(Reuters) - In a letter this week to Democrats on the U.S. House Financial Services Committee, Securities and Exchange Commission chair Jay Clayton said mandatory arbitration of shareholder disputes is “not a priority for me” and that he has not yet decided whether it would be “appropriate” for U.S. companies contemplating initial public offerings to include such provisions in their corporate charters. Clayton promised that before the SEC allows a company to cut off shareholders’ right to sue, the commissioners themselves would “give the issue full consideration in a measured and deliberative manner.”
Clayton gave a similar response under questioning in February by Senator Elizabeth Warren, a Massachusetts Democrat, but the new letter offers a more detailed explanation of the chair’s thinking. It also reveals that Clayton asked the SEC’s Division of Corporate Finance to review how the commission has previously dealt with mandatory arbitration proposals and how it might respond to future proposals. Clayton said he requested the review “in response to the recent heightened interest from Congress and others relating to the inclusion of mandatory arbitration provisions in the charters or bylaws of U.S. companies contemplating an IPO.”
Interest in mandatory shareholder arbitration hasn’t just come from Congress. Last summer, as you may recall, SEC Commissioner Michael Piwowar said in a speech to the Heritage Foundation that the commission was open to the idea as a lever to encourage companies to go public. That was big news.
For decades, as I’ve reported, the SEC has squelched corporate attempts to block shareholders, via mandatory arbitration provisions, from filing suits. Most recently, in 2012, the commission refused to accelerate an IPO registration statement for the private equity fund Carlyle when Carlyle floated the idea of requiring shareholders to arbitrate disputes.
That same year, when some renegade Pfizer investors attempted to introduce a shareholder proposal to amend the corporate bylaws to require arbitration, the SEC informed Pfizer that the proposed amendment would put the company on the wrong side of federal securities laws.
The mandatory shareholder arbitration issue has already created a public split among SEC commissioners. In February, after Bloomberg reported that the SEC was actively mulling a change in its long-held opposition to mandatory arbitration, SEC Commissioner Robert Jackson said in a speech to the CECP CEO Investor Forum that he is skeptical arbitration can protect shareholder rights. Whatever the SEC does, “we should do it only through a careful, public rulemaking process,” Jackson said. “In short: if we’re going to take away investors’ right to their day in court, I hope my colleagues on the Commission can agree that we should, at least, do so in the light of day.”
The Bloomberg report, which quoted securities lawyers who said SEC staffers had been nudging companies to step forward with mandatory arbitration proposals, fired up resistance from the Council of Institutional Investors and Democrats on the House Financial Services Committee.
CII General Counsel Jeffrey Mahoney sent a letter calling upon SEC Corporate Finance Director Walter Hinman to maintain the commission position that mandatory shareholder arbitration would violate the anti-waiver provisions of federal securities laws.
New York Democrat Rep. Carolyn Maloney said in a March 18 letter to Clayton that if the SEC planned to revisit the issue, “any examination … should be done in a transparent manner - one in which the public is fully informed and able to participate.” Anything less, Maloney said, “will be seen as a stealth attempt by the Commission to circumvent U.S. securities laws and the fundamental rights of shareholders.”
Clayton’s response this week to the House letter, in other words, was written within a vortex of controversy. In that context, it’s worth highlighting what the chair’s letter promised about the process the SEC will follow if an upcoming IPO registration includes a mandatory arbitration provision. The chair acknowledged the public policy stakes in the commission’s consideration and promised the SEC would take those into account. He also said he agreed it’s up to the commissioners themselves, and not just the Corporate Finance division, to decide whether to approve any IPO registration statement that requires shareholder arbitration.
Ominously, for opponents of mandatory arbitration, Clayton pointed out that despite the long history of shareholder litigation in the U.S., there are already “prevalent” restrictions on shareholders’ rights to sue foreign private issuers, unlisted U.S. companies and some companies conducting exempt share offerings. He also cited the U.S. Supreme Court’s increasingly pro-arbitration precedent. “Commentators have observed that there is uncertainty as to whether the Commission would have a basis to deny an acceleration request in these circumstances,” Clayton’s letter said.
Clayton notably did not pledge the SEC would engage in a formal rulemaking process under the Administrative Procedure Act before changing its longstanding policy of discouraging mandatory shareholder arbitration. Nor did he specifically promise the commissioners would solicit investors’ opinions about the issue if it comes before the SEC. He just said the SEC would be deliberative: “The commission would need to evaluate the specific facts and circumstances in the context of not just the federal securities laws but also state corporate and other federal law,” the letter said. “This is a complex legal and policy issue that requires careful consideration.”
And despite the low priority Clayton has accorded to mandatory shareholder arbitration, he does not wield complete control over the SEC’s consideration, as Clayton himself acknowledged last month in his appearance before the Council of Institutional Investors. Former SEC chief accountant Lynn Turner of Hemming Morse asked the chair if the SEC would follow formal rulemaking procedures when it weighed a change in policy for mandatory shareholder arbitration provisions. Clayton declined to commit to a particular process but promised the commission would consider “input from, I would say, all interested constituents.”
He went on: “Look, this is a big deal. So I’ll do it right. If I do it. I don’t want to do it. I got other things I want to do. That’s not my choice. If somebody wants us to decide it there’s not much I can do about that. (But) if it comes before us, I will do it in a fair way.”
Clayton, an appointee of President Trump, would almost certainly be the SEC’s deciding vote on a mandatory shareholder arbitration proposal. Commissioner Piwowar has already said he supports mandatory arbitration, in theory, and Commissioner Jackson has said he doesn’t. Presumably, the other two commissioners would divide along party lines, leaving Clayton as the final arbiter. I’m sure Clayton’s former partners at Sullivan & Cromwell wouldn’t be thrilled at the prospect of a new SEC policy that would ultimately cost them millions of dollars a year in lost fees for defending securities class actions. But they’re only one (and a small one, at that) of the many constituents the SEC chair has to think about if he’s forced to take a stand on mandatory shareholder arbitration.
Congresswoman Maloney said in a statement that she was gratified Clayton provided a detailed response to her letter, but “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.”
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