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July 6 - If there was any momentum for securities class action critics who are pushing to allow corporations to force investors into arbitration, it was halted on Friday.
U.S. District Judge Michael Shipp of Trenton, New Jersey, dismissed a test case against Johnson & Johnson in which Harvard Law School professor emeritus Hal Scott sought to clarify the legality of mandatory shareholder arbitration under state and federal law. Scott, a longtime shareholder class action critic, brought the test case after unsuccessfully pushing J&J to include a mandatory arbitration proposal in its 2019 proxy materials.
Shipp ruled in an unpublished opinion that the case was not ripe because Scott did not resubmit the mandatory arbitration proposal after J&J blocked it in 2019. Scott and his counsel, Jonathan Mitchell of Mitchell Law and Walter Zimolong of Zimolong Law, had argued that Scott needed a declaratory judgment that such a proposal was legal because J&J shareholders would otherwise rely on the company’s previous arguments against requiring investors to arbitrate federal securities claims.
The New Jersey judge said Scott’s assertion was “speculative and conclusory.” His suit, Shipp ruled, effectively asked for an advisory opinion on whether federal and New Jersey law permits mandatory shareholder arbitration – and because federal courts don’t issue advisory opinions, the case had to be dismissed.
The judge did grant Scott and his lawyers until July 14 to file an amended complaint. Scott and Mitchell did not respond to my email query.
The backstory on the litigation is quite complex. For years, as you probably recall, securities class action detractors like Scott have argued that individual shareholder arbitration is an efficient alternative to expensive, inefficient shareholder suits. Few companies have publicly joined this activist push for shareholder arbitration, although the private equity firm The Carlyle Group floated the idea ahead of its 2012 IPO. The Securities and Exchange Commission, a longtime opponent of mandatory shareholder arbitration, squelched Carlyle’s plan. The SEC also backed Pfizer Inc and Gannett Co Inc when they wanted to block arbitration proposals from going before shareholders.
But shareholder arbitration proponents were encouraged in the early years of the Trump administration by pro-arbitration comments from an SEC commissioner in 2017 and by the U.S. Supreme Court’s ruling in Epic Systems Corp v. Lewis, which held that the Federal Arbitration Act can displace the right to sue under other federal laws.
So in late 2018, Scott, as trustee for the Doris Behr 2012 Irrevocable Trust, asked Johnson & Johnson to allow shareholders to vote on a proposal that the company change its bylaws to require investors to arbitrate their federal securities claims. Johnson & Johnson opposed Scott’s proposal, which the company considered a violation of the anti-waiver provisions in federal securities laws. J&J’s lawyers at Skadden, Arps, Slate, Meagher & Flom asked the SEC in December 2018 if the company was permitted to exclude the mandatory arbitration proposal from the proxy materials it sent to shareholders in advance of the 2019 annual meeting.
As I’ve been saying since 2018, the posture of the case is a bit mind-bending: The company has been, in essence, defending its investors’ right to bring shareholder class actions against an attempt by an investor – the Behr trust – to persuade fellow shareholders to give up that right.
While J&J’s request was before the SEC, New Jersey’s then attorney general, Gurbir Grewal, told the commission that Scott’s proposal would be illegal under New Jersey law, citing a 2018 Delaware Chancery Court ruling that invalidated corporate charter provisions mandating a forum for federal Securities Act claims. (J&J is based in New Jersey.) The SEC, in turn, relied on Grewal’s “legally authoritative” statement in its February 2019 determination that J&J could exclude the Scott proposal.
Scott then sued J&J in New Jersey federal court. He originally demanded an injunction to force J&J to include his proposal in 2019 proxy materials. When the injunction was denied, he sought a declaration on the legality of his shareholder arbitration proposal.
The Delaware Supreme Court, meanwhile, was reviewing the Chancery Court decision underlying the SEC’s 2019 determination. In 2020, Delaware’s justices ruled in Salzburg v. Sciabacucchi that companies can specify a forum for shareholders' Securities Act claims.
Scott filed an amended complaint against J&J in New Jersey federal court. In an unexpected twist, J&J said that if he resubmitted his proposal for a shareholder vote on mandatory arbitration, the company would include the proposal in its proxy materials.
Scott nevertheless did not submit a mandatory arbitration proposal ahead of J&J’s 2020 or 2021 meetings, contending that the proposal would have been doomed without a court ruling on its legality, given J&J’s previous opposition. J&J said that was no excuse, arguing that Scott’s case did not meet constitutional requirements for a suit in federal court because there was no live controversy. (J&J counsel from Skadden did not respond to my query.)
Shipp’s decision to dismiss the suit means that the fierce debate over the legality of mandatory shareholder arbitration remains unresolved. As far as I’m aware, there’s no other case that even raises the issue.
Some of the heat around mandatory shareholder arbitration seems to have dissipated even before the dismissal of Scott’s J&J case. The SEC’s most outspoken supporter of shareholder arbitration, Michael Piwowar, is no longer a commissioner, and the Biden administration seems unlikely to back restrictions on investors’ right to sue. In fact, the New Jersey AG whose letter was instrumental in the J&J case will soon take over as the SEC’s enforcement director.
Scott blamed legal uncertainty, but there’s also an argument to be made that the rise of mass arbitration compromises whatever efficiencies companies might have realized from restricting investors’ right to sue. Corporations like J&J hate securities class actions, but they also know how to defend (or settle!) investors claims when those claims are lumped together in a single suit. Millions of individual arbitrations might not be a bargain at all.
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