July 20, 2017

Companies looking to force shareholders to resolve grievances through tightly controlled private arbitration, rather than class actions in open court, have a strange new champion: the U.S. Securities and Exchange Commission.

Yes, the same federal agency charged with protecting investors’ rights is now inviting companies to ask for permission to introduce binding-arbitration clauses into their bylaws before going public, according to one of the regulator’s three current commissioners. Allowing companies to introduce such binding-arbitration clauses into their bylaws would be a stark change by the SEC, which for decades has taken the position that such provisions are contrary to the federal securities laws.

“For shareholder lawsuits … companies can come to us to ask for relief to put in mandatory arbitration into their charter,” Commissioner Michael Piwowar said this week at a forum organized by the Heritage Foundation, a conservative think tank. “I would encourage companies to come and talk to us about that.”

If the SEC acts as Commissioner Piwowar suggested, investors in those issuers would be unable to pool their individual claims together to pursue class actions, leaving lawsuits viable for only the very largest shareholders.  The next step would be for companies already publicly listed to add similar provisions to their bylaws.

Commissioner Piwowar’s comments are the latest indication that the SEC under the Trump administration plans to collaborate more with the businesses it regulates, purportedly to encourage companies to raise capital on public markets – often to the detriment of its mission of investor protection.  He is one of two Republicans on the SEC, the other being Trump-appointed Chairman Jay Clayton.  The Republicans will retain their majority on the Commission when two vacancies are filled.

Investor advocates believe arbitration is far friendlier to defendants than complainants.  Arbitrators, who are chosen by the companies, need not abide by federal securities laws or evidentiary rules.  Proceedings are private and decisions essentially final.  There is little oversight or review.

Businesses in certain industries, including telecommunications and financial services, have made such clauses standard in customer agreements and contracts in recent years, prompting an outcry from advocacy groups who say they leave consumers essentially defenseless.

Arbitration has also become a flashpoint in an effort by the Republican-led Congress to curtail the authority of the Consumer Financial Protection Board, a regulatory agency created by the Obama administration with broad independence from both Congress and the President.

Just this month, the CFPB issued a rule prohibiting mandatory arbitration clauses in most financial contracts.  U.S. Sen. Tom Cotton of Arkansas, a Republican leader on the Senate Banking Committee, has pledged to use the Congressional Review Act to kill the rule before summer recess.

Whether binding arbitration provisions in public company charters are even allowed under current law is a subject of debate.  In a 2016 Georgetown Law Review article, for example, Tulane University Law School Associate Professor Ann M. Lipton argued that shareholders cannot be forced into arbitration because their rights are established under corporate and not contract law.

Companies have tried and failed to restrict their shareholders to arbitration before.  In 2012, the Carlyle Companies sought permission to introduce a binding arbitration provision as part of its IPO process, but withdrew the request after widespread criticism by institutional investors and the SEC staff’s refusal to accelerate the company’s listing with the clause in place.

Investors can take little comfort that the current Commission will take a similar stance if the issue resurfaces.  We will keep you apprised of efforts to prevent and, if necessary, fight this potential attack on investors’ rights.