Yes, show me how to whitelist

Ad blocker detected. Please whitelist us or give premium a try.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print