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Third SAC Podcast Tackles “Investment Adviser Arbitration – What You Need To Know”
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The current state of registered investment adviser (“RIA”) arbitration, and where things may be headed, were the core topics discussed recently by an experienced panel of securities arbitration experts in the third SAC podcast.

The video podcast was moderated by former FINRA Director of Arbitration and current SAC Board of Editors member George H. Friedman, and features as panelists Glenn Gitomer of McCausland Keen & Buckman, Salvador Hernandez of Riley Warnock & Jacobson, PLC, Ross Tulman of Trade Investment Analysis Group, and Jeffrey Zaino of the American Arbitration Association. Recorded in August, the video podcast, complete with a PowerPoint, examines the current state of RIA arbitration, the federal and regulatory landscapes, the advantages and disadvantages of resolving disputes through arbitration as opposed to litigation, a comparison of the AAA and FINRA arbitration programs, and the panel’s predictions for the future.

Dispute Resolution Requirements for Brokers and RIAs are Very Different

SAC President Rick Ryder set the table by noting that RIAs and broker-dealers (“BDs”) have different arbitration requirements, and that the past decade – especially since the 2010 enactment of Dodd-Frank, has accelerated the pace of change. “The ranks of the investment advisory community have grown rapidly over the past decade… RIAs are not required, as FINRA members are, to arbitrate upon the demand of a client. Advisor representatives are not required, as are brokers signing Form U4s, to arbitrate their employment disputes. RIAs are not subject to disciplinary sanctions, if they do not timely pay awards assessed against them in arbitration.”

Who’s Administering the Cases?

 The panel first discussed where arbitrations between customers and RIAs are heard. A consensus quickly emerged that most cases are heard by FINRA, with cases also being administered by the American Arbitration Association. How does FINRA have jurisdiction over RIAs disputes? Mr. Tulman answered: “Most of the cases that I'm seeing are large firms, they're broker dealers, and they're broker-dealers operating on dual platforms. That is, they have clients that have accounts that are both investment advisory accounts and brokerage accounts. And because of that, most of the IA cases I've seen are actually in FINRA.” Cases involving RIAs who are not dual-registered for the most part are going to the AAA, the panel said, because FINRA will only take these cases under very limited circumstances, including the execution of a special post-dispute Submission Agreement. Added Mr. Gitomer: “Where there are predispute arbitration agreements (‘PDAAs’), they typically by default designate the American Arbitration Association… There are, of course, those cases where we do have broker-dealers involved who are also serving as registered investment advisors, and in those cases, clearly FINRA is the default arbitration forum.”

Current State of the Federal Regulatory Landscape

Moderator Friedman, who also teaches arbitration at Fordham Law School, started the discussion by noting that Dodd-Frank section 913 invited the SEC to recommend a self-regulatory organization for investment advisors, and then asked for an update on this issue. Mr. Hernandez stated that there has not been much recent activity on this front and expressed his view that “the big question will be: Is FINRA the appropriate self-regulatory organization to oversee registered investment advisors or should a completely separate SRO be established? Right now, the answer to that question is unclear. The commentators I have read seem to think that FINRA is a logical entity to govern both.” Mr. Friedman reminded the panel that Dodd-Frank section 921 also allows the SEC to ban or regulate or limit pre-dispute arbitration agreements for BDs and that it also allows the Commission to do the same for investment advisor contracts. He then posed this question: “Let’s assume the Commission acts under Dodd-Frank to regulate PDAAs in broker-dealer contracts. Would you recommend they take a consistent approach with RIAs?” The panel answered in the affirmative, with some advocating a choice of forum.

The AAA as an Alternative

Moderator Friedman began the discussion by reviewing a 2013 survey conducted by Massachusetts Secretary Galvin, measuring the use of arbitration in investment advisor contracts. “They heard from about half of the investment advisors in the state,” he said. “Almost all used written contracts, and about half used mandatory pre-dispute arbitration agreements.” The Galvin survey also showed that, of those RIAs that are using mandatory arbitration agreements with a specified provider, about two-thirds name the AAA. Mr. Zaino stated that AAA does handle some RIA arbitrations, but this represents a tiny portion of its overall caseload. “We handle about 250,000 cases a year, and, out of that, our consumer disputes account for about 1,300 cases and, out of that, about 10 percent – 130 – involve registered investment advisor-type cases.” Mr. Zaino added that most customer-RIA disputes would be administered under the AAA’s relatively new Consumer Arbitration Rules, rather than the Commercial Arbitration Rules.

How does AAA decide which rules to apply? Said Mr. Zaino: “We have been applying the new consumer rules, effective September 2014, on investment cases when the investment is for personal use or gain and not invested on behalf of a company or a business. That's the distinction right there. The consumer rules are not used for business-to-business disputes at all.” These rules offer greater protections for consumers, he said, including a requirement that firms register arbitration clauses in AAA’s publicly-available Consumer Clause Registry. Mr. Gitomer added that, under the Consumer Arbitration Rules: “All the consumer has to do is pay a $200 filing fee. The other hearing session fees are borne by the RIA that has required the customer to submit to the AAA forum.”

What do the Parties Want?

As to whether RIAs should be advised to use a PDAA, Mr. Hernandez stated that the answer depended on the RIA’s client profile. “If the clients of the RIA are larger institutional-type clients, or clients with substantial assets, that RIA may want to remain outside of arbitration. Why is that? There are more procedures at their disposal. There's more expansive discovery. There's no question there can be depositions. There are motions to dismiss and there's an extensive summary judgment procedure. To the extent you are going to trial, you have a motion in limine practice to vet out evidentiary issues. Not all of these mechanisms are necessarily available in arbitration.” Some clients, however, may want to take advantage of arbitration’s streamlined nature, he added. On the customer side, Mr. Gitomer stated: “I always prefer arbitration, because in arbitration you don't have all the defense mechanisms that Sal has iterated at length -- and which cause extreme delay in getting the case resolved…. I also find that arbitration is almost always the fairest and most expeditious way of resolving a case.” He added that he has represented parties at both AAA and FINRA, that both organizations performed well, and that each has distinct advantages.

2020 Foresight

The Podcast closed with each of the panelists being asked to weigh in on where they think we're going to be five years from now. Mr. Gitomer thought “the most important thing going forward will be choice of arbitration forum.” Mr. Hernandez said: “It seems to be a good prediction that FINRA would be handling IA disputes on more of a formal basis, and not necessarily through the guidelines that FINRA released a couple of years ago. That could be easily established, even before there's further ‘harmonization’ – to use a word from the Dodd-Frank study -- between the fiduciary standards of an RIA, which is more stringent than the analogous standards of a registered rep. Expert Tulman thought “FINRA is going to go where their members go, and the members are clearly moving to the IA platform…. So, FINRA's going to face a choice. Either they're going to adjust and arbitrate the issues that their members are involved in, or they're going to get out of the arbitration business.” Mr. Zaino was optimistic about the future. “We're seeing some growth here at AAA, but I hope FINRA, AAA and other administrative agencies continue to get the word out about the advantages of ADR.”

The Last Word

Moderator Friedman closed by offering his views on the future. “First, in five years, someone will be the SRO for investment advisors. I just think it would be untenable for ten years to elapse from the enactment of Dodd-Frank for that issue not to be addressed. The fiduciary issue will be addressed as well.” As for arbitration, he believes that in five years both AAA and FINRA will still be administering RIA arbitrations, but that FINRA will be handling arbitrations on a more formal basis. “By that I mean, the SRO issue is going to be resolved. And whether FINRA is the SRO or some other entity is, I think FINRA is uniquely positioned to actually administer the arbitrations for the RIA SRO.”

(ed: *A full write-up of the video podcast is featured in the current issue of the Securities Arbitration Commentator (Vol. 2015, No. 6; October 2015). **Click here to link to the video, and check our Blog for a permanent link to this and future audio and video podcasts. ***FINRA was invited to participate but declined to do so. The forum did respond to a Q&A, which was published with the full write-up in the print newsletter. The edition also contains an article explaining and analyzing the AAA’s Consumer Arbitration Rules.)

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