Thursday, January 19, 2012
Carlyle Group, L.P., the private equity firm, is preparing to go public and has filed with the SEC a registration statement that discloses that its partnership agreement will require arbitration of all investors' disputes, including federal securities claims. In addition, the agreement provides that investors may only bring claims in their individual capacities and not as a class action. The agreement also contains a confidentiality agreement, so that parties cannot disclose any of the arbitration materials, including any awards. Here is the registration statement as filed with the SEC. The Registration Statement contains other anti-investor provisions that Steven Davidoff has ably analyzed in his New York Times Dealbook blog, Carlyle Readies an Unfriendly I.P.O. for Shareholders.
I have written two law review articles exploring the possibility that publicly traded issuers may seek to compel arbitration and prohibit class arbitration:
Arbitration of Investors' Claims Against Issuers: An Idea Whose Time Has Come?, Law and Contemporary Problems (forthcoming) and available on SSRN, and
Eliminating Securities Fraud Class Actions Under the Radar, 2009 Columbia Bus. Law Rev. 802 and available on SSRN.
As I describe in those articles, arbitration of investors' claims against public issuers is an "idea whose time has come" for over twenty years. Although proposals to require arbitration have been floated periodically, publicly traded domestic issuers and their counsel have not seriously pursued them, probably because of legal obstacles to their implementation, including the fact that the SEC has never publicly repudiated its staff position that an arbitration provision in a publicly traded issuer's governance documents would violate the anti-waiver provisions of the federal securities laws. In addition, until the recent U.S. Supreme Court opinion in AT&T Mobility LLC v. Concepcion, issuers and their counsel may not have perceived significant advantages to arbitration to warrant challenging the SEC on this issue and risking criticism in the court of public opinion. However, Concepcion is a game-changer; in that case the Court upheld a provision in a consumer contract that disallowed class arbitration. Accordingly, I predicted that issuers may be able to achieve an advantage to the adoption of an arbitration provision that they were not able to achieve previously -- the elimination of the securities class claim! My prediction has now come to pass.
Will the SEC try to stop Carlyle? When Christopher Cox was SEC Chairman, there were rumors that the agency was giving consideration to allowing issuers to require arbitration. Moreover, there are already foreign private issuers whose securities are traded in the U.S. markets that require arbitration, the best known of which is Royal Dutch Shell. In light of these developments, some Commissioners may be ready to back away from the agency's previous opposition to arbitration clauses in public issuer's governance documents.
To my knowledge only two of the current Commissioners have stated publicly an opinion on the use of mandatory arbitration in investors' agreements with their broker-dealers. Commissioners Elisse Walter and Luis Aguilar have previously expressed reservations about the use of mandatory arbitration clauses in customers' brokerage agreements, so I would expect that they would not look favorably on Carlyle's arbitration agreement, which is a considerable extension of the concept of an "agreement" for purposes of the Federal Arbitration Agreement. It is likely that it would come down to SEC Chair Mary Schapiro, who previously was the CEO of FINRA, which sponsors the primary arbitration forum for the securities industry. To date she has been circumspect about expressing a view on mandatory arbitration. Even assuming that she supports mandatory arbitration of customer-broker disputes, the Carlyle "agreement" mandating arbitration does not bear much resemblance to the arbitration agreements entered into between customers and their brokers. The latter involve an actual, one-on-one contractual rrelationship (albeit standard-form) between the customer and the broker. Including a arbitration provision in a governance document that is included in a Registration Statement and that purports to bind all subsequent investors may be a "bridge too far" for Ms. Schapiro.
Certainly the Carlyle Group is pushing the envelope here with its "take it or leave it" attitude. I hope the SEC shows some backbone and doesn't let this go by without a fight.