SEC Issues Policy Statement Regarding Issuer-Investor Mandatory Arbitration Provision

On September 17, in a 3-to-1 vote, the U.S. Securities and Exchange Commission adopted a new policy statement (the "Policy Statement"), which is intended to provide clarity for issuers with a mandatory arbitration provision for investor claims arising under the federal securities laws ("Mandatory Arbitration Provision") contained in the issuer's corporate charter, bylaws or elsewhere.[1] The Policy Statement concludes that, in the context of Mandatory Arbitration Provisions, the federal securities laws do not override the Federal Arbitration Act's ("FAA") policy of favoring enforcement of arbitration agreements. As a result, the presence of a Mandatory Arbitration Provision[2] "will not impact [the SEC's] decisions whether to accelerate the effectiveness of a registration statement" under the Securities Act of 1933 ("Securities Act") or the Securities Exchange Act of 1934 ("Exchange Act"), as well as decisions to declare effective post-effective amendments to registration statements and to qualify an offering statement or a post-qualification amendment under Regulation A. The Policy Statement also noted that the same conclusion would apply "if an Exchange Act reporting issuer were to amend its bylaws or corporate charter to adopt an issuer-investor mandatory arbitration provision."

According to SEC Chair Paul Atkins, the SEC's prior actions have "injected uncertainty" into whether registration statements filed by companies that have sought to include a Mandatory Arbitration Provision in their governance documents would be declared effective, and Atkins sought to provide clarity on the SEC's current position so that companies contemplating an IPO today would not interpret the SEC's prior actions "to reflect the Commission's current views on the issue." The Policy Statement seeks to clarify the SEC's position that Mandatory Arbitration Provisions are not inconsistent with the federal securities laws, while leaving issuers to decide whether such provisions should be adopted. The Policy Statement hypothesized that, notwithstanding this clarification of the SEC's position, some issuers may choose not to adopt Mandatory Arbitration Provisions due to state law considerations-including language in recently enacted Delaware corporate law provisions that may prohibit a Mandatory Arbitration Provision[3] -or concerns about potential negative reactions from shareholders, other investors, proxy advisors and stock exchanges.

Chair Atkins stated that the Policy Statement is "among the first steps of [his] goal to make IPOs great again." He noted that "[t]he next steps in this project include enhancing accommodations for newly public and smaller companies, expanding post-IPO companies' ability to easily access the public markets to raise additional capital, simplifying disclosure requirements for executive compensation and other topics to focus on material information, and modernizing the shareholder proposal process."[4]

Federal Arbitration Act Context

The Policy Statement reflects the Commission's analysis of the Supreme Court's evolving jurisprudence relating to the FAA and case-law developments involving the intersection of the FAA and other federal statutes. The Policy Statement noted that, in the past, the federal securities statutes were thought to potentially override the FAA because Mandatory Arbitration Provisions "could be viewed as inconsistent with the federal securities statutes in at least two respects: (1) issuer-investor mandatory arbitration provisions could violate the anti-waiver provisions[5] of the federal securities statutes by foreclosing a judicial forum; and (2) such provisions could unduly impede the ability of investors to bring private actions to vindicate their rights under the federal securities laws by foreclosing class action litigation in courts."

Applying current Supreme Court precedent,[6] however, the Commission concluded that "nothing in the text of the anti-waiver provisions or any other provision of the federal securities statutes demonstrates a clearly expressed congressional intention[7] to except [Mandatory Arbitration Provisions] from the [FAA]'s policy favoring arbitration." Furthermore, while acknowledging concerns that mandatory arbitration and class-action waiver provisions may operate to impede the viability of private class-action securities litigation, the Policy Statement concluded, based on recent Supreme Court decisions, that the federal securities laws do not explicitly grant a right to bring class action claims, and that these prudential concerns do not override the FAA's policy in favor of arbitration.[8]

As a threshold matter, the Policy Statement acknowledges that there may be circumstance where the FAA is inapplicable to mandatory arbitration and class-action waiver provisions in corporate charters or bylaws. The applicability of the FAA depends on whether there is a valid and enforceable written agreement to arbitrate, which is a question that in turn has been held to depend on state contract law.[9] In other words, the question of whether corporate charters and bylaws constitute enforceable contracts between a corporation and its shareholders depends on the law of the state that governs the corporation's affairs. The Policy Statement referenced Supreme Court precedent that has interpreted the FAA to potentially preempt state laws that "target arbitration either by name or by more subtle methods."[10] However, it also noted that "neither the Commission nor the staff is well-positioned to conclusively determine when the FAA applies," and therefore, when considering acceleration requests, "the staff will focus on the adequacy of the registration statement's disclosures, including disclosure regarding [Mandatory Arbitration Provisions]."

Implications for Issuers

The Policy Statement should provide issuers, particularly those seeking to IPO, with greater certainty regarding to the SEC's views on Mandatory Arbitration Provisions. However, issuers and other companies exploring the adoption of Mandatory Arbitration Provisions should note that the enforceability of such provisions remains subject to state corporate law limits, and should carefully consider the interplay between the FAA and applicable state law. Where such provisions are permissible, boards and management should also consider whether adopting such provisions aligns with the company's governance strategy, investor expectations and litigation risk profile. It remains to be seen how proxy advisors, such as ISS and Glass Lewis, and institutional investors would react to a Mandatory Arbitration Provision adopted by a public company. In addition, even if a company is not considering the adoption of such a provision, broader market perceptions of the SEC's shift in approach may influence the likelihood of shareholder proposals relating to Mandatory Arbitration Provisions, and a company may be required to articulate its position on such provisions.

For companies that are interested in adopting a Mandatory Arbitration Provision, it is important to carefully consider a number of elements related to the arbitral process, including the arbitral forum, related rules, treatment of class actions, and alignment with the company's risk profile and litigation strategy. The Policy Statement expressly declined to provide any SEC views "on the specific terms of an arbitration provision."

Furthermore, the Policy Statement does not affect the requirement that issuers must provide a complete and adequate disclosure of material information in a registration statement. In light of this guidance, issuers that have adopted a Mandatory Arbitration Provision should continue to carefully review any disclosure regarding such provisions, which may be subject to increased public scrutiny in light of the Policy Statement.