In response to a letter sent by Democrats on the House Financial Services Committee, Securities and Exchange Commission Chairman Jay Clayton has committed to holding a public vote by the full Commission on any decision regarding the inclusion of forced arbitration clauses in corporate governance documents.
“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,” Rep. Carolyn Maloney (D-N.Y.), a co-author of the initial correspondence, said in reaction to Clayton’s April 24 response.
“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,” she said.
In March, Maloney and Rep. Maxine Waters (D-Calif.) wrote to Clayton in an effort to remind him that, “Congress has repeatedly passed laws recognizing that private securities fraud class actions are an indispensable tool with which defrauded investors can recover losses without having to rely upon government action.”
As a matter of public policy, they wrote, “there is a strong public interest in ensuring that shareholders have access to the courts to resolve their claims,” which includes “the ability to participate in securities class-action lawsuits.”
Investors, concerned by recent rhetoric on the topic, are worried that public company shareholders may need to forego class action lawsuits and seek recovery individually through arbitration.
Clayton, asked about forced arbitration clauses in the past, has been diplomatic in his response and continues to take the same approach. No such debate by commissioners is afoot, nor likely to be in the near future, he has repeatedly said.
“I have not formed a definitive view on whether or not mandatory arbitration for shareholder disputes is appropriate in the context of an IPO for a U.S. company,”Clayton wrote.
He did, however, use the opportunity afforded him by the letter from Maloney and Waters to give what may be his most detailed overview to date on the topic.
“This matter is complex,” Clayton wrote. “It involves our securities laws, matters of other federal and state law, an array of market participants and activities, as well as matters of U.S. jurisdiction. It also involves many public policy considerations. This issue has come before the Commission in a variety of ways and contexts and may do so in the future.”
“Views of market participants on this issue, particularly in the case of an initial public offering of a U.S. company, are deeply held and, in many cases, divergent,” he added. In response to the recent heightened interest from Congress and others relating to the inclusion of mandatory arbitration provisions in their charters or bylaws, he has asked the Division of Corporation Finance to review how this issue has arisen in the past, and may arise in the future.
Clayton pointed out that the Division's view, thus far, is that if a U.S. company pursued a registered IPO with a mandatory arbitration clause in its governing documents, the decision about whether to declare the filing effective should be made by the Commission, not by its delegated authority.
He agreed with that assessment, adding that the Commission would “give the issue full consideration in a measured and deliberative manner.”
For now, however, Clayton wants the Commission to allocate its “limited rulemaking and other related resources to a portfolio of matters” that deal with currently pressing and significant issues for investors and markets, are central to the SEC’s mission, and/or are addressable through a reasonable share of Commission and staff time.
Those matters currently include:
standards of conduct for investment professionals, Congressionally-mandated rulemaking; the regulation of investment products, including ETFs;
the impact of distributed ledger technology (including cryptocurrencies and initial coin offerings);
and the elimination of burdensome regulations that do not enhance investor protection or market integrity with an eye toward facilitating capital formation.
“Any decision would be facts and circumstances dependent and could inevitably divert disproportionate share of the Commission's resources from the priorities I noted,” Clayton wrote. “In short, this issue is not a priority for me.”
When the issue last arose in the context of an IPO of a U.S. company in 2012, CorpFin took the position that it would not use its delegated authority to accelerate the effective date of a U.S. company's registration statement that included a mandatory arbitration provision.
In that context, Clayton wrote, “the Division was unable to conclude that such provisions are consistent with ‘the public interest and protection of investors’ as required by Securities Act.”
The company, unnamed in the letter, ultimately decided not to include the mandatory arbitration provisions in its governing documents.
“For many years, U.S. and non-U.S. companies have made other types of filings with the Commission that have included mandatory arbitration provisions for shareholder disputes in their governing or offering documents,” Clayton wrote. “In these circumstances, the relevant statutes and rules generally require appropriate disclosure regarding material risks to the issuer or of the offering, which would include risks relating to mandatory arbitration provisions and any impact on holders of the offered securities.”
Companies utilizing the SEC’s Regulation A exemption from registration, for example, have included mandatory arbitration clauses in their governing documents or subscription agreements.
Under Regulation A, a company may not sell its securities until the Division has qualified its offering statement.
In 2015, the Commission’s staff concluded that “there would not be grounds to withhold qualification of a Regulation A offering on the basis that the issuer had included a mandatory arbitration provision,” Clayton wrote. “Since then, certain offerings that have included a mandatory arbitration clause have been qualified under Regulation A, provided that the material risks of such a dispute resolution approach had been disclosed and the issuer otherwise qualified for the exemption.”
For many years, a number of foreign companies with securities listed or traded in the United States have also included mandatory arbitration and other analogous provisions in their filings.
These disclosures have typically included a risk factor informing investors that due to jurisdictional issues it may be difficult for them to obtain or enforce judgments or bring original actions, including actions styled as class actions, against the company.
“Mandatory arbitration clauses involve complexities beyond the Commission and its rules,” Clayton wrote. “For example, they raise issues under the state corporate laws under which the issuers are organized. In addition, federal case law regarding mandatory arbitration continues to evolve. Since 2012, when this issue was last presented to the Division in the context of an IPO, the Supreme Court has affirmed the strong federal interest in promoting the arbitration of claims under federal laws.”
Despite Clayton’s assurances, the debate over mandatory arbitration clauses is likely to continue and intensify in the coming weeks.
Commissioner Michael Piwowar, delivering a speech earlier this year at the conservative Heritage Foundation, used the opportunity to strongly urge pre-IPO companies to try including mandatory shareholder arbitration provisions in corporate charters to see how the SEC reacts.
There is also a lesson learned from the Consumer Financial Protection Bureau’s failed effort to kill arbitration demands.
The Dodd-Frank Act required the CFPB to study the use of mandatory arbitration clauses in consumer financial markets. Last summer, it finalized a rule banning companies from using mandatory arbitration clauses.
Many consumer financial products like credit cards and bank accounts have arbitration clauses in their contracts that prevent consumers from filing class action lawsuits and require the use of arbitration.
The CFPB’s rule restored consumers’ right to file or join group lawsuits. It included specific language that companies will need to use if they include an arbitration clause in a new contract.
The rule faced immediate repeal under the Congressional Review Act. In October, the Senate formally killed the ban in a vote largely along party lines. The vote had been a 50-50 tie, but Vice President Mike Pence cast the deciding vote to kill the ban.