Personal Finance

When signing up with financial adviser, beware mandatory arbitration clause

Michael Searcy
Michael Searcy

Many years ago, I was an expert witness in an arbitration hearing regarding a financial matter. That experience changed me and changed the way I do business.

I realized that, while there is a rightful place for mandatory arbitration clauses, that place is not in your financial planning or investment management contract. It’s simply not fair to the consumer.

Forced mandatory arbitration is on the rise. According to the National Association of Consumer Advocates, “forced arbitration is being written into more and more terms of agreements and contracts, including…retirement accounts, investment accounts…”

Brokerage firms seem to be a common place where these clauses are found, but many independent financial advisers have added them to their engagement contracts as well.

While the clause may seem unimportant to a customer when they’re opening their account, chances are they’ll have a different attitude when they’ve been wronged and realize they’ve waived their rights to be heard in the courts.

What is arbitration?

Arbitration is an alternative dispute resolution. Instead of taking a case to court, arbitration offers an alternative to reach a solution. The American Bar Association explains that arbitration is private and the arbitrator has the authority to make a decision about the dispute.

Going one step further, there is mandatory arbitration. In the case of mandatory arbitration, parties are required to give up the opportunity for judicial attention and are forced to appear before an arbitrator. The judgment, opinion or award of the arbitrator(s) is final.

Why my mind was changed

When I hired lawyers to provide advice for my firm, they suggested adding a mandatory arbitration clause to our contracts so we could avoid the court system if anything went wrong. The lawyers were clearly hired to protect my firm and I didn’t question the advice because they were doing their best to protect my firm. And many firms in the industry included these clauses, so it seemed standard and routine.

Fast forward several years to when I participated as an expert witness in an arbitration hearing.

The complaint was between a couple and their former adviser in which the adviser has made egregious errors and the couple wanted recourse for their situation. The arbitration panel was made up of a person who had a vague knowledge of the specific scenario being presented and two others who had no clue, experience or technical expertise. This panel of three would be making a binding decision.

Because I had prepared for the case with tax law, case law and insurance law to back up my statements, I believe the witness for the opposing side fabricated statements. The panel did not seem equipped to differentiate between the law and the misleading testimony so, the couple lost and their best interests were not served.

I realized the arbitration system can be so adversely stacked against the clients that they have very little chance for recovery in any situation.

It bothered me enough that I immediately went back to my office and informed all clients that they were henceforth released from any obligation of mandatory arbitration with my firm, that they could have full recourse to take any issue to the legal system they felt necessary. I also removed the clause from our contracts going forward.

I would never want to find myself in an unfair situation and I want the same for my clients.

How mandatory arbitration limits consumers

Some of the commonly noted drawbacks to mandatory arbitration include:

The clauses are put in place to protect a company, not the consumer.

Because mandatory arbitration is generally hidden in a contract and not easily understood, consumers enter into contracts at a disadvantage.

Arbitrators may be uneducated about the issue.

Arbitrators may be biased and are often chosen by the company.

As more companies include mandatory arbitration in their contracts, consumers lose the ability to “shop around” and instead are faced with a “take it or leave it” agreement.

Consumers lose their ability to sue for negligence, defective products or scams.

Take a look at any agreement you enter into with a financial adviser and see if they require the use of mandatory arbitration to resolve disputes or difference. If so, use my story as caution.

We are seeing a very gradual change in the financial services industry, where advisors who are truly trying to do what’s right for their clients and who embrace the fiduciary model are removing these clauses from their contracts.

Our greatest hope is that there should never be a situation where you would have to exercise legal action with your advisor, but if you do, you should never be limited in your quest for retribution.

Michael J. Searcy is a Certified Financial Planning professional and member of the Financial Planning Association of Greater Kansas City. He is president and CEO of Searcy Financial Services Inc., a fee-only registered investment advisory and financial planning firm located in Overland Park and manages their Naples, Florida location.

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