This is a significant development for public companies, reflecting a reversal of the SEC's long-standing approach to mandatory arbitration, meriting careful consideration of risks and benefits. While the full impact of this change remains to be seen, we explain the change in depth below, as well as preliminary considerations for companies and boards of directors.
On September 17, following a 3:1 vote, the SEC issued a policy statement providing its view that mandatory arbitration provisions for federal securities claims do not conflict with the federal securities laws. Mandatory arbitration provisions included in a company's corporate charter, bylaws or other organizational documents, if enforced, would require investors to bring claims for alleged violations of the federal securities laws through an inpidualized, non-class action, private arbitration process. Prior to this guidance, the SEC's pision of Corporation Finance effectively prohibited such arbitration provisions by refusing to declare a registration statement for an IPO effective if the company included one in its organizational documents. The pision of Corporation Finance applied this practice broadly, so this change is relevant for all companies considering adopting arbitration provisions, whether they are preparing for an IPO or are already public.
The sheer size of securities class actions can create significant pressure on companies to settle cases pre-trial, regardless of the companies' view of the merits of the claims. Requiring that cases be brought on an inpidual basis could alter this dynamic, potentially allowing companies to defend claims on the merits without risking damages that far exceed insurance limits and deterring cases that are of questionable merit from even being filed. Arbitration also generally involves far less discovery than a federal court proceeding, which could lead to significant cost savings and less distraction from business operations. These benefits could also translate into cost savings through lower D&O insurance premiums if the market adjusts to perceived lower claims exposure.
But there are countervailing factors that companies must seriously consider before adopting a mandatory arbitration provision. For example, although Delaware, where a high percentage of U.S. public companies are incorporated, permits the inclusion of forum selection clauses in corporate charters and bylaws, it recently adopted provisions in the Delaware General Corporation Law (DGCL) that require preserving access to at least one court in the State of Delaware for the enforcement of certain types of non-internal corporate claims. This statute could be interpreted to prohibit mandatory arbitration provisions for Delaware companies. And even if a mandatory arbitration provision would be permissible under state law, early adopters would likely see the validity of such provisions challenged as allegedly conflicting with federal law (notwithstanding the SEC's new position on the matter, which is ultimately not binding on courts) and/or as alleged breaches of fiduciary duty. In addition to these legal issues, companies will also need to consider the potential reaction of institutional investors, proxy advisory firms and other stakeholders.
Companies will also need to weigh potential disadvantages of the arbitral process for resolving federal securities claims as compared to civil litigation. While the unavailability of class actions may change the economic incentives for the plaintiffs' bar and the costs of discovery, companies may be more comfortable with the certainty and leverage gained from well-established procedures applicable to securities claims litigated in federal court. Those steps include the ability to have meritless claims thrown out on a motion to dismiss, which tends to be harder in arbitration, and to resolve claims from multiple plaintiffs in a single proceeding rather than through multiple (and perhaps hundreds or more) concurrent arbitrations. Companies may also appreciate the opportunity to appeal unfavorable decisions, something that is far more limited in arbitration.
Below, we first review the SEC's historical position and its rationale for its new policy. After that, we describe the types of claims and scenarios where mandatory arbitration provisions could be used and discuss relevant disclosure considerations. We then address the legal challenges that companies could face if they adopt mandatory arbitration provisions, before turning to the factors companies should consider in weighing the pros and cons of adopting one. Finally, we offer some practical guidance for drafting arbitration provisions to tailor them to companies' objectives for a fair and efficient dispute resolution process.
The change in the SEC's position
Historically, the SEC's pision of Corporation Finance held the view that mandatory arbitration provisions violated the anti-waiver provisions in the federal securities statutes. There was also a question as to whether such provisions unduly impeded the ability of investors to enforce their rights by foreclosing class actions. As a result, the pision would not declare effective a registration statement filed by a company that sought to put an arbitration provision in place because the pision believed such a provision was not consistent with "the public interest and the protection of investors," a determination it is required to make under Section 8(a) of the Securities Act. In a widely followed 2012 IPO, a company attempted to go public with such a provision in place, effectively testing the pision's policy. The company ultimately backed down when it was told that the pision would not declare the registration statement effective. The company did not challenge this decision in court, and, as a practical matter, a legal challenge would not likely have been feasible given the typical timeline for an IPO.
The pision's practice extended to registration statements filed by companies already public if those registration statements were subject to SEC review. Although it is possible that a company may have adopted an arbitration provision after it went public in a manner that would not have required SEC review, that would have been a rare exception.
The SEC's new position is that the presence of a mandatory arbitration provision does not violate the anti-waiver provisions of the federal securities laws or pose an impermissible impediment to the enforcement of investor rights. The presence of such a provision will therefore not impact the SEC's decision to declare a registration statement effective. In coming to this view, the SEC analyzed Supreme Court precedents relating to the Federal Arbitration Act (FAA) and the intersection of the FAA and other federal statutes. The FAA generally provides for the enforceability of written agreements to arbitrate controversies arising out of commercial transactions. Some of the relevant cases date back to the 1980s, but are now seen in a new light, in part due to additional arbitration-favorable decisions by the Supreme Court in more recent cases outside the securities law context.
In summary, the SEC now takes the position that the federal securities laws should not be interpreted to override the current federal policy favoring arbitration agreements reflected in the FAA. Specifically with respect to class actions, the SEC points out that the enactment of the Securities Act and the Exchange Act (the two statutes under which most securities class actions are filed) predated the amendment to the Federal Rules of Civil Procedure that enabled federal class actions.
Potential application of mandatory arbitration provisions
As the SEC notes in its policy statement, mandatory arbitration provisions may be contained in a company's corporate charter or bylaws. For foreign issuers, these provisions also could be included in the deposit agreements governing the American Depositary Receipts (ADRs) evidencing interests in the underlying foreign shares. Mandatory arbitration provisions do not need to be limited to stockholders. When included in bond indentures, they would apply to claims by bondholders. In partnership agreements, they would apply to claims by holders of public partnership units, and, in trust agreements, they would apply to claims by holders of trust securities.
The SEC's conclusion that arbitration provisions do not conflict with the federal securities laws applies principally to decisions to declare effective registration statements for IPOs. In a statement explaining his support for the new SEC policy, SEC Chair Paul Atkins characterized it as one of the first steps towards making "being a public company an attractive proposition for more firms by eliminating compliance requirements that yield no meaningful investor protections, minimizing regulatory uncertainty, and reducing legal complexities throughout the SEC's rulebook."
Beyond IPOs, the SEC has said that it will apply its new position to Securities Act registration statements for other securities offerings as well as to decisions to declare effective Exchange Act registration statements, such as those used for spin-offs, or decisions to qualify offering statements for Regulation A offerings. According to the SEC's statement, the same conclusion also applies, for example, if a public company were to amend its corporate charter or bylaws.
Mandatory arbitration provisions need not be limited to claims against companies. While the contract containing the mandatory arbitration provision—whether in a corporate charter, bylaw or bond indenture—would of course be between a company and its stockholders or bondholders, the provision conceivably also could mandate arbitration for claims against other parties, including a company's directors and officers, its independent auditors, and its underwriters.
Disclosure considerations
For companies that adopt mandatory arbitration provisions, the SEC highlights the need for complete and adequate disclosure. In this regard, the SEC's statement acknowledges that, as we discuss below, issues may remain regarding the legality of the provisions under state and federal law and recommends that those risks be addressed through disclosure. We expect that the SEC staff will thus focus on ensuring that a company's disclosure adequately explains how these provisions operate, as well as considerations relevant to stockholders, including any residual legal issues regarding their enforceability or reach.
Potential legal challenges
The SEC's new policy does not necessarily mean that courts will enforce mandatory arbitration provisions. Initial reactions from the plaintiffs' bar, the dissenting statement from a SEC Commissioner, a letter from U.S. Senators Warren and Reed, and experience with the earlier widespread adoption of federal and Delaware forum selection clauses all suggest that the provisions will be challenged in litigation.
Consistency with the federal securities laws
We anticipate that some stockholders and members of the plaintiffs' bar will take the position that mandatory arbitration provisions conflict with the federal securities laws, including the anti-waiver provisions. It is certainly relevant to the defense of such provisions that the SEC has now concluded, after analyzing Supreme Court precedent and other case law, that "the Federal securities statutes do not override the Arbitration Act's policy favoring enforcement of arbitration agreements." The SEC's view is not independently dispositive, however, particularly in light of last year's Supreme Court decision in Loper Bright Enterprises v. Raimondo, 603 U.S. 369 (2024), eliminating Chevron deference to permissible agency interpretations of the statutes they administer.
State law restrictions on arbitration and federal preemption issues
Litigation is also likely on the intersection of the FAA and state law, including the law of Delaware. A recent amendment to the DGCL permits the certificate of incorporation or bylaws to prescribe a forum or venue for claims by stockholders "in their capacity as stockholders ... relate[d] to the business of the corporation, the conduct of its affairs, or the rights or powers of the corporation or its stockholders, directors or officers" so long as the clause "allows a stockholder to bring such claims in at least one court in [Delaware] that has jurisdiction over such claims." DGCL Section 115(c). As noted by the SEC, this statute may be read to prohibit mandatory arbitration provisions in the certificates of incorporation or bylaws of Delaware corporations, giving rise to the question of whether any such prohibition is preempted by the FAA.
While the SEC declined to express a view on the preemption issue, its policy statement cites Supreme Court case law holding that "a state law that target[s] the enforceability of [mandatory] arbitration agreements either by name or by more subtle methods, such as by 'interfering with fundamental attributes of arbitration' may be preempted by the Arbitration Act" (quoting Epic Systems Corp. v. Lewis, 584 U.S. 497, 508 (2018)). Indeed, the Supreme Court has said that the FAA preempts state laws that "prohibit [...] outright the arbitration of a particular type of claim," as well as laws that are facially neutral but would "interfere [...] with fundamental attributes of arbitration and thus create [...] a scheme inconsistent with the FAA" AT&T Mobility, LLC v. Concepcion, 563 U.S. 333, 344 (2011).
In states like Delaware where there may be a state law restriction on arbitration provisions in corporate charters or bylaws, we anticipate that there will be discussions in the legislature about potential amendments in light of the SEC's newly expressed view.
Meanwhile, for companies incorporated in states other than Delaware, there may not be any potential conflict between state and federal law requiring a preemption analysis. In Texas, for example, there is at least some case law enforcing arbitration provisions in bylaws. And while the Texas Business Organizations Code states that the governing documents of a company incorporated in Texas "may require" that "internal entity claims" be brought only in Texas, there is no express statutory requirement that a stockholder be permitted to litigate such claims in a Texas court as opposed to arbitration. Similarly, in Nevada, another state, along with Texas, that is getting increased attention as an alternative to Delaware as a corporate home, the Nevada Revised Statutes do not require that stockholders be permitted to litigate these types of claims in a Nevada court.
Potential for fiduciary duty claims
To the extent that already public companies will amend their corporate charter or bylaws to adopt mandatory arbitration provisions, we anticipate that stockholder litigation for breach of fiduciary duty will follow shortly. Indeed, plaintiffs' firms have already publicly stated as much. In these claims plaintiffs could assert that an arbitration provision with a class action waiver will provide a personal benefit to directors in the form of reduced liability exposure that is not shared with stockholders.
However, the Delaware Supreme Court's reasoning in Maffei v. Palkon, 339 A.3d 705 (De. 2024),— holding that the board's decision to reincorporate in Nevada was not subject to an entire fairness review on the theory that Nevada law would be more defense-friendly—arguably would appear to suggest otherwise, at least where the arbitration provision is adopted on a "clear day" without specific pending or threatened litigation.
Plaintiffs can be expected to argue that the adoption of a mandatory arbitration provision, unlike reincorporation, can be intended only to benefit directors at the expense of stockholders (though given that the primary focus of Maffei was the impact of reincorporation on the directors' litigation exposure, this argument seems an uphill battle). Plaintiffs might also attempt to plead around Maffei by arguing that a board's adoption of a mandatory arbitration provision is itself a breach because it is likely to expose the company to litigation challenging the very adoption of that provision.
Companies that have undertaken a thorough, well-reasoned analysis of the value of a mandatory arbitration provision to the company (which might include limiting litigation expense, management distraction, and insurance premiums) weighed against the potential risks (which likely include reactive litigation, investor sentiment, and the procedural drawbacks of arbitration of securities claims)—and that have taken care to document that assessment—should be better positioned to defend the adoption of such provisions than those that have not.
Enforceability of class action waivers
Finally, there likely will be arguments that class action waivers are unconscionable or otherwise unenforceable. The Supreme Court, in AT&T Mobility, LLC v. Concepcion, has held that class action waivers in arbitration agreements are enforceable, subject to generally applicable contract defenses, such as fraud, duress or unconscionability.
A plaintiff may argue in response that a class action waiver is unconscionable because it could make pursuit of securities claims economically unfeasible on an inpidual basis. However, as discussed in the SEC's policy statement, this argument would seem to be foreclosed by the Supreme Court's ruling in American Express Co. v. Italian Colors Restaurant, 570 U.S. 228 (2013), which rejected these same arguments in the context of antitrust class actions. Thus, in the absence of specific facts showing fraud or duress, or provisions in the class action waiver and arbitration agreement more generally that would render them unconscionable, there appear to be reasoned arguments that class action waivers in securities-related arbitration agreements would be upheld.
Considerations for companies contemplating mandatory arbitration provisions
Even assuming that the legal challenges to the enforcement of mandatory arbitration provisions could be overcome, there are a variety of factors that we discuss below that companies should consider when deciding whether to adopt one.
Investor reaction
Companies should consider how their current and future investors may react, including how institutional investors may view such provisions and whether the presence of such provisions could affect the price at which those investors are prepared to invest. Relatedly, companies may be interested in understanding how proxy advisory firms will react. We expect that guidance on this point will come from ISS and Glass Lewis. Their previous stance on provisions requiring Securities Act claims to be brought in federal court instead of state courts may be instructive. ISS's policy is to support such provisions unless they restrict the forum to a particular federal district court. Glass Lewis has a more negative view on federal forum provisions but will support them in specific circumstances. Both proxy advisory firms also disfavor fee-shifting bylaws, and fee shifting can be a feature of arbitration.
The views of insurance providers
The insurance industry, particularly the units that provide director and officer liability insurance and securities litigation enterprise coverage, has perhaps the broadest visibility into the potential pros and cons of arbitration of federal securities claims. Undoubtedly, an insurance industry perspective will develop and manifest itself in the insurance it is prepared to provide and the pricing at which it will do so. We expect this to be significantly impactful on company choices, and for good reason.
Arbitration of securities claims compared to today's class action regime
There are potential benefits of arbitration for the resolution of federal securities claims: an enhanced ability to defend cases on the merits without the overhang of potential damages in excess of insurance coverage, the chance to deter the filing of meritless claims, greater confidentiality, less discovery, and the potential for overall cost savings and reduced distraction.
Companies and their advisors should, however, also carefully consider the potential disadvantages of an inpidual arbitration regime as compared to today's class action structure. For example, securities cases currently follow a predictable process laid out in the Private Securities Litigation Reform Act (PSLRA) and precedent cases. A lead plaintiff and counsel are appointed, giving defendants a single counterparty with which to deal; discovery is stayed while a motion to dismiss is pending; defendants have significant success disposing of cases at the pleading stage, with around half of all cases getting dismissed; and defendants are typically able to resolve cases that survive a motion to dismiss, through settlements covered by D&O insurance, at some point before trial if class certification is not denied or summary judgment is not granted.
An inpidual arbitration regime for securities claims would look fundamentally different. Instead of dealing with a single court-appointed lead plaintiff and counsel, companies could face numerous arbitration demands from stockholders represented by different counsel. That poses risks of duplicative proceedings (including potentially non-coordinated discovery and motion practice) and creates challenges for achieving a global resolution. One need only look at the "mass arbitration" phenomenon that has developed in consumer cases to appreciate the challenges posed by a large volume of arbitration demands. There is also no guarantee that the same arbitrator will be appointed to handle factually related claims. This raises the risk of inconsistent outcomes and, potentially, the inability to use favorable precedent in future cases.
The procedural rules and practices of most arbitration institutions also differ from those in typical federal court proceedings. One example is that arbitration rules generally do not provide for dispositive motions as a matter of right. The absence of such a critical defense tool in securities cases would make it harder to have non-meritorious claims dismissed simply based on the pleadings. Even where the arbitration rules permit motion practice, companies may question whether arbitrators will be as open to dispositive motions to dismiss as federal courts. Another critical procedural difference is the limited appealability of arbitration awards, which makes it hard for companies to overturn rulings perceived as erroneous or even contrary to law.
We discuss in more detail below how some of these drawbacks of the arbitral process for the resolution of securities cases can potentially be addressed through thoughtful drafting of arbitration provisions.
Potential future changes in the SEC's views
While today's SEC leadership no longer opposes mandatory arbitration provisions, the SEC's view may evolve or change if there are changes in the administration, SEC leadership or the political environment. Companies should consider whether they want to be exposed to such potential swings in regulatory views, particularly as it may take time to resolve the potential legal challenges discussed above.
Additional considerations for non-U.S. companies
Companies based outside the United States, and companies with most of their assets outside the United States, will also want to consider the relative enforceability outside the United States of judgments issued by U.S. courts and arbitrators. The United States is a signatory to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitration Awards. Under the terms of this convention, arbitration awards issued in one signatory state are presumed to be enforceable in the jurisdiction of other signatory states unless certain narrow discretionary grounds to refuse enforcement are met. This treaty makes it much easier to enforce a foreign arbitration award across borders than a court judgment. As such, a foreign investor who successfully arbitrates a securities dispute against a U.S. company—or a U.S. investor who successfully arbitrates a securities dispute against a foreign company listed on a U.S. stock exchange—could seek to enforce that award in the territory of any other New York Convention signatory state where the company has assets.
Drafting considerations for mandatory arbitration provisions
Companies choosing to adopt mandatory arbitration provisions will want to consult with experienced securities litigation and arbitration counsel to tailor default arbitration rules to be included as part of any adopted provisions to best fit a securities case, also taking into account how the provisions will be viewed by investors, proxy firms, and other stakeholders. Potential issues to address include:
- Choice of arbitration provider. There are numerous institutions capable of administering arbitration in the United States, including, for example, the International Chamber of Commerce (ICC), American Arbitration Association (AAA), and Judicial Arbitration and Mediation Services (JAMS). Each institution has different procedural rules, including defaults for the number of arbitrators and manner in which they are selected, the scope of discovery, how evidence may be presented, the availability of emergency relief, and whether dispositive or summary disposition is permissible. While these rules can be varied by the parties in an arbitration agreement and through subsequent agreement, companies will want to carefully consider which institution and rules best suit their needs.
- Dispositive motions. Summary disposition of cases is rare in arbitration. Companies will therefore want to select institutions that allow dispositive motions to be filed or draft arbitration provisions that grant parties the right to file motions to dismiss and other pre-trial dispositive motions.
- Discovery. Arbitrations are not bound by the U.S. Federal Rules of Civil Procedure, and courts have routinely held that parties who choose arbitration have waived their right to pre-trial (and, certainly, extensive pre-trial) discovery, including depositions. In consultation with counsel, companies will want to draft arbitration provisions to avoid the often far-ranging and expensive discovery in securities cases while ensuring the ability to develop and present defenses, all while balancing potential negative reactions from investors to provisions that are deemed too one sided.
- Potential for consolidation or coordination. Certain institutions administering arbitrations have rules that would permit the consolidation of cases in certain circumstances—an outcome that companies may prefer to restrict to avoid a class-like aggregation of claims. Companies may, however, want to create opportunities for coordination between similar proceedings to avoid duplicative depositions. Companies, therefore, should consult with counsel to determine whether consolidation is in their interest and how best to structure a mandatory arbitration provision accordingly.
- Appellate opportunities. By choosing arbitration, parties trade certainty for finality and grounds for appeal are exceptionally limited. Despite this, parties have attempted to create pseudo-appellate mechanisms in arbitrations. The enforceability of these provisions can be challenged and their viability will depend on how the provisions are drafted.
- Application to claims against non-company defendants. To avoid multi-forum disputes, arbitration provisions should be drafted to maximize coverage for other potential defendants in securities cases, particularly for company-indemnified parties like directors, officers or underwriters. Companies can take advantage of lessons learned from disputes over the enforcement of federal forum provisions and the favorable case law allowing underwriters to enforce those provisions despite not being signatories.
Conclusion
The SEC's policy statement marks a significant shift that opens up new possibilities for companies interested in exploring mandatory arbitration as a way to manage exposure to potentially meritless securities claims. While the SEC's policy statement removes one obstacle to the adoption of mandatory arbitration provisions, potential legal challenges remain, some of which may only be resolved in future litigation. Adopting such provisions, whether at the IPO stage or for already public companies, will require careful risk and benefit analysis, and, if pursued, planning to ensure that the provisions fit companies' needs and are appropriately tailored to harness the potential benefits of arbitration in the specific context of federal securities claims. Nonetheless, we expect that some companies will take the plunge, and it will be instructive to observe how investors, insurers, courts, and state legislators react to what could become a new paradigm for the resolution of securities claims.
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