Efforts by state securities regulators — with the backing of a high-ranking SEC official — to restrict or end the use of mandatory-arbitration clauses in brokerage contracts are giving some financial advisers headaches.
Scuttling mandatory arbitration could create a field day for plaintiff's attorneys, drive up professional insurance rates and eliminate an important safety valve, critics charge.
“Anybody can just file a claim,” said Dominic Lucente, a certified financial planner at Northeast Planning Associates Inc. “The cost to defend yourself and the time could be huge.”
Mr. Lucente added: “There are claims that can be sorted out quickly and easily in arbitration that don't need to go forward. If you do away with arbitration, everything would go to a full-blown court case.”
State regulators, on the other hand, contend that in-vestors should be allowed to go to court to settle a grievance against their broker. They visited Washington last week to build momentum for efforts to restrict or end the use of mandatory arbitration clauses.
One powerful voice in Washington they won't have to convince is Luis A. Aguilar, a member of the Securities and Exchange Commission.
In a speech at a North American Securities Administrators Association Inc. conference last Tuesday, he called for an end to the practice.
“A client's right to bring private actions under the Exchange Act is meaningful, and the client should not be required to waive — prematurely — their legal rights, including their rights to bring an action in federal or state court,” Mr. Aguilar said in prepared remarks.
The Dodd-Frank financial reform law gives the SEC the authority to prohibit or curtail compulsory arbitration for clients of brokers and investment advisers, but the regulator has yet to address the issue.
“I believe the commission needs to be proactive in this important area,” Mr. Aguilar said in his speech. “We need to support investor choice.”
Allowing clients to take claims to court would “enhance investor protection and add more teeth to our federal securities laws,” he said.
NASAA MEETINGS
About 17 NASAA members conducted meetings with more than 40 lawmakers on Capitol Hill last Wednesday, delivering the same message as Mr. Aguilar's. They also met with officials at the SEC and the
Financial Industry Regulatory Authority Inc.
John Cronin, securities director in the Vermont Department of Financial Regulation, said that he and his colleagues are making headway.
“I think some key folks in Washington have been watching this issue,” he said, citing the SEC in particular. “I know they're taking a hard look at it.”
Adviser opposition to the movement isn't universal. In fact, state regulators have some support among investment advisers.
The arbitration process is too constricting and often results in settlements before advisers can prove their innocence, said Fred Hensler, president of Hensler & Associates Wealth Management Inc.
“It's a spin cycle that you can't get out of. That's frustrating for someone who has run an exceptionally clean business for the last 20 years,” Mr. Hensler said.
In his view, a miffed client is almost always “going to get money” through arbitration, while a day in court might result in more wins for advisers.”
Mr. Hensler added: “If you did get to court, it would be much cleaner than if you [went through] arbitration.”
Bradley Meister, owner of Meister & Associates LLC, worries about a spike in legal costs if arbitration, which he backs, is limited.
“You're creating a whole new source of income for trial attorneys,” he said. “My big fear is that [the cost of] our errors-and-omissions-insurance coverage will jump way up.”
Arbitration is a “much more effective way, a less expensive way, to resolve any conflicts between an adviser and their client. A lot of times, problems can be solved before you get an attorney involved,” Mr. Meister said.
Almost all brokerage contracts include a clause mandating mandatory pre-dispute arbitration, which are also appearing in agreements between clients and investment advisers, according to state regulators.
Controversy over compulsory arbitration spiked this year when a Finra hearing panel ruled that the regulator couldn't stop The
Charles Schwab Corp. from using the arbitration agreements to prohibit clients from engaging in class actions.
"SOLE FORUM'
That decision, however, hasn't blunted the push to eliminate arbitration, at least among some regulators.
“Arbitration has increasingly become the sole forum available to an aggrieved investor,” A. Heath Abshure, Arkansas securities commissioner and NASAA president, said in a speech at the NASAA conference. “Part of investor protection is ensuring civil remedies for investors, and one size does not always fit all when it comes to remedies.”
It isn't clear whether the SEC will propose arbitration reform. At least three of the five commissioners would have to support such a proposal.
“I would be very supportive of taking another look at the question,” SEC member Elisse Walter said on the sidelines of the NASAA conference last week.
But “arbitration presents a number of very significant advantages over court litigation for investors,” she said.
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