Friday, November 16, 2018
Mandatory shareholder arbitration being considered by SEC ... again?
Apparently the whole issue of mandatory arbitration of shareholder disputes has begun to percolate again. The issue is whether the SEC should permit registration statements to go effective with mandatory shareholder arbitration provisions in their corporate charters. This had been percolating for some time as a high priority item for some interest groups, waiting for a Republican administration to push it through. So, here we are, a two years into the Trump Administration and the scuttlebutt is that there is talk of moving forward with this.
Commissioner Pierce seems fine with the idea. Commissioner Piwowar is already on the record as good to go with this. Commissioner Clayton (here) and then Commissioner Jackson, on the other hand seem reticent to move away from the status quo (so, no). We'll see where it goes from here, but clearly if this is going to move, now is the time.
Before things move too quickly, though, just a gentle reminder that under §115 of the Delaware Corporation Law, mandatory arbitration provisions that prevent shareholders from bringing their cases in the Delaware Chancery Court are not permitted to be included in the corporate charter. Section 115 reads as follows:
The certificate of incorporation or the bylaws may require, consistent with applicable jurisdictional requirements, that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts in this State, and no provision of the certificate of incorporation or the bylaws may prohibit bringing such claims in the courts of this State. “Internal corporate claims” means claims, including claims in the right of the corporation, (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery. (Emphasis added)
Even if the SEC permits a corporation to go public with such a provision, such a provision would violate state corporate law.
Given that more than 60% of publicly traded companies are incorporated in Delaware, if the SEC were to move forward with permitting mandatory shareholder arbitration, most listed corporations would not be in a position to include such provisions. So, why bother? Indeed, there are lots of good reasons why the SEC shouldn't take a permissive approach towards shareholder arbitration.
First, I'm no fan of the litigation flotsam that jammed up the courts these past few years. Frankly, the disclosure settlement litigation was mostly just rent seeking in the economic sense. We're all better off without it. However, the creation of law by courts operating in the open is a public good. If shareholder claims were to be moved into arbitration we would lose the value of incremental developments of the law and the value associated with investors as well as managers actually knowing what the law is. All of that becomes a closely held mystery once we move a substantial block of shareholder claim resolution into private arbitration.
Second, in confidential arbitration bad actors and bad actions go unnoticed. Or, to the extent self-interested managers are successfully sued, there is little prospect for accountability. For example, if a board engages in a self-dealing transaction is sued, then discovery, the trial and then the opinion are all held in confidence - not disclosed via any court filing system and not filed with the SEC, except in the most cursory fashion. That can't be good for "price discovery." Who wants that kind of system? Bad actors.
So, count me down as a "no" if the SEC is still actively considering this bad idea.