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Regulation and Compliance > Federal Regulation > DOL

Panelists say DOL arbitration provision must go

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The first morning of the Department of Labor’s public hearing on its proposed conflict-of-interest rule brought attention to a provision that could protect advisors from the plaintiffs bar, a group that DOL opponents say would benefit if the rule is finalized.

The proposed rule, which attempts to create a best-interest standard of care by imposing fiduciary requirements on nearly all advisors to IRAs and 401(k) plans, includes language which is consistent with existing policy under the Financial Industry Regulatory Authority, the broker-dealer industry-funded watch dog that litigates regulations violations through arbitration panels.

Language in the DOL’s proposal prohibits advisors from including contractual provisions that release the advisor from liability or forbid a client to bring a class-action suit, as does FINRA’s policy.

In effect, it is a prohibition against fine print that says clients can’t sue.

But in its provision, the DOL says that advisors would be free to include pre-dispute arbitration clauses in customer contracts.

That means advisors could present clients with a contract that says complaints could only be brought through FINRA’s arbitration panels, not in a court of law.

That’s a substantial problem with several of the first morning’s panelists, but none were as colorful in their disdain for the language than James Keeney.

Keeney, a Sarasota, Florida-based attorney who has represented plaintiffs in hundreds of claims against broker-dealers, RIAs, and insurance agents and companies, is an active FINRA arbitrator and a former trustee of the Public Investors Arbitration Bar Association.

In his comment letter to the DOL, Keeney argued that allowing advisors to contractually limit potential fiduciary claims to arbitration hearings would “swallow” the entire proposed regulation, and render the well-intended designs of the DOL “illusory” for retirement investors.

In his testimony at the open public hearing, Keeney went further, calling the arbitration provision a “fatal flaw” of the proposed regulation.

A financial advisor more often acts as a “used car salesman,” said Keeney, as they are beholden to monthly sales quotas, rendering the advice they give as inherently conflicted.

The Best Interest Contract Exemption, which would place extensive disclosure requirements on advisors and brokers looking to be compensated in commissions, is “self-defeating” because it allows advisors to limit claims to arbitration panels, he said. “Retirement investors will be forced to waive their sixth amendment rights to a jury trial,” said Keeney.

To his mind, limiting claims to arbitration hearings provides a get-out-of-jail-free card for advisors who fail to comply with the BICE in the future.

After a quarter century of representing investors’ claims in securities arbitration panels, Keeney doesn’t have much faith in their structural integrity.

“FINRA is an industry trade association,” he said, not an effective oversight authority. “I can certify that the Finra arbitration system is fundamentally biased against retirement investors.”

Arbitrators are voted on by FINRA staff, and their training is “wholly inadequate,” said Keeney.

He went on to paint a fox-guarding-hen-house picture of hapless arbitrators sometimes falling asleep during testimony, hearings ranging deep into the night, claimants’ counsel often quitting their post in the middle of a hearing, and procedural structure so lax that it still fails to deploy the services of a court reporter.

In the end, when awards are given, they are typically a “fraction” of the loss incurred by investors.

Worse, FINRA arbitrators are not required to explain why they ruled the way they did, and state and federal law grants courts limited jurisdiction to overturn a binding arbitration panel’s finding, added Keeney.

Other witnesses backed up Keeney’s testimony.

One, Mercer Bullard, director of the Business Law Institute at the University of Mississippi Scholl of Law, testified bluntly that the Best Interest Contract Exemption provision “is not going to be enforceable in arbitration.”

Bullard, who favors limiting conflicts of interest and supports the thrust of the DOL’s efforts, expanded on his views of the rule’s arbitration clause after Timothy Hauser, deputy assistant secretary for program operations and a member of the DOL’s four-person panel, pressed for his reasoning.

“It will not be possible to get a fair hearing in arbitration” under the rule as it is written, said Bullard.

Bullard noted that FINRA Chair Richard Ketchum has said in public comments and in his comment letter to the DOL that the organization’s judicial arbiters are likely to not understand the rule.

That lack of understanding will add to the already ambiguous judicial structure of FINRA arbitration hearings, testified Bullard.

“Arbitration is a black box,” he said. “No one knows how they make decisions.”

After Hauser asked what would happen if the DOL were to hypothetically erase the arbitration clause, Bullard testified that it would be better to allow some specific conflicts of interest under the Best Interest Contract Exemption, specifically with respect to advisors marketing propriety funds and allowing advisors to market variable annuities and mutual funds equally.

Easing those restrictions would be a better option than putting investors’ fates in the hands of arbitration panels, said Bullard.


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