Class Arbitration: Are Investment Advisers Representatives Excluded?

Investment Adviser agreements typically contain provisions which require all disputes between the Registered Investment Adviser (“RIA”) and Investment Adviser Representative (“IAR”) to be determined in a final and binding arbitration.  These agreements also preclude class claims from being brought to arbitration.  In effect, RIAs have thereby evaded being the subject of class actions brought by IARs, at least for now. 

At the beginning of the year, the National Labor Relations Board (“NLRB”) decided a case which outlaws contract provisions in which the employer conditions employment upon signing an agreement that precludes employees from filing joint, class, or collective claims in any forum.  However, the claims must address issues such as wages, hours, or other working conditions. 

D.R. Horton v. Michael Cuda involved an employment contract where the employee was required to submit all claims to arbitration.  The agreement also prevented employees from consolidating or bringing class claims.  The NLRB determined that these agreements prohibit the exercise of substantive rights that are protected under Section 7 of the National Labor Relations Act (“NLRA”).  The NLRB’s decision specifically outlines certain limitations to its holding.  In particular, the decision is only applicable to “employees” as defined in the NLRA.  This definition specifically excludes independent contractors.

It should be noted that the US Supreme Court recently ruled in AT&T Mobility LLC v. Conception that the Federal Arbitrations Act (“FAA”) permits companies to require customers to arbitrate their complaints individually, precluding class action claims.  D.R. Horton differs in that it involved employee class actions, which is protected by statute, versus customer or consumer class actions.  However, since D.R. Horton has been appealed to the 5^th Circuit Court of Appeals, it will be interesting to see the outcome, and whether or not the Supreme Court will grant certiorari.  My guess is that it will.   

That being said, the hurdle for IARs is that they are often classified as “independent contractors” rather than employees.  Not only is this usually set forth in their investment advisor agreements, but the type of relationship between the employer and the IAR has some characteristics of an independent contractor.  However, they also have employer-employee characteristics that could be crucial in determining the type of employment relationship. 

There are various factors that determine whether one is considered an employee versus an independent contractor.  These factors include but are not limited to the following: (1) the level of control the employer has over the work performed by the individual; (2) whether the employer or worker furnishes the tools, materials, supplies, or equipment needed to perform the job; (3) whether the worker provides services for more than one firm or company at a time; (4) whether the worker can realize a profit or loss as a result of his services; (5) whether the employer set the work schedule; and (6) whether the employer hires, supervises, or pays assistants of the worker.

Perhaps one of the more determinative factors in defining an employment relationship is the level of control and supervision the employer has over an individual.  By design, RIAs are required to supervise the conduct and activities of any IAR that represents it, whether the IAR is an employee or an individual that provides investment advice on behalf of the RIA.  An RIA’s legal duty to supervise its IARs emanates from a number of sources.  For instance, Section 203(e)(6) of the Investment Advisers Act of 1940 permits the SEC to take action against an RIA for failing to supervise its IARs.  Pursuant to SEC Rule 206(4)-7 under the Advisers Act, RIAs are required to adopt policies and procedures that are reasonably designed to prevent violations of securities laws by the adviser and its supervised persons.   Furthermore, SEC Rule 204A-1 requires RIAs to adopt a code of ethics which sets forth the standard of business conduct to be exhibited by IARs. 

Generally, investment advisory agreements authorize RIAs to monitor and evaluate the IAR and subject the IAR to the supervision of the adviser.  Moreover, the duty to supervise an IAR may also stem from the fiduciary duty the RIA owes to its clients.  This supervisory duty and level of control is often implemented with periodic or annual compliance audits of each IAR.  Despite this level of control, the IAR is often contractually defined as an independent contractor.   

Therefore, as it stands, IARs could face a substantial but perhaps surmountable hurdle in bringing class arbitration claims if the investment advisor agreement defines the representative as an independent contract and precludes class actions.  Since the NLRA definition of employee precludes traditional independent contractors, there may be no statutory protection granted to some IARs.