Arbitration of Shareholder Actions May Be DOA

The trial balloon of allowing mandatory arbitration of shareholder actions may have just been shot down by House Financial Services Committee Chair Barney Frank. In a letter to SEC Chair Christopher Cox, Rep. Frank criticized suggestions that the Commission may begin permitting public companies to impose mandatory arbitration requirements on shareholders through the registration process.

The idea, whose time may have already come and gone, was floated by the Paulson Commission report on the capital markets, which urged the SEC to allow public companies to contract with their investors to provide for alternative procedures in securities litigation, including arbitration or non-jury trials. A recent WSJ article said the SEC staff was looking at it.

The report analogized the idea to the now quite common arbitration agreement used to resolve broker-customer disputes under substantive Exchange Act rights. The SEC General Counsel’s office has historically taken the position that the US Supreme Court rulings allowing arbitration in the broker-customer world should not be extended to the context of issuer-shareholder disputes. But the report concluded that as a legal matter there is nothing to prevent it.

But Rep. Frank warned that allowing such covenants to be included in registration documents would represent a drastic change in shareholder rights. Calling such agreements contracts of adhesion, he said that companies should not be permitted to impose them unilaterally. While agreeing to consider reasonable measures to improve the efficiency and competitiveness of the financial markets, he cautioned that Congress and the SEC must examine the consequences very carefully before allowing public companies to deny shareholders meaningful avenues of redress as the owners of those public companies. Moreover, given the severe limits on the right of appeal available in arbitration, he believes that investors would be required to risk losing their rights under federal securities laws in order to invest in the public markets

It is hard to see how this idea can get any kind of traction with that level of opposition from the SEC’s and financial industry’s oversight chair.