The Office of the Investor Advocate of the U.S. Securities and Exchange Commission (“SEC”) recently released a report about the SEC staff’s study of mandatory arbitration clauses in investment advisory client agreements used by investment adviser firms registered with the SEC.
Key Findings and Recommendations
The SEC’s Office of the Investor Advocate expressed concerns that certain restrictions associated with some mandatory arbitration clauses could mislead retail advisory clients, place an investment adviser’s interest before a client’s interest and consequently result in the in the investment adviser breaching its fiduciary duty. The primary findings and recommendations include the following:
Limitation on Damages and Types of Claims: The SEC’s Office of Investor Advocate believes that the language in an investment advisory agreement preemptively limiting the damages available to clients, or types of claims that clients may assert against the investment adviser in an arbitration, might mislead retail clients into not exercising their legal rights and would constitute a breach of the investment adviser’s fiduciary duty.
Placing Adviser’s Interest Before Client’s Interest: Absent evidence that a client has provided informed consent, the SEC’s Office of Investor Advocate concludes that an investment adviser is placing its interests before a client’s interest and thus breaching its fiduciary duty when utilizing an arbitration clause with any of the following restrictions or requirements:
- Exclusion from participating in class action lawsuits;
- Arbitration venues irrespective a client’s physical location;
- Application of commercial arbitration rules meant for business-to-business disputes; and
- Fee-shifting provisions imposing arbitration costs on the client.
Disclosure of Arbitration: The Investor Advocate’s Office recommends that the Commission require investment advisers registered with the SEC to disclose arbitration information to clients and such disclosures should be similar between and SEC and state registered investment advisers.
Prohibition of Restrictive Terms: The Office of the Investor Advocate encourages the Commission to prohibit investment advisers registered with the SEC from using certain restrictive terms in mandatory arbitration clauses that negatively affect clients.
Temporary Suspension: The SEC’s Investor Advocate Office urges the SEC to suspend the use of mandatory arbitration clauses until further analysis of their impact on clients.
Action Steps for Investment Advisers
Given these developments, investment advisers registered with the SEC should engage legal counsel to review current investment advisory agreements, focusing upon the following:
- Whether to remove mandatory arbitration clauses; or
- Whether to keep the mandatory arbitration clause but revise certain restrictive provisions and/or develop processes to ensure informed consent about such provisions.
Conclusion
The Investor Advocate’s report provides a guide to how investment advisers registered with the SEC should approach mandatory arbitration clauses in client agreements. It is imperative for SEC-registered investment advisers to take the initiative in reviewing and, if necessary, amending their agreements or updating their informed consent processes in light of these recommendations. As always, consultation with legal counsel is crucial in navigating these changes.
Resources
Investment Advisers Should Review Client Agreements for Liability Hedge Clauses (10/5/2023)
SEC Enforcement Action: In the Matter of Titan Global Capital Management USA LLC (8/21/2023)
Key Takeaways from NASAA’s 2023 Investment Adviser Coordinated Exam (8/15/2023)
SEC Issues Investment Adviser Exam Priorities for 2023 (2/16/2023)
Recorded Webinar: Reviewing and Updating Investment Adviser Client Agreements (4/27/2022)
- Included with an Annual Compliance Program (Bronze, Silver, Gold, Platinum & Titanium packages) through our Knowledge Base at
https://www.ria-compliance-consultants.com/knowledge-base/reviewing-and-updating-investment-adviser-client-agreements/ or - Available for an a la carte purchase through our Online Store at https://www.ria-compliance-consultants.com/product/reviewing-and-updating-investment-adviser-client-agreements/
SEC Enforcement Action: In the Matter of Comprehensive Capital Management, Inc. (1/11/2022)
SEC Release No. IA-5248: Commission Interpretation Regarding Standard of Conduct for Investment Advisers (6/5/2019) at pages 10 – 11
Understanding the Provisions Required for Registered Investment Adviser Client Contracts (5/16/2013)
Disclosures
The information contained in this blog post is general in nature, intended for educational purposes only and is not intended to be a comprehensive analysis of this topic. This is merely a summary and does not necessarily include all material facts from the report or underlying study. RIA Compliance Consultants, Inc. has not verified the accuracy of the securities regulator’s report and is not offering any definitive opinion on its research, analysis and findings. This post is not intended to constitute compliance consulting advice or apply to any particular investment adviser firm’s specific situation. Please consult the applicable securities regulator’s order, rules and published guidance for more details about the topics referenced above. RIA Compliance Consultants, Inc. is not a law firm and does not provide legal services. This blog post should not be considered legal advice. RIA Compliance Consultants, Inc. recommends that an investment adviser discuss the use of pre-dispute, mandatory arbitration clauses in client agreements with its legal counsel. For more information about the limitations of this blog post and information on our website, please see our Disclosures webpage.
Posted by Bryan Hill
Labels: Arbitration, Client Contracts, SEC
