Loyola University Chicago School of Law, JD 2023
For several years, broker-dealers and investment advisory firms have typically required harmed investors to dispute matters through arbitration rather than the court system. However, the House of Representatives’ Financial Services Committee has approved a bill aimed at prohibiting mandatory arbitration commonly imposed by broker-dealers and investment advisory firms. H.R. 2620, known as The Investor Choice Act, restricts investment advisors and broker-dealers from including pre-dispute binding arbitration clauses in their client agreements. The Investor Choice Act addresses “long-standing and deeply unfair practices of forcing customers to resolve their claims through arbitration instead of as part of a class action,” according to Maxine Waters, Chairwoman of the Financial Services Committee.
What is the Investor Choice Act?
The Investor Choice Act, which was introduced by Illinois Representative Bill Foster, was passed by the committee by a vote of 27-23. In essence, H.R. 2620 would amend the Securities Exchange Act of 1934. The legislation specifies that it shall be unlawful for any broker, dealer, funding portal or municipal securities dealer to enter, modify or extend an agreement with clients of that entity with respect to a future dispute between the parties that: 1) mandates arbitration for that dispute; 2) restricts, limits, or conditions the ability of a client of that entity to select or designate a forum for resolution of that dispute; or 3) restricts, limits or conditions the ability of a client of that entity to pursue a claim relating to that dispute in an individual or representative capacity or on a class action or consolidated basis. However, revising the Securities Exchange Act of 1934 only restricts broker-dealers from mandating arbitration. Therefore, H.R. 2620 also amends the Investment Advisors Act of 1940 by making it unlawful for any investment advisor to enter, modify or extend an agreement with clients of the investment advisor with respect to a future dispute between the parties. Furthermore, the legislation indicates that a security or investment may not be registered with the Securities and Exchange Commission (SEC) if the issuer mandates arbitration for any dispute between the issuer and the shareholders of the issuer.
Why is the Investor Choice Act necessary?
Due to the prevalence of mandatory arbitration in the financial services industry, the committee also released a parallel background memo illustrating the frequent and severe problems surrounding pre-dispute mandatory arbitration. The committee cited four issues including: 1) cases being decided by nonlawyers; 2) decisions that are not bound by legal precedent and do not adhere to federal or state rules of evidence; 3) documents and evidence submitted that do not become publicly available; and 4) that nearly thirty percent of arbitration awards against broker-dealers in 2020 remain unpaid. The committee further contends that mandatory arbitration clauses often result in less-favorable outcomes for investors because awards provided by arbitration panels are typically lower compared to litigation. Additionally, several organizations including the North American Securities Administrators Association (NASAA) and the Public Investors Advocate Bar Association (PIABA) have voiced their support in favor of the bill. When discussing the legislation’s potential impact on retail investors, NASAA President Melanie Lubin explained that “the legislation would return to them the right to evaluate their dispute resolution options and then select their preferred type of action and forum for bringing allegations against a company or individual.” Additionally, the PIABA issued a statement supporting H.R. 2620 and pointed out that the legislation would retroactively apply to current agreements that require arbitration, incorporate forum selection clauses, or limit class actions.
What is the future for H.R. 2620?
While the legislation has cleared a major hurdle in securing committee approval, H.R. 2620 must still fight an uphill battle prior to becoming a law. As the committee voted on the legislation, the bill received support only from Democrats on the committee. Therefore, it is likely that the legislation will be passed by the House of Representatives because Democrats own the majority. However, the Senate is split 50-50 between Republicans and Democrats, which will make it difficult for the legislation to receive approval from both sides of Capitol Hill. In a recent House committee debate regarding the legislation, Representative Bill Foster contended that investors should possess other alternatives besides mandatory arbitration, which is coordinated by the Financial Industry Regulatory Authority (FINRA). Foster alluded to concerns such as FINRA arbitration panels showing bias toward broker-dealers, an ineffective appeal process and firms failing to pay arbitration awards. The Dodd-Frank financial reform law provided the SEC authorization to prohibit mandatory arbitration clauses enforced by broker-dealers and investment advisory firms; however, the SEC has not used its authority to ban mandatory arbitration since the law’s adoption in 2010.