SEC Commissioner Michael Piwowar recently said that the SEC is open to allowing companies that are going public to provide for mandatory shareholder arbitration in their corporate charters. Piwowar’s remarks have prompted a firestorm of discussion of the issue of mandatory arbitration of securities class actions, including helpful analyses by Alison Frankel and Kevin LaCroix of issues that arbitration provisions would raise.
If Piwowar’s thought turns into action, there will be numerous public policy and legal issues to sort out—including whether a corporate charter can bind an individual purchaser of stock asserting an individual claim based on an offering or secondary-market purchase, as opposed to a current stockholder asserting a corporate claim in a derivative action.
I will set those tricky issues aside for now—they would be the subject of much analysis and intense battles between investor advocates and some corporate-interest advocates.
But first, we defense lawyers should sort out whether a system of securities litigation without securities class actions, including a system of arbitrations, would be helpful to defendants.
I believe the idea of mandatory securities disclosure arbitrations is a bad one—for defendants.
Our current securities-litigation system is straightforward, predictable, and manageable. There is a relatively small group of plaintiffs’ firms that file securities class actions. The Private Securities Litigation Reform Act provides a framework for the procedural and substantive issues. Securities class actions rarely go to trial, and they settle for a predictable amount. Indeed, executives who do their best to tell the truth really have nothing to fear under the securities laws. The law gives them plenty of protection, and the predictability of the current system allows them to understand their risk and resolve litigation with certainty. There are certainly problems with the current system, but as I recently wrote, they primarily stem from the splintered structure of the defense bar and the skyrocketing legal fees charged by the typical defense firms—not from the litigation itself.
The allure of abolishing securities class actions is that securities disclosure litigation would be greatly reduced. But that’s a Siren song. A system of arbitration of securities disputes would not rid us of securities disclosure claims. Plaintiffs’ securities lawyers handle securities cases for a living, and they aren’t going to become baristas or bartenders if securities claims must be arbitrated. They will simply initiate arbitrations on behalf of their clients.
These arbitrations would be unmanageable. Each plaintiffs’ firm would recruit multiple plaintiffs to initiate one or more arbitrations—resulting in potentially dozens of arbitrations over a disclosure problem. Large firms would initiate arbitrations on behalf of the institutional investors with whom they’ve forged relationships, as the Reform Act envisioned. Smaller plaintiffs’ firms would initiate arbitrations on behalf of groups of retail investors, which have made a comeback in recent years. We often object to lead-plaintiff groups because of the difficulty of dealing with a group of plaintiffs instead of just one. In a world without securities class actions, the adversary would be far, far worse—a collection of plaintiffs and plaintiffs’ firms with no set of rules for getting along.
Securities-disclosure arbitrations would cost multiple times more to defend and resolve.
- Motions to dismiss would cost more. Some motion to dismiss arguments would be the same, but some would be different due to differences in the cases and plaintiffs’ counsel, so the total cost of motions to dismiss would increase. The defendants would need to defeat each and every arbitration claim on a motion to dismiss to avoid discovery of the same scope faced in a securities class action that has survived a motion to dismiss.
- Discovery burdens would increase. More cases would involve discovery. If any of the arbitration claims were to survive a motion to dismiss, a company would be subject to discovery, meaning that there would likely be discovery in the vast majority of securities disclosure arbitrations, as opposed to just less than half today. Discovery would be broader too. If multiple claims survive, defendants would face overlapping and inconsistent obligations. It’s easy to imagine at least one arbitrator out of the many arbitrators handling similar claims allowing very broad discovery. That single ruling would define the defendants’ discovery burdens.
- Settlement would be more expensive. If securities class action opt-out litigation experience is indicative of the settlement value of such cases, they would tend to settle for a larger percentage of damages than today’s securities class actions. Settlement logistics would be vastly more difficult too. It’s hard enough to mediate with one plaintiffs’ firm and one lead plaintiff. Imagine mediation with a dozen or more plaintiffs’ firms, each representing multiple plaintiffs.
- Settlement would not yield finality and peace. Even when settlement could be achieved, it wouldn’t preclude suits by other purchasers during the period of inflation alleged in the arbitrations because there would be no due process procedure to bind them, as there is when there’s a certified class with notice and an opportunity to object or opt out. Indeed, there likely would develop a trend of random follow-up arbitrations by even smaller plaintiffs’ firms after the larger cases have settled. There would be no peace absent the expiration of the statute of limitations.
This parade of horribles just scratches the surface, but it suffices to show that mandatory securities arbitration is a bad idea for defendants.
We have a prominent example of how disheveled securities litigation can be without the securities class action mechanism to provide certainty and peace: limited federal-court jurisdiction under Morrison v. National Australia Bank, 561 U.S. 247 (2010). If the post-Morrison framework is any indication of what we would face with securities arbitrations, look out—Morrison has caused the proliferation of unbelievably expensive litigation around the world, without the ability to effectively coordinate or settle it for a reasonable amount with certain releases.
These unmanageable and unpredictable economics would disrupt D&O insurance purchasing decisions and cost. Under the current system, D&O insurers and brokers can reliably predict the risk a particular company faces based on its size and other characteristics. A company can thus purchase a D&O insurance program that fits its risk profile.
Compounding the uncertainty of all of this would be the role of SEC and other government enforcement. Even with the regulatory relief promised by new SEC Chair Jay Clayton, the job of the human beings who work at the SEC is to investigate and enforce the securities laws. They aren’t going to not do their jobs just because government regulation has been eased in the bigger picture. And they will step in to fill the void left by the inability of plaintiffs to bring securities class actions. Experienced defense counsel can predict how plaintiffs’ firms will litigate and resolve a securities class action, but they have much less ability to predict how an enforcement person with whom he or she may never have dealt will approach a case.
The idea of abolishing securities class actions comes up from time to time. Fortunately for defendants, it hasn’t become reality. The world of securities litigation with securities class actions is far safer for companies and their directors and officers than it would be without them. Predictability of the process and outcomes are key to a manageable system of resolving securities disclosure disputes. Mandatory arbitration would disrupt both process and outcomes.
I hope the current idea blows over.