On The Case

CalPERS, Colorado pension fund want a say in mandatory shareholder arbitration case

(Reuters) - The pension funds for public employees in California and Colorado have moved to intervene in New Jersey federal court litigation that marks the first court test of the legality of mandatory shareholder arbitration. The intervention motion, filed by Deepak Gupta of Gupta Wessler, Salvatore Graziano of Bernstein Litowitz Berger & Grossmann and Marc Gross of Pomerantz, sends a strong signal that the New Jersey case could have major implications for shareholder class actions. If you haven’t been paying attention to Doris Behr 2012 Irrevocable Trust v. Johnson & Johnson, it’s time to start.

The case, as I’ve reported, has a weird posture. The plaintiff is a trust led by retired Harvard Law professor Hal Scott – a longtime skeptic of securities class actions and a proponent of corporate bylaws compelling shareholders to arbitrate claims. The trust owns a small stake of about 1,050 shares of Johnson & Johnson. Last year, it submitted a proposal calling for a shareholder vote on an amendment to J&J’s bylaws that would mandate arbitration of federal securities claims.

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That’s right: A shareholder proposed an amendment that would eliminate shareholders’ right to sue. Johnson & Johnson opposed the trust’s proposal, arguing at the Securities and Exchange Commission that mandatory shareholder arbitration is illegal under federal securities laws. J&J's lawyers at Skadden Arps Slate Meagher & Flom eventually secured a letter from the SEC blessing the company’s decision not to include the proposal in proxy materials for its annual meeting in April 2019. The SEC relied largely on an opinion from the attorney general of J&J’s home state of New Jersey, who said mandatory shareholder arbitration is illegal under state law.

The trust sued J&J in March, seeking a declaration that its mandatory arbitration proposal is legal under both New Jersey and federal law. The trust also sought a preliminary injunction to force J&J to include its proposal in proxy materials. U.S. District Judge Michael Shipp of Trenton squelched the motion in an April 8 decision, holding that the trust couldn’t show irreparable harm if its proposal were delayed until a future J&J annual meeting. The underlying litigation over the legality of the trust’s mandatory arbitration proposal is continuing, with J&J’s dismissal motion due to be filed this week.

The pension funds argued in their motion to intervene that the court also needs to hear from major shareholders that believe the Behr trust’s mandatory arbitration proposals are illegal. It simply doesn’t make sense, they said, to rely only on Johnson & Johnson to defend the proposition that shareholders have a right to sue the companies they’ve invested in, especially because J&J is right now facing a shareholder class action in Trenton that alleges it deceived investors. J&J, which denies the allegations, has moved to dismiss that case.

There may come a time, said the California Public Employees’ Retirement System and the Colorado Public Employees’ Retirement Association, that J&J decides that it’s against the company’s interest to continue arguing that shareholders have a right to sue. To guard against that possibility, the funds said, the court should allow intervention by large J&J shareholders – the funds own more than 10 million shares – who will protect the interests of J&J investors in litigation over the legality of mandatory arbitration.

“It’s a strange situation,” said fund counsel Deepak Gupta in an interview. “Right now Johnson & Johnson is taking the right position under the law. But we believe shareholders deserve a say in litigation over shareholders’ rights.”

One of the key issues in the case, Gupta said, is the fundamental nature of the relationship between shareholders and corporations. The funds believe corporate bylaws are not a contractual agreement subject to preemption under the Federal Arbitration Act. The Behr trust argues conversely that the FAA preempts any New Jersey law prohibiting mandatory shareholder arbitration. Gupta said it’s important for Judge Shipp – and, eventually, appellate courts – to hear from CalPERS and the Colorado PERA on this crucial question.

He also said the usual arguments against third-party intervention don’t apply in this case. The litigation is at a threshold stage, the funds have not requested a delay in the proceedings and discovery issues won’t arise because the legality of mandatory shareholder arbitration is purely a matter of law.

“In short, there is no downside to intervention,” the funds’ motion said. “On the other hand, intervention will fully preserve shareholders’ ability to direct litigation that concerns their interests, including in any future appeals.”

Seems right to me. This is too potentially significant a case to decide without allowing institutional investors a say.

I emailed Scott and trust counsel Walter Zimolong of the Zimolong firm but didn’t hear back. Nor did J&J counsel Andrew Muscato and Susan Saltzstein of Skadden respond to my email. According to the pension funds’ intervention motion, the company has said it will not take a position on intervention but reserves the right to challenge arguments by the funds. The trust said it did not have a position on intervention but reserved the right to file a response.