Having lost the battle to prohibit class action waivers in consumer arbitration agreements, consumer advocates have embarked on a new crusade. Their new crusade is a misguided attempt to persuade the Securities and Exchange Commission (SEC) not to approve initial public offerings by companies whose corporate charters or bylaws require individual arbitration of shareholder disputes. They also argue that the amendment of existing charters or bylaws to add an individual arbitration requirement should not be permitted. This initiative is likely to fail, however, because the securities laws are preempted by the Federal Arbitration Act (FAA) and the underlying policy arguments made by consumer advocates are flawed.
In a letter dated August 21, 2018, to SEC Chairman Jay Clayton, a coalition of 133 public advocacy groups called "Secure Our Savings" (SOS)—spearheaded by Paul Bland, Executive Director of Public Justice, a national nonprofit legal advocacy organization—argued that forcing allegedly defrauded shareholders to arbitrate their claims individually would eliminate the deterrent effect of class action shareholder lawsuits and the opportunity for investors to recover their losses. According to the letter, "the issues in a typical case of financial fraud are too complex, and the costs of discovery and expert testimony are too high, for these claims to be dealt with effectively through individual arbitration." Moreover, the letter states, private securities class actions "serve as an essential supplement to Commission action." At the same time, the Consumer Federation of America, one of the signatories to the SEC letter, issued a report arguing that mandatory shareholder arbitration is against the law and the public interest.
If these arguments sound familiar, it is because they are recycled from the efforts of Public Justice and many of the other SOS participants to persuade the Consumer Financial Protection Bureau (CFPB) to prohibit class action waivers in consumer arbitration agreements. Although the CFPB issued a final rule in July 2017 containing such a prohibition, Congress repealed the rule under the Congressional Review Act in October 2017—before the rule's effective date.
SOS contends that arbitration clauses in corporate governance documents should not be permitted because Congress, had it wanted to allow arbitration of shareholder claims, could have done so in one or more of the securities statutes passed after the FAA's enactment in 1925. But SOS's argument misstates the U.S. Supreme Court's test for determining whether federal statutory claims can be arbitrated. Under that test, arbitration of shareholder claims must be allowed unless the securities laws clearly demonstrate that Congress intended to preclude arbitration.
In its decision in Epic Systems Corp. v. Lewis issued earlier this year, the Supreme Court held that employers can lawfully require employees to resolve employment disputes through individual arbitration rather than by joining other employees in class or collective actions. The Court rejected employees' argument that language in the National Labor Relations Act protecting the right to engage in "concerted activities" superseded the FAA. Epic imposes a very high bar for arbitration opponents to overcome when they argue that another federal statute is not subject to the FAA—namely that the other statute must show that Congress had a "clear intention" not to permit arbitration of claims arising under the statute.
In Epic, the Supreme Court relied on its 2012 decision in CompuCredit Corp. v. Greenwood, a case involving the Credit Repair Organizations Act (CROA), which held that when Congress intends to carve out an exception to the FAA, it knows how to do so and does so expressly. The Supreme Court has also previously held that customer claims against broker-dealers are subject to arbitration under the Securities Act of 1933 and the Securities Exchange Act of 1934, the very same statutes under which shareholders often bring claims. (See Shearson/American Express, Inc. v. McMahon, 482 U.S. 220 (1987), and Rodriguez de Quijas v. Shearson/American Express, Inc., 490 U.S. 477 (1989).)
SOS argues that congressional intent to preclude shareholder arbitration is shown by language in the Securities Act of 1933 and the Securities Exchange Act of 1934, which creates federal court jurisdiction and authorizes private suits. It also cites anti-waiver language in these statutes providing that "[a]ny condition, stipulation, or provision binding any person acquiring any security to waive compliance with any provision" or related rules or regulations "shall be void." However, the statutory language relied on by SOS does not even mention arbitration, much less expressly preclude it.
In fact, nothing in the securities statutes expressly forbids the use of arbitration to resolve shareholder disputes. Notably, the Supreme Court compelled arbitration in CompuCredit even though CROA creates a statutory right of action and contains a non-waiver provision. Accordingly, under Epic and CompuCredit, arbitration of shareholders' statutory claims is permitted because the FAA trumps the securities laws.
In addition, contrary to SOS' arguments, arbitration does not deprive a shareholder of a substantive statutory right; it merely changes the forum for effectuating that right. See Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20, 26 (1991) ("[b]y agreeing to arbitrate, a party does not forgo ... substantive rights" but "only submits to their resolution in an arbitral, rather than a judicial, forum"). The U.S. Supreme Court has also repeatedly rejected the argument that arbitration is an ineffective forum for vindicating small dollar consumer claims. (See Am. Express Co. v. Italian Colors Restaurants. The Supreme Court rejected plaintiffs' argument that class action waiver was unenforceable because it was impossible for them to pursue their federal antitrust claims in an individual arbitration given the great cost of doing so compared to the relatively small amount of recoverable damages.)
Moreover, individual arbitration is superior to class action litigation for shareholders, as shown by the CFPB's exhaustive study of consumer arbitration. The study clearly established that arbitration is a faster, cheaper and more effective way for individuals to resolve disputes with companies than class action litigation and that consumers recover far more in arbitration than in class litigation.
SOS further argues that corporate bylaws are not "agreements" subject to the FAA because the elements of privity and consent are lacking. However, "'[i]t is well established that “[c]orporate charters and bylaws are contracts among a corporation's shareholders.'" (Oliveira v. Quartet Merger Corp., 662 F. Appx 47, 48 (2d Cir. 2016), quoting Airgas, Inc. v. Air Prods. & Chems., Inc., 8 A.3d 1182, 1188 (Del. 2010).)
A 2013 law review article likewise states that "the courts would uphold a by-law amendment that requires individual arbitration in place of securities class actions." (Hal S. Scott and Leslie N. Silverman, Stockholder Adoption of Mandatory Individual Arbitration for Stockholder Disputes, 36 Harv. J.L. & Pub. Pol’y 1187, 1226 (Summer 2013).) This article also concludes that "[s]ecurities class actions are a flawed regime that stockholders should have the opportunity to replace: they provide little meaningful compensation to institutional or individual stockholders, and instead primarily benefit plaintiffs' attorneys who recover up to 35% of a settlement value in contingency fees; they do little to deter wrongdoing, as the actual wrongdoers are rarely held personally responsible for losses; and finally, they have a major negative impact on the competitiveness of the U.S. capital markets."
Based on the above, should the issue arise in the future, the SEC would have a solid legal and policy basis for permitting arbitration provisions with class action waivers to be used in corporate charters or bylaws.
The attorneys in Ballard Spahr's Consumer Financial Services Group pioneered the use of arbitration provisions in consumer financial services agreements. Litigators in the Group and the firm's Litigation Department regularly defend against class actions in state and federal courts around the country.
Ballard Spahr's Securities and Capital Markets Group advises private and public companies, underwriters, selling stockholders, and officers and directors, as well as private equity funds, venture capital firms, and institutional investors in compliance matters, capital-raising activities, and other transactions.
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