Depending on your point of view, you may have experienced either heart palpitations or increased serotonin levels when you heard, back in July 2017, that SEC Commissioner Michael Piwowar had, in a speech before the Heritage Foundation, advised that the SEC was open to the idea of allowing companies contemplating IPOs to include mandatory shareholder arbitration provisions in corporate charters. As reported, Piwowar “encouraged” companies undertaking IPOs to “come to us to ask for relief to put in mandatory arbitration into their charters.” As discussed in this PubCo post, at the same time, in Senate testimony, SEC Chair Jay Clayton, asked by Senator Sherrod Brown about Piwowar’s comments, responded that, while he recognized the importance of the ability of shareholders to go to court, he would not “prejudge” the issue. According to some commentators at the time, to the extent that these views appeared to indicate a significant shift in SEC policy on mandatory arbitration, they could portend “the beginning of the end of securities fraud class actions.” Then, in January of this year, the rumors about mandatory arbitration resurfaced, which cited “three people familiar with the matter” for the proposition that the SEC is “laying the groundwork” for this “possible policy shift.” But in recent Senate testimony, Clayton reportedly put the kibosh on these signals.
The concept of mandatory arbitration of shareholder claims has been run up the flagpole a few times in the past. The idea took hold in the late 1980s, when SCOTUS concluded that stock brokers could enforce mandatory arbitration agreements with customers. However, in subsequent encounters, the SEC has not been particularly receptive to the idea. When a private equity fund sought to go public in 2012 with a provision in its partnership agreement requiring mandatory individual arbitration of any disputes, including disputes under the federal securities laws, Corp Fin advised that it would not accelerate effectiveness of its registration statement, and the provision was withdrawn. Then, in an interesting turn of events, binding shareholder proposals were submitted at several companies seeking to amend their bylaws to include mandatory shareholder arbitration provisions. (If this seems a bit curious, the argument submitted by the proponent was that the costs of frivolous class action litigation were ultimately borne by the shareholders, and preventing these suits would therefore benefit shareholders.) Some of these companies, attempting to exclude the proposals from their proxy statements, contended that they should be excludable under Rule 14-8(i)(2)— on the basis that implementation would cause the company to violate applicable law—because implementation would violate Section 29(a) of the Exchange Act. Section 29(a) declares void any provision “binding any person to waive compliance with any provision of this title or of any rule or regulation thereunder….” Since the bylaw prohibited claims subject to arbitration from being brought in a representative capacity, that is, in class actions, the company argued, the provision effectively waived shareholders’ abilities to bring claims under Rule 10b-5. The SEC allowed exclusion of the shareholder proposal, agreeing that there was some basis for the view that implementation of the proposed bylaw amendment would cause the company to violate the federal securities laws.
The impetus for the recent reemergence of the concept of mandatory arbitration in the context of IPOs seems to be the continued hand-wringing over the dearth of IPOs. Commissioner Michael Piwowar has previously observed that, “since 2000, the average annual number of IPOs is 135—less than one-third the average annual number of IPOs—457—in the 1990s…. In the 1980s and 1990s, IPOs with proceeds of less than $30 million constituted approximately 60 percent and 30 percent, respectively, of all IPOs. In fact, some of the most iconic and innovative U.S. companies…entered the public market as small IPOs. This trend reversed in the 2000s. IPOs with proceeds less than $30 million accounted for only 10 percent of all IPOs in the period 2000-2015. By comparison, large IPOs have increased from 13 percent in the 1990s to approximately 45 percent of all IPOs since then.”
Not everyone agrees that the fretting over the decline in IPOs is appropriate. According to EY, what happened—largely the result of acquisitions and delistings—happened primarily by 2002; it’s not just a recent phenomenon. And much of the decline may reflect the popping of the dot-com bubble in the first years of the new millennium. Accordingly, some would argue that a number of those companies should not have gone public in the first place and that measuring against the height of the bubble is wrong-headed.
More recently, a Treasury report, A Financial System That Creates Economic Opportunities—Capital Markets, issued in October last year, asserted that concerns about becoming the target of securities class actions may discourage companies from going public. To make matters worse, the report observed, the number of class actions has recently increased from 151 in 2012 to 272 in 2016, with 317 filed in the first nine months of 2017 (although still below the peak of 498 actions in 2001). The level of class actions was particularly striking in light of the decline in the number of public companies. However, most cases settled; according to the report, only “21 cases since the adoption of the Private Securities Litigation Reform Act of 1995 have gone to trial.” The report also observed that some commentators view class actions as useful tools for accountability and deterrence of wrongdoing. At the end of the day, however, the report did not advocate mandatory arbitration; instead, it recommended that both the states and the SEC “investigate the various means to reduce costs of securities litigation for issuers in a way that protects investors’ rights and interests, including allowing companies and shareholders to settle disputes through arbitration.”
But according to an article in Pensions & Investments, in testimony regarding ICOs before the Senate Banking Committee on Tuesday, February 6, Clayton indicated that barring shareholder securities fraud litigation was not in the offing. In questioning, Senator Elizabeth Warren, referring to the news report cited above that the SEC was considering allowing companies to adopt mandatory arbitration provisions, asked whether Clayton would support this “enormous change.” According to the article, “Mr. Clayton said that while he could not dictate whether the issue comes before the Securities and Exchange Commission, he is ‘not anxious to see a change in this area.’” In addition, he observed, “‘If this issue were to come up before the agency, it would take a long time for it to be decided, because it would be the subject of a great deal of debate. In terms of where we can do better, this is not an area that is on my list of where we could do better,’ Mr. Clayton told the committee.”