The SEC’s recent report on the use and abuse of mandatory pre-dispute arbitration agreements by registered investment advisers found that “approximately 61% ofSEC-registered advisers that serve retail investors incorporated mandatory arbitration clauses into their investment advisory agreements.”

OnDec. 5, 2023, the Office of the Investor Advocate (OIAD) published its Report on Activities for the Fiscal Year 2023, an annual report it submits to Congress regarding the Office's research activities and policy recommendations concerning investor interests and welfare.

According to the Investment Advisers Act of 1940, a Registered Investment Adviser(RIA) has a fundamental fiduciary duty to always act in the best interests of their clients. The Office of Investor Advocate (OIAD) has expressed its opinion that restricting the types of claims and award amounts in mandatory arbitration agreements could potentially violate an RIA’s fiduciary duty. Such restrictions may mislead retail clients and discourage them from exercising their legal rights.

The impact to the client is at the heart of this current debate.  The OIAD also concluded that when RIAs unilaterally select venue, forum, rules, etc., it can become onerous for the client in terms of convenience and cost, running contrary to the client's best interest.  

Organizations like NASAA and PIABA go even further, arguing, respectively, that “forced arbitration at the demand of [RIAs] is inimical to the basic fiduciary nature of an investment advisory relationship,” and that “a true fiduciary would not impose any forced arbitration obligation and would instead let its customer make their own choice of forum, whether court or arbitration” – and  many states take a similar view.

Keep in mind, the “fiduciary duty” standard that applies toRegistered Investment Advisers (RIAs) is designed to distinguish them from their broker-dealer counterparts. This distinction grants RIAs less regulation due to the elevated level of care they are required to provide. However, it seems implausible that clauses intended to favor the RIA in terms of convenience and cost would meet any reasonable standard for fulfilling their duty of care or loyalty. This becomes especially relevant when considering the lack of regulatory oversight and transparency.

Changes to client agreements banning mandatory arbitration just emphasizes the need fora compliance program that is cutting edge and on the forefront of technical advances.  Adopting automation in compliance workflows is not just a technological upgrade but a strategic move that aligns with our industry’s growing need for commitment to compliance excellence. It empowers advisors to navigate the regulatory landscape with confidence and focus on what truly matters—providing clients with the best possible financial advice and services.

Avery by RegVerse, our comprehensive suite of tools enables RIAs to automate compliance and surveillance programs, building and maintaining trust through a foundation based on regulatory compliance. Our human supervised AI Data model is cutting edge for an ever evolving industry.  

Contact us today for a demo on Avery by RegVerse as we watch the development of decision the SEC will make on mandatory arbitration clauses.

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Resources used:

MicrosoftWord - PC-BM FINAL- SEC Arbitration Letter - 1.30 (hastingsgroupmedia.com)

Investoradvocates call on SEC to end RIAs' use of mandatory arbitration(investmentnews.com)

MandatoryArbitration among SEC-Registered Investment Advisers

Mandatoryarbitration clauses in registered investment advisor agreements draw scrutinyfrom regulators | Reuters

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Key Terms: Arbitration, OIAD, Mandatoryarbitration, Clientcontracts, Arbitrationclause

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