Disputes are a persistent reality of trust law and even the most meticulously-drafted and expertly-administered trust can be embroiled in litigation, often involving trust investments. In an effort to avoid litigation, many investment advisors and banks include in their routine account agreements, provisions requiring arbitration in the event of any dispute. When a trustee opens an account that contains a mandatory arbitration provision, are the beneficiaries also bound?
Professor Mary Radford delves deep into the practice, cases, and theory of predispute arbitration provisions. Her discerning and experienced eye expertly distills the essence of a trustee’s fiduciary responsibilities with the practical realities of investing in the 21st century. This article appealed to me because it offers a thoughtful, sophisticated, and wide-ranging look at an increasingly common provision. At a time that arbitration clauses are under review, the article connects trust law to the wider world; it is a good example of the law as “seamless web.”
Part I presents the background of predispute arbitration agreements, with a focus on those used in the securities industry. Professor Radford marshals this material in a clear and concise fashion to provide the necessary starting point for the analytical framework going forward. Noting the longstanding federal policy favoring arbitration for the resolution of disputes, it is the SEC and the Financial Industry Regulatory Authority (FINRA) that developed the rules that actually govern these account agreements. The still-controversial rules became widespread after the Supreme Court effectively upheld the enforceability of the provisions in the late 1980s. This securities industry perspective, however, must be reconciled with a trustee’s fiduciary duties. Radford concludes that a trustee does have the authority to enter into these agreements, but that does not necessarily answer the question as to the beneficiary’s rights.
Part II reviews the cases that consider whether a nonsignatory trust beneficiary can be bound by the trustee’s agreement to arbitrate. The cases are few in number and weigh in favor of upholding the arbitration provision. Because the cases tend to be in state court proceedings and some are unpublished opinions, Radford wisely uses the cases, not as precedent, but as illustrations of the range and depth of the legal theories courts use in upholding the arbitration provision.
Part III is the legal center of the article. It discerns and examines the main theories courts have used in determining whether to enforce the arbitration provision against nonsignatory beneficiaries. Estoppel theory, a common approach, simply provides that a person cannot assert a claim that is based on an agreement and then disavow another portion of that agreement. Third party beneficiary is the second theory that courts have used and its focus is on the intent of the parties. Agency theory is also applicable given the contractual nature of the transaction. Often the agreement will include a provision that extends the agreement to the signatory’s successors and assigns. Finally and returning to the basics, courts note that there is a strong federal and state policy favoring arbitration of disputes. Radford provides a useful template for evaluating the impact of predispute arbitration provisions, agreed to by a trustee, on the nonsignatory beneficiaries.
Part IV discusses the current landscape of arbitration agreements. It starts by pointing up the flaws in the cases that allow nonsignatory beneficiaries to avoid arbitration. One court premised its refusal to enforce the provision because the beneficiary had no knowledge of the agreement. Radford points out that this theory would create a “dangerous” precedent. A beneficiary would only need to deny knowledge of the contract in order to avoid the contract. She rightfully points out that it would be far better to allow a beneficiary to proceed against the trustee on grounds of failing to keep the beneficiary reasonably informed than to fail to enforce contracts properly entered into by the trustee. Another court attempted to make the financial services institution a fiduciary to the nonsignatory beneficiaries separate and apart from the account. This is “troublesome” as Radford points out because without the account agreement there is no connection to the nonsignatory beneficiaries. While there may in some circumstances be some duty, it is necessary to first find a relationship between the parties in order to define the duty. Duties do not just exist in the ether.
Taking on the big picture, Radford asks the basic question: what is it that we lose when we force a securities arbitration on a nonsignatory? Radford addresses two major issues to the beneficiary – costs and fairness, and the larger societal issue of the negative impact on the development of trust law. There are no easy answers here. The differential in costs between an arbitration and litigation will depend on a number of factors and cannot be answered definitively. Fairness is equally elusive. Investors are skeptical of the overall fairness in FINRA arbitrations. There is a sense, supported by scholarship, that arbitration favors the “big guys” over the “little guys.” There is also the perception that arbitrators have an industry bias. Interestingly and in response to this criticism, a recent change in FINRA procedures allows customers with claims of $100,000 or more to choose a panel composed entirely of public arbitrators (that is, arbitrators who are not associated with the financial services industry), rather than a mixed panel. A study in 2013 showed that customers who used an all public panel were successful 62% of the time, compared to a 44% rate when a mixed panel was used. This corresponds favorably with a 60% success rate generally for plaintiffs in trials. Finally, there is the policy concern that FINRA arbitrations are not required to give reasons for the decisions. While the result in any particular arbitration may be understandable to the participants, the lack of a reasoned decision means that the “development and the evolution of theories in this area of the law cannot occur” because the “decisions are made under a shroud of secrecy.”
In the conclusion, Radford acknowledges that she has ”grappled with the issues” and “has not been very successful in coming up” with workable solutions. This is not a failure, this is a generous recognition that as long as Congress does not prohibit the predispute arbitration provision, there is little that can be done from the trust law perspective. To prohibit trustees from signing these agreements would likely foreclose trustees from using most financial services institutions; that is simply not practical. Similarly labelling these agreements as a breach of fiduciary duty is equally impractical and runs afoul of the prudent investor standard. Most promising and original is the author’s proposal to amend FINRA rules in cases involving a trust beneficiary. If the panel of arbitrators could include arbitrators who have knowledge of trust law, the “subtleties of the trust-related claims” would not be lost in the arbitration process. This could address the bias perception and perhaps reduce the need to pursue a secondary action against the trustee in court.
Radford’s article is a reminder that in understanding trust law, it is as important to have a sense of the practical realities in which a trust operates, as it is to know the history and theory of the law.