More On Legal & Compliancefrom The Advisor's Professional Library
- Do’s and Don’ts of Advisory Contracts In preparation for a compliance exam, securities regulators typically will ask to see copies of an RIAs advisory agreements. An RIA must be able to produce requested contracts and the contracts must comply with applicable SEC or state rules.
- Dealings With Qualified Clients and Accredited Investors Depending upon an RIAs business model and investment strategies, it may be important to identify “qualified clients” and “accredited investors.” The Dodd-Frank Act authorized the SEC to change which clients are defined by those terms.
Lost in the debate over a fiduciary standard for brokers was a little reported and largely ignored ruling by the SEC to allow disgruntled investors the option of choosing a “non-industry related” arbitration panel. The SEC acted on a proposal by FINRA to expand its two-year pilot program testing these rights to all investors.
I’ve been accused of being overly skeptical of anything proposed by FINRA, but over the years, I’ve come to the conclusion that one can’t be “too” suspicious of the brokerage industry’s SRO. In this case, the timing alone of FINRA’s proposal (which they’ve had over two years to make) leads one to suspect some correlation with the Dodd-Frank broker/advisor reregulation: Perhaps an attempt to head off any thought that a broker fiduciary standard would create investor grievances outside of its arbitration system?
The effect of a new fiduciary standard on arbitration was not addressed in Section 913 of the Dodd-Frank Act nor, as far as I can tell, in the SEC’s report on implementing the new law. Still, many of us who advocate cleaning up the brokerage industry’s abusive client practices hope that the current arbitration system would be swept out with the rest of the trash. Apparently, FINRA fears much the same thing.
Securities arbitration is hard to criticize due to the scant information that FINRA releases about individual cases or even general results. Ironically, this “black-box” treatment of arbitration cases by FINRA has become the focus of some of the most pointed criticism of it: How can anyone outside of FINRA tell if it’s actually working to protect investors? Given FINRA’s track record on investor protection, it’s not exactly entitled to the benefit of the doubt.
As the next best thing to real data, I am acquainted with more than few industry folks who serve as FINRA arbitrators, and have talked with many of them about their experiences. The overwhelming consensus seems to be, as one arbitrator
put it: “In my experience, almost all arbitrators really try to do the right thing by investors, but the way FINRA’s rules are written, their hands are often tied.” I know, there’s probably no Pulitzer Prize in that bit of investigative reporting.
Yet as bad as a deck stacked against investors is, the even bigger problem with arbitration is that, unlike court cases, there is no record of information from past arbitration rulings that is published to create consistency in how decisions are made, or to inform investors what the precedents are in their particular circumstances.
Even the U.S. Golf Association (USGA) publishes a growing body of its rulings so that players can better apply the overly convoluted rules of golf. Now I realize that people’s money isn’t as important as getting their golf scores right, but it’s a distant second, and should arguably be afforded the same rational consideration.
But by positioning securities arbitration as “investor friendly” by allowing investors themselves to choose non-industry arbitrators to apply its self-protecting rules, FINRA through the SEC has set the stage for a broker fiduciary standard to be enforced by arbitration as well. Of course, its supporters will point out how much cheaper this system is for investors rather than having to go to court. That is, not coincidentally, the same argument they make for the suitability standard and for commissions. I wonder how investors would feel about these “savings” if they understood the real costs of the abusive practices they result from?