One of the trendy concepts in certain circles in recent years has been the idea of litigation management bylaws – that is, the adoption by company of bylaw provisions that help manage the company’s litigation risks. For example, one bylaw provision that has been widely adopted by publicly traded companies is a forum selection provision specifying a particular jurisdiction as the preferred forum for litigating shareholder disputes.
Another one of the proposed litigation management bylaws that has proven more controversial is the idea of a mandatory arbitration clause, requiring shareholder claimants to submit claims – including even claims under the federal securities laws – to arbitration. This idea, which has been percolating for years, received a significant boost in a statement from SEC Commissioner Michael Piwowar. In a recent letter to a member of Congress, SEC Chair Jay Clayton weighed in with his views on the topic, suggesting that the idea is not a particular priority for him. But aspects of his communication and of the current state of debate on the issue suggest that the idea is probably not going to just go away.
As I noted at the time, SEC Commissioner Michael Piwowar caused quite a stir last summer when he suggested that the SEC would favorably view submissions by IPO companies that included bylaw provisions requiring mandatory arbitration of securities claims. The idea of mandatory arbitration for shareholder claims has continued to circulate in the intervening months.
For example, an October 2017 U.S Treasury Department Capital Market Report (here) recommended that the SEC investigate ways to reduce the cost of securities litigation, including allowing companies and shareholders to settle disputes through arbitration. Indeed, there has been considerable speculation that the new SEC leadership might be “laying the groundwork for a possible policy shift” to allow mandatory arbitration provisions.
More recently, SEC Chair Jay Clayton said during questioning about the possibility of mandatory shareholder claim arbitration provisions at a February 6, 2018 Senate Banking Committee hearing that “I am not anxious to see a change in this area,” adding that if the topic came before the SEC “it would take a long time for it to be decided because it would the subject of a great deal of debate.”
Other voices have actively expressed skepticism about the mandatory arbitration clause idea. In a February 24, 2018 speech, Rick Fleming, Investor Advocate at the SEC, called mandatory arbitration of shareholder claims “an illusory remedy.” He said that while there “may be some validity” to the concerns that have been cited in support of mandatory arbitration provisions, “stripping away the right of a shareholder to bring a class action lawsuit seems to me to be draconian, and, with respect to promoting capital formation, counterproductive.”
More recently, in a February 26, 2018 speech, then-newly appointed Democratic Commissioner Robert J. Jackson, Jr. said in a speech said he is “concerned” about the idea of mandatory arbitration provisions. Jackson noted that due to budget constraints and an expanding agenda, there are limits to what the SEC itself can do. At a time of increasing budget constraints, Jackson said, this is “hardly the time to be thinking about depriving shareholders of their day in court.” If investors are barred from bringing suits in court, “then the burden of investigating and litigating these cases may fall entirely on the SEC.” How much, Jackson asked, “would Congress need to appropriate to make sure we have enough resources to do the job?”
Clayton’s April 24, 2018 Letter
In an April 24, 2018 letter to Democratic Congresswoman Carolyn B. Maloney (here), SEC Chair Jay Clayton weighed in with a more detailed expression of his views on the idea of mandatory arbitration of shareholder claims. His overall point of the detailed letter is that “I have not formed a definitive view on whether or not mandatory arbitration for shareholder disputes is appreciate in the context of an IPO for a U.S. company.” He also said that in light of other issues on which he and the agency are focused, the issue is “not a priority for me,” noting that any decision on the issue by the agency would “divert a disproportionate share of the Commission’s resources” from matters Clayton considers to be of higher priority.
In addition to these general statements, Clayton also provided important additional commentary in which he added his perspective on how he and the agency would consider the issues that the idea of a mandatory arbitration clause presents.
The idea of mandatory arbitration of shareholder claims, Clayton said, is “complex” and involves important issues under federal securities laws and state corporate laws, as well as “many public policy considerations.”
In light of these various important considerations, any review of a mandatory arbitration clause in the context of a U.S. IPO Company’s registration statement “should be conducted in a measured and deliberative manner.” If a U.S. company were to submit an IPO application that included a mandatory arbitration clause in its governing documents, “the decision about whether to declare the filing effective should be made by the Commission, not the Division [of Corporate Finance] by delegated authority.”
Clayton’s letter reviews the history of agency actions and practices within which any such request would be considered. For example, his letter alludes, without naming the company, to the 2012 effort by Carlyle Group, to submit an IPO registration statement including its corporate bylaws that contained a mandatory arbitration provision (discussed in detail here). Carlyle Group ultimately withdrew the arbitration provision under pressure from the Division of Corporate Finance, which indicated it would not accelerate the effective date for a registration statement of an applicant with a mandatory arbitration clause in its bylaws.
Clayton also noted that the federal securities laws “provide a basis for private rights of action by investors” and that there is “a long history of claims of this type” in federal and state courts. However, Clayton also noted notwithstanding this extensive history that “direct and indirect limitations of these kinds of actions have been prevalent for many years.”
For example, a variety of companies conducting exempt Regulation A offerings have included mandatory arbitration clauses in their governing documents. In addition, many foreign issuers with securities listed or traded in the U.S. have included mandatory arbitration provisions or analogous provisions in their filings. Clayton noted with respect to these foreign issuers that the agency’s staff has “focused on the disclosure of the material risks related to those limitations.” Clayton also noted that the U.S. Supreme Court has “affirmed a strong federal interest in promoting the arbitration of claims under federal laws.”
Clayton’s detailed letter highlights his view that the issues other than the introduction of mandatory arbitration clauses more urgently require the agency’s attention and resources. Nevertheless, while emphasizing that the issue is not a priority for him, his letter does not close the door on the idea. To the contrary, he noted in his letter that the “views of the market participants on this issue … are deeply held, and in many, cases, divergent.” And while it is not a priority for Clayton himself, he acknowledges that it remains the subject of “heightened interest” and he says that he has “encouraged those with strong views to support their position with robust, legal and data driven analysis.”
Clayton’s suggestion that even though the idea of mandatory arbitration clauses is not a priority for him that he is not going to close down discussion of the idea came as something of a disappointment to Congresswoman Maloney, to whom Clayton addressed his letter. In an April 26, 2018 statement, Maloney said “While I’m pleased that Chairman Clayton took my letter so seriously, and wrote a detailed response, I’m still very disappointed that he has not committed to opposing the use of forced arbitration clauses in company bylaws should this come up for a Commission vote. Allowing companies to use forced arbitration clauses would devastate investor confidence in our markets, and would prevent shareholders from holding the next Enron or WorldCom accountable in court.”
The likelihood is that even though Clayton believes the SEC has bigger fish to fry, this issue is unlikely to just go away. As Alison Frankel noted in an April 27, 2018 post on her On the Case blog, Clayton wrote his letter is “written within a vortex of controversy.” Clayton’s express reference to the existence, despite the long history of shareholder litigation in this country, of “prevalent” restrictions on investors’ rights to sue, for example, in the context of exempt offerings and foreign issues, may hearten those who favor the expansion of the use of mandatory arbitration provisions, as should express reference to the U.S. Supreme Court’s recent statements in favor of arbitration generally.
Frankel notes that Clayton’s letter suggests that if this issue is going to come up at the agency, it is going to come up in the context of a specific company’s registration statement submission, and not through a formal rulemaking process – and therefore not involving all of the formal processes that formal rulemaking requires. Clayton does suggest that any submission would be reviewed at the Commission level rather than at the delegated-authority division level.
However, as Frankel also notes, given the apparent split on this issue at the Commission level, Clayton himself “would almost certainly be the SEC’s deciding vote on a mandatory shareholder arbitration proposal.” Under these circumstances, a prospective IPO company candidate might well choose to include within its pre-effective registration statement submission incorporating a corporate charter with a mandatory arbitration provision, if for no other reason than to try to force a decision on the issue. Indeed a company could try this at any time.
For that reason, it seems unlikely to me that this issue is just going to go away, even though it is not a priority for Clayton. To the contrary, it seems likelier to me that this issue is going to bubble up and require Commission action, sooner rather than later.
Quarterly Claims Update Webinar/Cryptocurrency Focus: On May 1, 2018, at 11:00 am EDT, I will be participating as a panelist in the Advisen Quarterly Claims Update webinar. This quarter’s session will have as its particular focus the emerging issues surrounding cryptocurrencies and Initial Coin Offerings (ICOs). The session will be moderated by Advisen’s Jim Blinn. The panel will also include Garrett Koehn of CRC Insurance Group and Paul Tomasi of E-Risk Services. Information about this free one-hour webinar, including registration instructions, can be found here. The quarterly claims update webinars are always interesting, this one is likely to be particularly so.