Saturday, July 22, 2017
Sometimes it almost seems like SEC Commissioners aren’t reading my articles
So Michael Piwowar inspired a bit of heartburn in the plaintiffs’ bar this week when, during a speech to the Heritage Foundation, he encouraged corporations to add mandatory arbitration provisions in their charters prior to an IPO. This is a subject on which I’ve frequently posted, but since it’s in the news again I can’t let it go by without comment.
Mandatory arbitration is an idea that terrifies plaintiffs’ attorneys because arbitration clauses typically come with a class action waiver, and that could sound the death-knell for federal securities litigation. Moreover, because the Supreme Court has interpreted the Federal Arbitration Act to bar most attempts at regulating contracts to arbitrate, see, e.g., AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011), the fear is that once an arbitration clause makes it into the corporate governance documents, it’s pretty much game over. The plaintiffs’ bar has long taken comfort in the fact that (at least until now) the SEC has taken the position that such provisions are impermissible, which is exactly why Piwowar's remarks raised concern. Delaware, of course, recently amended its corporation law to prohibit the use of mandatory arbitration clauses in corporate charters and bylaws, see Del. Code tit. 8, § 115, but there’s some question as to whether the prohibition extends to federal securities claims, and, even if it does, whether Delaware’s law is preempted by the FAA.
But, as I explained in my article Manufactured Consent: The Problem of Arbitration Clauses in Corporate Charters and Bylaws, 104 Geo. L.J. 583 (2016) (and, to a lesser extent, my chapter Limiting Litigation Through Corporate Governance Documents, in Research Handbook on Representative Shareholder Litigation (Sean Griffith et al., eds., forthcoming 2017)) - and as I previously posted here, here, and here - I don’t think existing law permits charters and bylaws to regulate federal securities claims. And even if charters and bylaws do extend that far, I do not believe the FAA applies. To summarize briefly (you can consult older posts or Manufactured Consent for the long version):
First, corporate charters and bylaws only govern internal governance matters, i.e., the matters typically governed by the internal affairs doctrine. This makes sense; corporate law is intended to govern stockholders’ relationship to the corporation in their capacity as stockholders. It does not govern matters outside the role of the stockholder as a member of the corporate polity, such as personal torts. Federal securities law may be closely related to corporate law, but it’s a different animal, and therefore outside the scope of the state-constructed corporate entity.
Second, though it is fashionable to describe charters and bylaws as “contractual,” I do not believe they are, at least not in the manner envisioned by the FAA. Within the corporate form, shareholders are not treated as autonomous counterparties bargaining with directors over terms. Thus, the preconditions for contract envisioned by the FAA jurisprudence are not present.
All of which is to say – I don’t think Piwowar’s suggestion is viable, no matter whether the SEC has changed its views. Of course, there’s always the chance it’ll take a lot of litigation to settle the matter.