Employee Benefits News examines legal developments that impact the employee benefits and executive compensation employers provide, including federal and state legislation, rules from federal...
By Sean Forbes
Robo-advisers like Betterment LLC, Financial Engines Inc. and Wealthfront Inc. stand to win a lot of business even if the Department of Labor fiduciary rule they avidly support is revised or scrapped.
But as the number of retirement savers using robo-advisers increases, it’s also creating the potential for those savers to lose a mechanism they might lean on to enforce their rights: class actions. That’s because many robo-advisers require their customers to arbitrate disputes and give up their right to class actions—one of the very things the fiduciary rule is attempting to curtail.
A major component of the rule is that it allows advisers to work on commissions but requires them to sign contracts with their customers and those contracts can’t make arbitration mandatory. This provision could be one that the Trump administration targets, particularly in light of recent moves in Congress to stymie class actions.
The rule was scheduled to be implemented April 10, but the DOL has proposed a delay as it complies with an order from President Donald Trump that it review the regulation.
Robo-advisers provide investment advice through online, algorithm-based platforms with varying degrees of human involvement. The industry is on track to have $2.2 trillion in assets under management by 2020, up from $200 billion in 2016, London-based management consulting firm A.T. Kearney said in a recent report.
Bloomberg BNA looked at the client agreements or terms and conditions for 11 robo-advisers and determined that the majority include arbitration clauses, either under the rules of the Financial Industry Regulatory Authority, the American Arbitration Association or the Judicial Arbitration and Mediation Services Inc. (JAMS).
Seth Rosenbloom, associate general counsel at New York-based Betterment, told Bloomberg BNA in an email that such stipulations aren’t unique to his firm. “Plan sponsors sign arbitration agreements and this is standard (with potential advantages for both parties), as are the agreements themselves.”
Bloomberg BNA was unable to track down a Financial Engines client agreement, but the company disclosed in its most recent regulatory annual report filing that it uses pre-dispute clauses. It said, however, that changes in the legal landscape could “invalidate pre-dispute arbitration clauses in our agreements, leading to increased costs to litigate any claims against us.”
Arbitration clauses are the norm for the industry, Mike Jurs, director of public relations for Financial Engines, told Bloomberg BNA in an email. “We don’t see any disconnect between this standard practice and any technical requirements that other service providers with different business models may have to comply with to manage their conflicts,” he said.
And then there are the exceptions: Two of the agreements Bloomberg BNA reviewed don’t mention arbitration. Rebalance IRA’s one-page sample agreement includes a strict limits-on-liability clause and also states that clients don’t waive their rights to claims under federal or state securities laws. New York-based LearnVest Inc. states that disputes will be handled in New York under state law.
Whether arbitration should be mandatory is a “very complex” question, Ron Rhoades, director of Western Kentucky University’s financial planning program, told Bloomberg BNA. “Many feel that claimants deserve their day in court, while others say a firm’s reputation is its number one asset,” he said. Firms don’t want to see their reputations destroyed in court by frivolous claims, he said.
In addition, it doesn’t appear that in practice, robo-adviser arbitration requirements have been causing investors trouble. There is scant evidence that robo-advisers have been involved in arbitration claims or enforcement actions. Bloomberg BNA found no mention of the robo-advisers that specify FINRA as the preferred arbitration forum on FINRA’s arbitration awards database. Advisory firms must disclose on their Form ADV whether they have been subject to any disciplinary actions. All of the Form ADVs that Bloomberg BNA reviewed showed that the companies had no material disciplinary events.
On the other side of the ledger, arbitration can be prohibitively expensive for investors, Andrew Stoltmann, president-elect and executive vice president of the Public Investors Arbitration Bar Association, in Chicago, told Bloomberg BNA.
“I’ve long taken the position that a fiduciary who includes binding arbitration in his new account agreement is stepping very close to the line in terms of breaching fiduciary duty,” Stoltmann said. JAMS arbitration, for example, can cost at least $25,000 before even getting an arbitration result, which “effectively closes the door for anybody who wants to file a claim,” he said.
As expensive as JAMS is, the AAA could be even worse. “AAA is crazy expensive,” Nicholas J. Guiliano, a securities arbitration attorney and founder of the Guiliano Law Firm PC in Philadelphia, told Bloomberg BNA. An investor “could easily spend $50,000 for an arbitration case, which will scare off claims, because nobody has the money to bring” one, he said.
Could the fiduciary rule change the landscape? Maybe, maybe not. “Assuming the rule stays in place—and that’s a massive assumption of course—I think that would arguably trump any separate agreement” that a registered investment adviser “might have with its customers,” Stoltmann said.
Arbitration agreements also prevent arbitrators from learning from one another to the detriment of investors, Julie G. Reiser, a partner at Cohen Milstein Sellers & Toll PLLC, in Washington, told Bloomberg BNA.
“The arbitration process is between private parties and typically arbitration outcomes remain confidential,” Reiser said in an email. “This means that consumers who have the same dispute against a corporation can receive different outcomes in arbitration as there are no published opinions that create precedent for the next dispute. It also means that companies can continue acting as if deceptive practices or defective products are isolated and avoid public pressure to change. Transparency is a hallmark of the court system that results in more corporate accountability.”
Although arbitration is perfectly legal, “there’s just no good reason to force one avenue of dispute resolution before a dispute ever arises,” Reiser said.
To contact the reporter on this story: Sean Forbes in Washington at firstname.lastname@example.org
To contact the editor responsible for this story: Jo-el J. Meyer at email@example.com
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