A California retiree suspects his investment advisor has cost him a quarter million dollars from improper trading or spending and decides to take legal action. But, like many in similar situations, the retiree discovers a clause in his contract with the advisor requires any dispute be mediated by JAMS, a for-profit organization of alternative arbitration formerly known as Judicial Arbitration and Mediation Services. The fees for employing JAMS could be as high a $450,000, however, thus making the effort prohibitive.
It’s not an isolated case. Attorneys and arbitration experts say the JAMS forced arbitration process for registered investment advisors harms investors and allows RIAs, who seemingly serve as their clients’ fiduciaries, to exploit the provisions and use them as a shield to avoid liability for their misconduct.
“They will make the client travel to the lower Seychelles Islands and use tribal law that only protects the advisor,” said Hugh Berkson, a securities lawyers and president of the Public Investor Arbitration Bar Association (PIABA). “It protects them and keeps clients from suing for anything short of murder.”
SEC calls JAMS mediation ‘untenable system’
In a report issued in late June, The Securities and Exchange Commission, acknowledged what PIABA said was an “untenable system for aggrieved investors,” which can often dissuade wronged investors from seeking damages for breach of fiduciary duty. But, while JAMS mediation problem obviously exists, the SEC stopped short of doing anything about it.
“While we appreciate the SEC’s attempt to address the problem, we find it frustrating that the SEC ran into the same problem we did: there is no source of hard data on the subject,” Berkson said. “American Investors would have benefitted if the SEC, which regulates these advisers, had stated an intent starting with a requirement that those advisors report the exact same information brokers must, followed by a mandate that financial professionals carry insurance.”
Ironically, Registered Investment Advisors aren’t subject to the same disclosure requirements that brokerages are and thus their arbitration cases and complaint outcomes are not discoverable.
“So, nobody knows when they go to arbitration, and when they do, what the outcome is,” says Berkson. “It’s really important that you look at the background of your financial professional, to make sure that you’re comfortable with whoever it is, and there aren’t dozens of complaints against them. Except that if it’s an investment advisor, they don’t have to report those complaints. So the investors are never going to see it. So, the problem is, we’ve seen arbitration clauses being used as shields, and we believe that there’s a real problem with payment of awards, because they’re not maintaining insurance.”
Report a ‘double whammy’
The incoming president of PIABA, Joseph Peiffer, said the SEC’s report was a “double whammy” for American investors.
“After losing their clients’ hard-earned money, advisors often slip fine print into contracts that prevent investors from seeking justice,” Peiffer said. “The SEC must act to put an end to this.”
PIABA cited an extreme injustice case of an incapacitated senior suffering from a traumatic brain injury whose RIA lost most as the result of improper high-risk investment strategies. Due to a provision in the RIA’s contract, the claim could only be adjudicated in a private dispute resolution forum.
“To file the case, the conservator would have to advance more than $30,000 to cover the investor’s share of the anticipated forum fees.” PIABA said in an opinion piece in Financial Planning magazine. “The conservator was hesitant to proceed, knowing he would have to deposit more than $30,000. So much of (the incapacitated senior’s) money had already been lost, he was not sure he could risk losing any more of her money on fees.”
Regulators not able to assess depth of problem
But in the much-anticipated SEC report on the matter, which was ordered by Congress, the SEC essentially said complaints from PIABA and others were anecdotal and regulators were not able to fully assess the depth of the problem.
“Based on estimates, a majority of investment advisory agreements contain mandatory arbitration clauses, and some contain restrictive terms that could negatively affect the arbitration process or outcome for clients,” the SEC acknowledged. “Some of these restrictive terms are impermissible in agreements between brokers and their customers (such as terms prohibiting class actions or specifying certain forum locations), and might also be impermissible in other dispute resolution forums”
But, the SEC said given the absence of publicly available information about adviser arbitration or the number of unpaid awards, “a quantitative evaluation of the ‘effects’ of contracts with mandatory arbitration clauses would require further inquiry.”
The report, however, agreed that establishing uniform disclosure requirements for adviser arbitration information could, as some stakeholders suggest, increase public access to this information, as well as regulatory and investor insight into advisory conduct
“The SEC took the easy out and didn’t offer any policy solutions,” said Berkson. “So, unless Congress tells them to do something, I get the feeling they’re not inclined to do anything.”
Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at email@example.com.
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