Explores Opening Door To Arbitration
Agency to Study Option That Could Let Firms Limit Holder
By Kara Scannell
The Wall Street Journal
Monday, April 16, 2007
WASHINGTON -- The Securities and Exchange Commission is
exploring a new policy that could permit companies to resolve
complaints by aggrieved shareholders through arbitration,
limiting shareholders' ability to sue in court.
The initiative is at the discussion stage and may not lead to
any changes in rules or practices. But any move toward
arbitration could realign the balance of power between
shareholders and corporate managements at a time when that
balance has tipped increasingly toward shareholders. It could
also limit shareholders' ability to recover money damages or
other compensation from corporations.
The idea of giving companies the option of arbitrating
shareholder disputes is likely to spark fierce opposition from
both investor-rights groups and trial lawyers. As a result,
there's a good chance that it could fall flat.
The SEC staff is studying whether corporations should be
permitted to amend their bylaws to allow for arbitration, a
change that in some cases might require shareholder approval,
according to people familiar with the matter. The study comes
after the idea was raised by private commissions looking into
concerns about the competitiveness of U.S. financial markets,
these people said.
The initiative could become part of a broader package of SEC
proposals, including a controversial measure to let shareholders
change company bylaws to allow them to nominate their own
directors on corporate ballots. That measure has been opposed
by the business lobby, which argues it could entrench special
interests. However, the SEC might seek to make it more
palatable to business by packaging it with changes that business
would support, like the option to use arbitration.
In an interview Friday, however, SEC Chairman Christopher Cox
sounded a cautious note. "I don't believe arbitration is a
panacea," he said.
Business groups, some academics and others have long argued that
the potential for shareholder lawsuits has helped to dull the
competitive edge of U.S. financial markets. Last year, U.S.
companies paid $17.16 billion to settle a total of 95
shareholder class-action lawsuits alleging misdeeds ranging from
securities fraud to accounting irregularities, according to data
from Cornerstone Research.
Critics of these lawsuits say multimillion-dollar settlements
have lined the pockets of lawyers at the expense of
shareholders, created burdensome costs, and frightened off
companies that might otherwise have chosen to list their stocks
in the U.S.
The idea of using arbitration to resolve disputes between
companies and their shareholders was recommended in November by
a blue-ribbon committee led by Harvard Law Professor Hal Scott,
and encouraged by Treasury Secretary Henry Paulson.
Among other things, the panel's report said, the "SEC should
permit public companies to contract with their investors to
provide for alternative procedures in securities litigations,
including providing for arbitration (with or without
class-action procedures) or non-jury trials." The report
recommended a shareholder vote for companies seeking to change
their bylaws to allow for arbitration.
The idea may be addressed at an SEC roundtable, a forum in which
the SEC invites people from all sides to debate an issue and
help the agency's staff review the options.
Mr. Cox, the SEC chairman, has a history of seeking to limit
what he sees as excessive securities litigation. While a
Republican congressman representing Southern California, he
helped write the 1995 Private Securities Litigation Reform act,
which aimed to reduce the number of frivolous lawsuits filed
against corporations. Earlier this year, the SEC sided with
business in a "friend of the court" brief it filed in a Supreme
Court case dealing with the standards a plaintiff needed to meet
for a case to proceed. The SEC says it sided with the standard
accepted by the majority of appeals courts.
Many kinds of disputes have already moved out of the courtroom
and into arbitration. Brokerage firms, for example, require
clients to agree to resolve claims before arbitration panels.
Companies also routinely include arbitration clauses in
contracts with each other and with employees.
Critics of arbitration say the three-member arbitration panels
used in brokerage disputes often favor the industry over the
consumer. In arbitration, the extent of a consumer's right to
receive and review relevant information from the opposing side,
a process known as discovery, is less clear than in litigation.
Arbitration hearings also are often conducted in private, rather
than in a public forum.
In 2006, 42% of investors who filed arbitration claims against
brokers received some form of compensation, down from 53% in
2000, according the National Association of Securities Dealers.
Trial lawyers have lost ground in several high court cases in
recent years. An SEC move toward permitting shareholder
disputes to be resolved through arbitration could further reduce
the influence of the so-called plaintiffs bar.
Although settlement amounts are up significantly from past
years, the overall number of securities class-action lawsuits
filed has declined to its lowest level in 10 years, according to
a joint study Cornerstone Research and Stanford Law School.
The latest SEC discussions are part of a series of initiatives
that appear designed to reduce the regulatory burden on U.S.
business. Earlier this year, the SEC changed the way its
commissioners review cases involving potential corporate
penalties. Instead of waiting until the SEC staff reaches a
preliminary settlement, the change lets commissioners weigh in
earlier in the process. Mr. Cox has said this will lead to
faster resolutions and stiffer penalties. Some staff members
fear the change may deter staff attorneys from seeking
If the move toward arbitration gathers steam, some consumer
groups may worry that by curbing shareholder litigation, the
nation will lose a powerful deterrent to corporate wrongdoing.
Individual shareholders might also have to incur the expense of
hiring a lawyer, rather than simply signing on as a member of a
The move would mark a significant policy shift by the SEC in its
interpretation of federal securities laws. The issue is a
thorny one for the SEC and could come down to how it reconciles
arbitration with provisions in securities laws that protect the
right of shareholders to sue. In a case related to the
brokerage industry, the Supreme Court has ruled that requiring
arbitration doesn't violate the so-called antiwaiver clauses of
the Securities Act of 1933 and the Securities and Exchange Act
In 1990 the issue came up in a corporate context. A
Pennsylvania-based bank sought to have a mandatory arbitration
clause included in the charter of its savings-and-loan
subsidiary, which it planned to take public. The SEC, under
then-chairman Richard Breeden, refused to approve the
registration statement because of the antiwaiver clauses, and
the company dropped its initial public offering.
Write to Kara Scannell at