By Suzanne Barlyn
Feb 13 (Reuters) - A state regulator is taking issue
with arbitration agreements many registered investment advisers
require their clients to sign when they open accounts, saying
they conflict with a fundamental duty to serve their clients'
A recent survey by Massachusetts' top securities regulator,
William Galvin, suggests that many registered investment
advisers have agreements with clients that require arbitrating
future legal disputes, instead of going to court.
While a federal arbitration law allows the practice, it
clashes with an adviser's obligation to act as a fiduciary, or
in a client's best interest, Galvin wrote in a letter to the
U.S. Securities and Exchange Commission on Tuesday.
The regulator's concerns spotlight a longstanding debate
over whether retail investors and customers in other industries
should have to sign mandatory arbitration agreements with
service providers. Supporters say the process is faster and
cheaper than court. Opponents say consumers should have a choice
between court and arbitration.
For registered investment advisers, the debate takes on an
added dimension: securities laws require them to act in their
clients' best interests. But the potential advantages of
arbitration often benefit the adviser, some lawyers for
investors say. Among them: arbitration proceedings are private.
Most details about the cases are typically not made public - an
advantage that can protect an adviser's reputation.
Galvin's office surveyed the 710 investment advisers
registered in Massachusetts. Of 370 who responded, about half
use contracts that require clients to resolve future legal
disputes through arbitration. Galvin asked the SEC to ban the
practice, or at least study the issue.
"They're not putting that in their agreements because it's
in their customers' interests," said Mark Maddox, a securities
lawyer in Fishers, Indiana, and former Indiana Securities
Commissioner. "Advisers are putting it in there because it's in
their own interests."
ROOM TO GROW
Mandatory arbitration clauses are standard among another
type of financial adviser: those who work for securities
brokerages. While registered investment advisers register with
states or the SEC, brokerage advisers register with the
Financial Industry Regulatory Authority (FINRA), Wall Street's
But brokers, unlike registered investment advisers, are not
required to act in clients' best interests. Instead, they simply
must recommend securities and strategies to clients, based on
factors such as risk tolerance and age.
Concerns among investor advocates about such brokerage
industry agreements and industry-run arbitration ran so deep on
the issue that the Dodd-Frank financial reform law authorized,
but did not require, the SEC to restrict mandatory arbitration
agreements if it found that this would protect investors.
While the debate has focused mostly on brokerage agreements,
no single source keeps track of how many of the roughly 28,000
investment advisers registered with the SEC and states also
require arbitration. The results of the Massachusetts sampling,
however, jolted some lawyers.
Galvin's finding that 50 percent of advisers who answered
his survey use mandatory arbitration agreements is probably
"slightly higher" than what it would be nationally, said Maddox,
who has represented investors in arbitrations involving
investment advisers. But that could change. Some states,
including Vermont, tried to prohibit mandatory arbitration
clauses for their registered advisers, but were thwarted by a
federal law allowing arbitration when parties agree.
FINRA, in fact, recently opened its arbitration forum to
disputes between investment advisers and investors. [ID:
nL1E8LTAOL] Only a small number of investment advisers resolve
their disputes there. Others go to court or arbitration forums
like the American Arbitration Association or JAMS Inc. Those
options are typically more expensive than FINRA arbitration.
It could be a long time before the SEC takes up the issue of
mandatory arbitration, if it does at all. The agency, which is
in the midst of a leadership change after Mary Schapiro stepped
down and former federal prosecutor Mary Jo White was nominated
to succeed her, is already behind on developing many rules the
Dodd-Frank Act requires.
An SEC spokesman declined to comment on whether the agency
will study arbitration, but said it looked forward to reviewing
In the meantime, investment advisers who use arbitration
clauses do so at their own risk. "It's a gray area, somewhat,"
because of potentially conflicting laws and other guidance, said
David Tittsworth, executive director of the Investment Adviser
Association, a Washington-based trade group.
Advisers should at least consider their fiduciary duty and
potential concerns related to mandatory arbitration agreements
before including one in client contracts, Tittsworth said.
Even if the practice is legal, it could raise questions
among potential clients about the adviser's integrity, in a
relationship rooted in trust, not a contract, said Tamar
Frankel, a professor at Boston University School of Law. Asking
a client to sign a waiver can undermine that trust early in a
relationship, Frankel said.
Follow us on Twitter @ReutersLegal | Like us on Facebook