Two of the recent reports of blue ribbon groups looking at the competitiveness of U.S. capital markets recommended among other things that the SEC should consider permitting public companies to amend their charters to provide for arbitration of securities claims. According to an April 16, 2007 Wall Street Journal article entitled, “SEC Explores Opening Door to Arbitration” (here, subscription required), the SEC, as part of a “broader package” of shareholder rights proposals, is now exploring whether or not to allow corporate charter provisions requiring the arbitration of complaints by aggrieved shareholders.
The Interim Report of the Committee on Capital Markets (here, at pages 109 to 112) recommended “that the SEC should permit public companies to contract with their investors to provide for alternative procedures in securities litigations, including providing for arbitration (with or without class action procedures) or non-jury trials.” The Interim Report went on to state that “the Commission should not force shareholders to accept the costs that go with class action securities litigation, particularly the substantial and unpredictable risk of large jury verdicts that effectively force settlement of what may well be non-meritorious claims.”
The Bloomberg/Schumer Report (here, at pages 100-104) recommended that the SEC reverse “its historical opposition to the arbitration of disputes between investors and publicly traded companies.” The Report asserts that “shareholders should have the opportunity before the fact to determine whether submitting the future securities grievances to arbitration is in their own and the company’s best interest.” The Report also states that arbitration “would benefit all parties involved,” by reducing cost and speeding resolution, while permitting SEC enforcement action in appropriate cases.
While the SEC is exploring the possibility of allowing companies to amend their charters to require arbitration of shareholder claims, the Journal reports that SEC Chairman Christopher Cox does not believe that arbitration is a “panacea.”
There are several obvious shortcomings for the use of arbitration for shareholder fraud claims. First, there is limited opportunity in an arbitration proceeding for discovery, in a type of dispute that increasingly depends on extensive review of electronic communications and other electronic documents and data. Second, there is limited opportunity for appeal, which could substantially affect the rights of plaintiffs and defendants whose legal rights are determined by the arbitration panel. Third, arbitration hearings typically are conducted in private, rather than in a public forum, which would undercut the deterrent effect of private securities claims. Fourth, even if the company were able to require shareholders to pursue claims against the company and company officials through arbitration, shareholders would still be free to pursue related claims against other defendants (underwriters, accountants, lawyers, for example) in court. An overview of arbitration can be found here.
The Journal article anticipates that the arbitration proposal “is likely to spark fierce opposition from both investor-rights groups and trial lawyers.” Another group that might be motivated to object is the states’ attorneys general, who have recently discovered the profit and political appeal of class action opt-out cases (refer here) and who recently filed an amicus brief in the Tellabs case in the U.S. Supreme Court arguing against pleading restrictions that would limit their rights to bring shareholder claims (refer here). The Journal article notes that as a result of likely opposition, there is “a good chance” that the idea of permitting companies to require arbitration of shareholder claims “could fall flat.”
But even if the SEC were to go ahead, the possibility of a charter amendment requiring arbitration would be optional – that is, companies, would have to affirmatively choose to include the arbitration requirement in their charters. For existing public companies, that would presumably require a shareholder vote approving the charter amendment. To consider what shareholders might be asked to approve, it is worth thinking about what a proposed charter amendment might look like.
A prescient April 10, 2007 article entitled “Compelling Arbitration of Stockholder Class Actions Based on Federal Securities Law” (here), by Joseph Bartlett and Cathy Reese of the Fish & Richardson firm, takes a look at what enabling charter language might look like (including a sample charter amendment). The proposed language has some interesting features, including, for example, a requirement that the SEC be notified of the arbitration and have the opportunity to participate. The sample language brings home some of the limitations as well – for example, should a shareholder be compelled to Wilmington, Delaware to arbitrate? Looking at the proposed charter amendment makes me wonder how many companies’ shareholders would approve these kinds of charter amendments?
D & O Conference: This week, I will be participating in the American Conference Institute event entitled “D & O Liability Insurance” in New York City (refer here). On Wednesday April 18, 2007, I will be speaking on a panel entitled “State of the Market: New Coverages and Developing Exposures,” and on Thursday, April 19, 2007, I will be on a panel entitled “Boards of Directors: What are They Worried About and What are They Looking For?” If you attend the Conference, I hope you will greet me and introduce yourself.