Client attorneys say RIAs force disputes into costly arbitration

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RIA clients seeking compensation for losses as a result of advisors’ harmful conduct may have an even smaller chance of success than customers of dually registered firms and brokerages.

Customer agreements requiring RIA clients to pursue any claims through arbitration forums operated by alternative dispute resolution services JAMS and the American Arbitration Association pose costs so high that they’re out of reach for clients who can’t afford to spend tens of thousands of dollars, according to attorneys from the Public Investors Advocate Bar Association. While they often criticize the FINRA arbitration process, they view it as a better forum for clients seeking damages for unsuitable recommendations or other claims.

With legislation backed by PIABA, state regulators and prominent Democrats pending in Congress, rising concerns about unpaid FINRA awards and expungement cases and a growing impact investor campaign against mandatory arbitration of sexual harassment claims, the provisions of RIA customer agreements have come under more scrutiny as well.

“You have a fiduciary preemptively taking away a customer’s right to a jury trial but also taking away a customer’s right to dispute resolution based on cost factors,” said Michael Edmiston, an attorney with Jonathan W. Evans & Associates and PIABA’s current president. “I don’t know how any RIA can say they’re acting in a customer’s best interest when they do that.”

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The prices often run to $50,000 or more up front for any clients, who are also subject to hourly fees collected by the arbitrators, according to attorney Lisa Bragança of Bragança Law, who sits on the board of the PIABA Foundation. Most RIAs force client claims into either JAMS or AAA rather than enabling them to file lawsuits in courts, she said, describing the client contract provisions as “a giant blockade at the door” to the judicial system and arbitration forums.

“It’s not less expensive than a court proceeding when you’re doing it through AAA and JAMS,” Bragança said. “Just because something is efficient doesn’t mean that it’s just.”

Representatives for the SEC declined to comment, while representatives for JAMS didn’t respond to inquiries. A spokeswoman for AAA, Victoria Castelbuono, emailed a statement saying that the organization “does not handle a significant number of cases involving RIAs.”

AAA has resolved more than 400,000 cases of all types in 2021, as of Nov. 15, according to its website. JAMS administers about 18,000 cases each year in filings “ranging from two-party personal injury mediations to complex, multi-party, multimillion-dollar arbitrations in the United States and other jurisdictions worldwide,” its website states.

The number of FINRA arbitration cases has tumbled in 2021, after the regulator imposed minimum fees starting last September for cases filed by registered representatives seeking expungement of client complaints. More than 60% of cases resolved in the first three quarters of the year ended in settlements among the parties, with only 31% of clients receiving damages in the more than 200 cases that reached a decision, according to the regulator.

With client advocates and impact investors arguing that forced arbitration in any forum gives too much of an advantage to firms and sweeps disturbing cases out of public view, some Democrats in Congress have taken up the issue with support from PIABA, the North American Securities Administrators Association and progressive interest groups such as the American Association for Justice and Public Citizen.

In April, Sen. Jeff Merkley of Oregon and Rep. Bill Foster of Illinois re-introduced the Investor Choice Act, which would ban mandatory arbitration and lift restrictions on class action lawsuits in RIA and broker-dealer client agreements. Given industry opposition, the bill isn’t likely to pass the closely divided Congress. Still, it has received 13 co-sponsors in the House and Senate.

“Individuals shouldn’t need to surrender their legal rights because they choose to work with a financial advisor or broker-dealer to plan for their retirement and invest their hard-earned money,” Rep. Foster said in a statement this spring. “This legislation levels the playing field for consumers and prevents them from being victims of a rigged system that denies them fair legal recourse if they are wronged.”

Under questioning by co-sponsor Elizabeth Warren of Massachusetts at his Senate confirmation hearing in March, SEC Chair Gary Gensler expressed some openness to efforts to change the current state of industry arbitration.

“Let me ask about the tilted roulette tables on Wall Street,” Warren said to Gensler. “If someone has been cheated by a broker-dealer, hypothetically, for example, if Robinhood cheated individual investors, hypothetically, should that company be able to use forced arbitration clauses to avoid getting sued and held accountable?”

“I think, Senator, that while arbitration has its place, I think it’s also important that investors, or in that case, customers have an avenue to redress their claims in the courts,” Gensler replied.

Cryptocurrency brokerage agreements are adding urgency to the matter, according to Bragança, who said they sometimes mandate that clients show up for proceedings in remote locations such as the U.S. Virgin Islands. One company where she’s a customer once gave her a contract that called for her to appear in Switzerland. In one irony, she said that there are even investor advocate attorneys who stipulate that clients must resolve any disputes in arbitration.

Edmiston became PIABA’s president in October, and he plans to ask the SEC to conduct “a sweep and study of the use of dispute resolution clauses in RIA customer agreements,” he said. “Nobody at this point has a grasp on how frequently dispute resolutions are used, the providers, the cost issues and, most importantly, whether customers are able to afford arbitration.”

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