New SEC Policy Statement Allows Companies Seeking To Register Securities To Include A Mandatory Arbitration Provision In Their Corporate Governance Documents

Citing a host of recent U.S. Supreme Court rulings interpreting the Federal Arbitration Act (FAA), the Securities and Exchange Commission (SEC) has "determined that the presence of an issuer-investor mandatory arbitration provision will not impact decisions whether to accelerate the effectiveness of a registration statement under the Securities Act." This new policy statement reverses the agency's previous position that it would not use its authority to accelerate the effective date of a company's registration statement when the company's governing documents contained a mandatory arbitration provision covering disputes under the federal securities laws.

This is an issue we have been following for decades. It began about 30 years ago when Alan (then at a prior firm) and a former partner represented a mutual thrift institution which had converted from mutual-to-stock form and included an arbitration provision (one without a class action waiver) in the constituent documents of the holding company it organized as part of the transaction. They were forced by the SEC staff to eliminate the arbitration clause as a condition of it accelerating the effective date of the registration of its new issue of stock under the Securities Act of 1933. More recently, at Ballard, we issued an alert and blogged about this subject and did a webinar about it a dozen years ago. This coincided with our pioneering work regarding the use of arbitration provisions (including class action waivers) in consumer contracts.

The SEC's new policy statement explains that under the Supreme Court's decisions in Epic Systems Corp. v. Lewis and CompuCredit Corp. v. Greenwood, when Congress does not displace the FAA using unambiguous statutory language, there is a strong presumption that the FAA applies exclusively to any issues regarding the enforceability of the arbitration agreement. Applying that standard, the SEC concluded that "we can discern nothing in the Federal securities statutes that demonstrates a clear and manifest congressional intention to displace the FAA in the context of issuer-investor mandatory arbitration agreements."

The SEC cautioned that "we do not consider it within the Commission's purview to conclude whether any particular issuer-investor mandatory arbitration provision is enforceable for purposes of the FAA." It further stated:

[W]e acknowledge there may be instances in which the FAA does not apply, such as where there is no valid and enforceable written agreement for purposes of the FAA. Given that neither the Commission nor the staff is well-positioned to conclusively determine when the FAA applies, and in light of ... case-law developments discussed above, we believe that any relevant issues concerning an issuer-investor mandatory arbitration provision are best addressed through complete and adequate disclosure of material information in the registration statement. Accordingly, when considering acceleration requests ..., the staff will focus on the adequacy of the registration statement's disclosures, including disclosure regarding issuer-investor mandatory arbitration provisions. Nothing in this statement should be understood to express any views on the specific terms of an arbitration provision, or whether arbitration provisions are appropriate or optimal for issuers or investors.

Nevertheless, the SEC's policy statement appears to effectively put to rest an argument that consumer advocates made preemptively in 2018 that even if an arbitration provision could be included in corporate governance documents, it should not be permitted to contain a class action waiver. The SEC determined that under analogous Supreme Court precedent such as American Express Co. v. Italian Colors Restaurant "the FAA is not displaced merely because bilateral arbitration may undermine the economic incentive of some persons to bring private Federal securities law claims." The SEC explained:

[N]o provision in the Federal securities statutes "guarantee[s] an affordable procedural path to the vindication of every claim." Further ..., the Federal securities statutes do not expressly include a right to proceed through class actions or collective actions. Finally, because the Securities Act and the Exchange Act ... were enacted before class-action proceedings were permitted, it stands to reason that "the individual suit" based on claims under those acts that was considered adequate and consistent at the time those statutes were enacted remains so notwithstanding the advent of class-action litigation. Accordingly, the potential for an issuer-investor mandatory arbitration provision to diminish, or even eliminate, the economic incentive for some investors to bring private claims under the Federal securities laws is not a sufficient basis to conclude that the Federal securities statutes displace the Arbitration Act's mandate.

In a dissenting statement, SEC Commissioner Caroline Crenshaw called the new policy "another way to stack the deck against investors" and prevent them from "vindicating their rights," while enabling companies to avoid legal scrutiny.

Consumer advocates have been stung by the SEC's new policy, characterizing it as "a significant regression of investor rights and protection," asserting that "the SEC has now embraced arbitration for all investor lawsuits, and the elimination of all securities class actions" and even questioning whether the inclusion of an arbitration clause in corporate governance documents would breach a duty of loyalty owed by an issuer to its shareholders. They are also urging Congress to enact legislation that would amend the FAA to exclude securities and other consumer disputes from its coverage. However, previous attempts to enact such legislation have failed, and given the current political landscape, the current effort is likely to fare no better.

We applaud the SEC for issuing this long-overdue policy statement and await further developments as it is applied in specific factual settings. It will be very interesting to see what comes next, since many questions remain unanswered. For example, as the SEC acknowledges:

[P]otential uncertainty exists regarding the intersection of the FAA and state law. For example, Delaware recently amended its General Corporation Law in a way that may prohibit certificates of incorporation or bylaws from including an issuer-investor mandatory arbitration provision. Other states may adopt different approaches on this issue ....This statement expresses no view on whether this or any other state law provision is consistent with the FAA.

The policy statement also does not address whether the SEC will accelerate the effective date of a registration statement if it contains a broader mandatory issuer-investor arbitration provision that also covers disputes unrelated to the securities laws. Further, it is unclear how, if at all, the policy statement will affect the rule of the Financial Industry Regulatory Authority (FINRA), the independent, non-governmental organization that regulates brokers and broker-dealer firms in the United States, that "[c]lass action claims may not be arbitrated under the [FINRA] Code." However, the listing rules of the major stock exchanges (NYSE, NASDAQ) do not appear to have specific provisions that forbid mandatory arbitration clauses in the governance documents with respect to shareholder-company disputes.

While a long time in the making, the SEC's policy statement is just the beginning of a new chapter in consumer arbitration law. We plan on writing more about this and presenting a webinar in the near future. Stay tuned.