Senate and House Strike Deal on Fiduciary Duty Issue

On June 24, 2010, lawmakers from the House and Senate working to merge two versions of the financial-regulation overhaul into a single bill agreed to let the SEC impose a fiduciary duty on brokers once the regulator completes a six-month review. House lawmakers had earlier proposed implementing stiffer rules without a study period, prompting opposition from senators led by Tim Johnson, a South Dakota Democrat.

Johnson proposed language that could have, among other things, maintained the study requirement. However, Johnson's proposal made it even more difficult for the SEC to act on its findings by allowing the SEC to set new rules regarding the fiduciary duty standard only if the agency concluded after its study that regulatory gaps between certain brokers and investment advisors could not be addressed through other approaches.

A fiduciary duty would obligate brokers to act in the best interest of their clients and to disclose all conflicts of interest. Brokers now only have to ensure a product is suitable before marketing it to a customer. As discussed in an earlier blog post, the expansion of the fiduciary duty has met resistance from the broker-dealer and insurance industries whose sales practices would be subject to the new fiduciary duty standard. Whereas consumer advocates have said the fiduciary obligation is needed because investors can be misled into buying products they don’t understand and are often confused by the titles used by financial advisers.

However, the debate is not over just yet, even if federal lawmakers pass the legislation. Once the job of conducting the study and making the rules goes to the SEC, the debate over the details of just how the new rules will apply will likely continue.

A copy of the Businessweek article discussing this development can be found here, and an article from Financial Advisor Magazine can be found here.

The Uncertain Future of Mandatory Arbitration Provisions

On May 20, 2010, the U.S. Senate passed its version of the financial reform bill. The U.S. House of Representatives passed its financial reform legislation earlier this year. The two bills have varying degrees of regulation and differences on how to regulate. One such difference involves mandatory arbitration provisions included in brokerage firm and investment advisory contracts. Currently, most brokerage or investment advisory firms require customers sign a contract in order to open an account. The contract usually requires all claims arising out of or related to the contract to be submitted to arbitration. These mandatory arbitration provisions often specify the arbitral venue and the arbitration rules that will apply.

According to Senate Bill 3217, the Securities and Exchange Commission (“SEC”) would be given the authority to determine the permissibility of mandatory arbitration provisions to govern the arbitrability of securities claims. The Senate specifically gives the SEC the option to reaffirm, prohibit, or impose certain conditions on the use of mandatory arbitration provision in broker-dealer and investment advisor agreements.

On the other hand, the House legislation does not give the SEC the authority to reaffirm current practices regarding mandatory arbitration. Rather, HR 4173 only permits the SEC to restrict or prohibit the use of mandatory arbitration provisions in such contracts. Therefore, without the ability to reaffirm the status quo, it would seem that mandatory arbitration provisions included in brokerage and advisory contracts would no longer restrict a defrauded investor from choosing to seek redress in a judicial forum. Further, the House legislation requires the U.S. Government Accountability Office (“GAO”) to report to Congress on the costs to parties in an arbitration proceeding versus the costs to parties in litigation and the percentage of recovery in both forums. The inclusion of the GAO report is to address concerns that arbitration may not be less costly to the parties or more expedient than litigation and that arbitration may actually undermine investor interests.

The U.S. Department of Treasury in its report last June takes the most stringent approach to mandatory arbitration provisions in brokerage agreements. In its financial reform proposal, the Treasury recommends that legislation should be enacted to prohibit mandatory arbitration provisions in these contracts and that the SEC should be given “clear authority” to enforce arbitration provision violations. Like the House, the Treasury proposal also suggests that a study should be conducted to determine whether investor rights are undermined because of an inability to seek redress in court.

Historically, violations of federal securities laws were considered a non-arbitrable issue. In 1953, the U.S. Supreme Court articulated this view in Wilko v. Swan when it held that an agreement to arbitrate a claim under Section 12(a)(2) of the Securities Act of 1933 was unenforceable. 346 U.S. 427 (1953). Over 35 years later, the Supreme Court overruled its position in Wilko in Rodriguez v. Shearson/American Express, Inc. 490 U.S. 477 (1989). The Court in Rodriguez held that a predispute agreement to arbitrate claims under the Securities Act of 1933 is enforceable and resolution of the claims only in a judicial forum is not required because arbitration does not inherently undermine a person’s substantive rights under federal securities laws. Id. at 485-86. It is important to note that since the decision in Wilko, arbitration had become more common and the Federal Arbitration Act had been significantly amended strengthening judicial and legislative favor toward the use of arbitration to settle disputes, which further justified the Supreme Court’s overruling. Id. However, the Supreme Court has also held that a predispute arbitration agreement that effectively deprives a claimant of statutory remedies violates public policy and is unenforceable, thus limiting the scope of Rodriguez. Mitsubishi Motors Corp. v. Soler Chrysler Plymouth, Inc., 473 U.S. 614, 637, n. 19 (1985).