A long-standing tradition of not allowing forced arbitration clauses in IPO agreements could come to an end, a move that would strip investors of their rights to sue as a group when defrauded.
Consumer groups, however, won’t let the matter end without a fight. On Tuesday 133 of them joined together to call on the SEC to protect the rights of shareholders, launching a website called SecureOurSavings.com. They also sent a letter to the SEC asking for the Commission to reaffirm the past policy, or at least not to make any change without debate with the public’s input.
“If you look at what makes markets work in this country for investors and corporations alike, it’s the transparency we provide and the confidence that the markets are well-regulated,” said Barb Roper, director of investor protection at Consumer Federation of America. “Private class action lawsuits play a crucial role by supplementing the SEC’s enforcement and being a deterrent to fraud that the SEC alone cannot match.”
If a company went through an IPO with a forced arbitration clause that banned class actions – and then defrauded investors – the investors would be unable to band together to mount a case against the company in court. Instead, they would each have to bring their own case via arbitration, which would put the company, with its resources, at a distinct advantage.
Though never addressed head-on by any specific rule, both Republican and Democratic SEC commissioners have traditionally interpreted the rules as not allowing companies to have forced arbitration clauses in IPOs or to put them into shareholder agreements after the fact.
Adherence to these norms is in doubt. Last year, SEC Commissioner Michael Piwowar encouraged companies to attempt to IPO with forced arbitration clauses.
“We’ve already seen some market actors in the past try to [put these clauses into shareholder agreements] and the SEC stood in their way and stopped them,” said F. Paul Bland, executive director at Public Justice. “What Piwowar is urging companies to do is exactly what the SEC told them in the past saying what they couldn’t do.”
Shareholder groups became more aggrieved when SEC Chair Jay Clayton equivocated on his personal support for preserving shareholders’ rights to sue.
These groups have one win under their belt so far. Clayton committed to Rep. Carolyn Maloney (D-NY) that the Commission would have a “measured and deliberate” process to discuss whether these clauses should be allowed in IPOs, rather than simply delegate the matter without discussion, as Yahoo Finance reported last week.
But shareholder groups are still looking for a commitment from the SEC to keep with established norms and discourage IPOs with arbitration clauses, or at least have an open debate with public input. Opponents of the SEC prohibiting these clauses usually take the view that an investor can always choose not to buy a share that has a provision for forced arbitration, and the SEC should not regulate that, instead deferring to state law.
A world without shareholder lawsuits
Many expect that if one company made its IPO with clauses preventing shareholder class actions, the floodgates would open. Modern tech companies are notorious for using special voting structures to conserve voting power — think Snap (SNAP) — and rumors have floated around that many companies would love to use forced arbitration in shareholder agreements.
“I think the chances are very significant that some companies take a run at this,” said Bland. “A lot of executives, given the choice, are going to be very interested in saying ‘you can’t sue us’ — and they’re being encouraged to [by Piwowar].”
Removing the possibility of shareholder lawsuits would undermine the integrity of US capital markets, Roper said. The ability for investors to sue acts as a deterrent for companies to commit fraud, and when lawsuits themselves are brought the discovery period acts as another layer of disclosure.