Suits against fiduciaries and Mediation/Alternative Dispute Resolution

Understanding the rules of arbitration and mediation can help prepare you to resolve disputes early

Financial advisors can often pride themselves on their flexibility and creativity in finding solutions for their clients – whether by creating a better dashboard for client’s employees to view their plan choices or by using new technology to provide one-on-one customer service like webinars by Skype and customer service chats by text. But even the most dedicated financial advisor with the flexibility of a yoga teacher can run into a dispute or misunderstanding with a client.


Often disputes concerning financial services will be governed by the contract between the parties. Most financial advisory services contracts contain a provision for arbitration. Arbitration under those provisions of contracts is usually handled by FINRA.  The American Arbitration Association (“AAA”), the group certifies arbitrators and creates a set of rules that arbitrations operate under, revised its rules in Fall of 2013. The AAA’s rules for commercial disputes changed on several levels, but most interestingly added provisions about mediation. Not long after, FINRA announced it would be changing its rules as well to improve transparency in the process as well as impartiality and efficiency. Both AAA and FINRA address commercial disputes concerning investments. So both now have made mediation as an option for investors.


It’s worth noting here that the Fiduciary Rule that is in place or could be in place, often discusses arbitration provisions on class claims. To translate from legalese: the Fiduciary Rule addresses a when a group of investors with similar claims (e.g., all were advised to buy stock in Widget Co. No. 6 by a firm with a financial interest in Widget Co. No. 6) wants to bring an action in unison (a class action). Most of what FINRA and AAA work on involves suits by a single investor against a financial investment company. That means, most likely, the Fiduciary Rule, however and whenever it passes, won’t effect mediation on single investor disputes.


Mediation is a more informal step to resolving disputes, and has become much more common over the last decade as the cost and length of arbitration has started to pace that of litigation.  Once upon a time, arbitration was a shorter, and therefore possibly less expensive route to resolving disputes. It took place in a neutral environment where results could be somewhat anticipated or predicted (as opposed to an unpredictable result from a jury).  Over the last decade arbitration has become as bogged down in paper and experts as litigation.


Mediation, on the other hand, most often occurs earlier in the process of a case. This may be where parties have yet to seek reams of paper in requests for information or schedule depositions of key employees. This means suits may be resolved quicker with less financial expense.


FINRA’s arbitration process is split into two camps: the Customer Code, which governs arbitrations between investors and industry parties and Industry Code which governs arbitrations between or among industry parties only. FINRA added a mediation code to its customer code in 2008 and continued to amend that section through 2015. FINRA’s mediation rules, like those of the AAA, are voluntary, unlike arbitration (which is usually mandatory). By being voluntary, parties can begin negotiating their disputes, and at least resolve a portion of them on their own.  FINRA’s rules also allow for parties to continue settlement discussions and negotiations separate from the mediation process. Nor will mediation stay arbitration proceedings at FINRA.


According to the New York Times, in 2013[1] about 18 % of customer cases were decided in arbitration and of those cases about 77 % resulted in some sort of relief to the customer, either in money damages or in requiring remedial action by the investment advisor.  The leading cause of those cases? Breach of fiduciary duty. Most of those cases involve allegations that a financial advisor directed an investor towards a stock purchase that didn’t fit their needs, such as a non-income producing stock for a recent retiree in need of cash. For example, August of 2017, an investor scored a major win in an arbitration at FINRA with a $433,000 award. As reported in the Investment News,[2] the investor alleged unsuitability, failure to supervise, negligence and other assertions in her claim.  However, the advisors she arbitrated against were expelled from FINRA and have since closed shop. That investor, like almost 1/3 of those who arbitrate through FINRA, may never see her damages as advisors continue to dodge paying arbitration awards. This may mean that FINRA will push harder on its arbitration rules, or it may mean more incentives towards mediation (which takes place at an earlier stage of the dispute).


For FAs working with defined benefit claims, a fiduciary claim might involve the five major areas defined by ERISA: the Exclusive Benefit Rule; the Prudent Man Rule; the Prudent Diversification Rule; the need to adhere to Plan Documents; and the rule against Prohibited Transactions. 


ERISA-related disputes have an extra layer to them. Those claims must follow the Plan’s administration rules about disputes first. After that remedy is pursued (or “exhausted” in legal terms), then the claim may be limited to remedies laid out in ERISA.  Further, mediation may be even more suitable to claims specific to ERISA, as discovery under ERISA is limited (no witnesses and limited evidence) and the range and scope of remedies in an ERISA-related case are usually limited to requiring a plan administrator to provide benefits due or take some other action.


Some larger companies keep a mediation manual on hand. That manual explains the mediation process to key employees and can help streamline a response to a suit to direct it towards voluntary mediation. Having a mediation manual on hand before a dispute can help resolve suits earlier, with less stress (or lost time) to key employees.



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