Mandatory pre-dispute arbitration clauses in advisory contracts are all the rage… and I mean that both literally and figuratively. It has become both a popular dispute resolution mechanism between advisors and their clients, and at the same time has enraged critics the likes of which include a cadre of House and Senate members led by Senator Stuart Smalley of Minnesota. I’m paraphrasing, but Senator Smalley thinks mandatory arbitration clauses in advisory contracts are “stinkin’ thinkin’”.
Criticisms notwithstanding, the SEC has yet to act on its Dodd-Frank-given powers to restrict mandatory pre-dispute arbitration clauses pursuant to Section 205(f) of the Advisers Act, and it does not appear to be a current priority to do so. Thus – at least for the time being – such clauses appear here to stay.
But it’s worth pointing out that arbitration is not the only game in town. When crafting investment advisory contracts, it’s important to carefully consider other dispute resolution mechanisms that may be a more attractive alternative for both firms and their clients. The point of this article is not to say that arbitration is good or bad, but simply to emphasize the point that other options exist.
Option 1: Smoke the Peace Pipe
Before taking to arms and preparing for an expensive battle in a formal proceeding like arbitration, an advisory contract can either encourage or attempt to require the parties to first try to resolve the dispute among themselves. The primary goal here is for the advisor and client to settle the matter as soon as possible after a dispute arises, and for both parties to either amicably part ways or even let bygones be bygones and continue the advisory relationship.
Avoided cost is the mutual motivator; attorneys are expensive and arbitration is far from free. Avoided cost can also be thought of in terms of the value placed on both parties’ time. Formal proceedings can be incredibly long, laborious and involved, and the longer the process the more the parties can become emotionally invested (and drained).
Because we don’t live in Utopia and disputes don’t often end with a beer and a handshake, and because such contractual clauses are hard to define and enforce, internal resolution should only be thought of as the first step in a longer, pre-scripted dispute resolution sequence.
Option 2: Mediate
The next potential step in a pre-scripted dispute resolution sequence (after singing Kumbaya) is mediation. There is one important thing to remember about mediation: it is not binding in and of itself. Unlike a judgment rendered in a court of law or by arbitrators, a mediator can only encourage the parties to reach a binding, mutually agreeable settlement. A mediator does not render a decision, assess damages or pick a winner and a loser. But at the same time, it can be helpful to have a third-party act as the “go between” whose only motivation is to help the parties find a solution to the dispute.