SEC Commissioner Michael Piwowar caused great concern during a July 17, 2017 Q&A by inviting public companies to approach the SEC about including mandatory arbitration provisions in their corporate charters. The SEC has previously and consistently denied companies the ability to go public if they were to include such a requirement in their governance documents. But Piwowar’s suggestion signals that at least one of the five SEC commissioners (there are currently two vacancies) might now be inclined to allow such provisions. Make no mistake, mandatory arbitration would deny defrauded investors an effective remedy for corporate fraud.
As we recently discussed in an article published by Law360 (reprinted with Law360’s permission on the Barrack, Rodos & Bacine website), mandatory arbitration would effectively strip investors of the ability to protect themselves against wrongdoing by corporations and their directors and officers. The nature of securities claims, as opposed to typical commercial claims, puts plaintiffs at a distinct disadvantage even without the restrictions inherent in arbitration, as their role in the transactions giving rise to the claims does not typically extend beyond purchasing the securities at issue. As a result, plaintiffs have limited or no access to evidence beyond that available in the public sphere. The Private Securities Litigation Reform Act of 1995 (“PSLRA”) includes additional hurdles for investor-plaintiffs, such as a heightened pleading standard that plaintiffs must meet before they are permitted access to discovery. The upshot is that investors that survive these hurdles can obtain discovery of the company’s internal documents and take depositions under oath of persons with particular knowledge of the facts and issues involved in the case, which are essential to be able to prove the claims.
In stark contrast, the Commercial Arbitration Rules and Mediation Rules of the American Arbitration Association, the largest arbitration forum in the United States, are structured to sharply limit discovery; the arbitrator’s management of the exchange and production of information is undertaken “with a view to achieving an efficient and economical resolution of the dispute….” Indeed, even the rules specific to “large, complex commercial disputes” provide for depositions only “in exceptional cases.” As a result, investors who pursue arbitration will be left at a distinct disadvantage, barred for the most part from obtaining the types of meaningful discovery that is necessary to prove corporate fraud.
What’s more, recent empirical evidence demonstrates that arbitration fails to provide as much protection as class action litigation. In an August 22, 2017 New York Times op-ed, Richard Cordray, director of the Consumer Financial Protection Bureau, detailed the results of a seven-year CFPB study into consumer arbitration:
We found that group lawsuits get more money back to more people. In five years of group lawsuits, we tallied an average of $220 million paid to 6.8 million consumers per year. Yet in the arbitration cases we studied, on average, 16 people per year recovered less than $100,000 total.
Class action securities litigation is similarly beneficial to investors. Following enactment of the PSLRA in 1995, which encouraged large institutional investors to serve as lead plaintiffs in securities litigations, 91 of the 100 largest securities class action settlements were led by institutional investors, and these class actions collectively recovered approximately $60 billion for investors. These settlements include recoveries arising from notorious examples of corporate fraud such as Enron, WorldCom, Tyco International, and Cendant. The benefits of these recoveries flowed not just to the investors who led the suits, but also to countless other investors whose losses, while often in the thousands or tens of thousands of dollars, would not have been sufficient to warrant an individual action, whether in court or in arbitration.
In sum, class action securities litigation is a necessary tool to redress securities fraud. Mandatory arbitration is an insufficient alternative that would provide no deterrence to wrongdoers who commit fraud at the expense of the investing public. Investors must challenge any effort to allow companies to mandate arbitration of securities fraud claims.
Samuel M. Ward, a partner in the San Diego office of Barrack Rodos & Bacine, regularly participates in the prosecution of securities class actions. Michael A. Toomey (LAW ’10), an associate in the firm’s New York office, concentrates his practice on actions involving corporate governance as well as on securities class actions. A longer version of this article was published by Law360, August 9, 2017.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or The Temple 10-Q, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.