Like winter in Westeros, the fight over mandatory arbitration of shareholder disputes is coming. We don’t know when. We don’t know where. But thanks to a recent SEC ruling, we’ve now learned this much: the great battle probably won’t be waged via a Johnson & Johnson proxy vote.
For any viewers who have forgotten details of the epic drama, a quick recap. Two seasons ago, in 2017, the man at the throne of the SEC, Jay Clayton, was executing on a plan to make the process of going public less burdensome for corporations (thus furthering his ultimate goal of letting the investing public share in their success). Toward that end, Clayton took certain actions, like allowing companies to submit IPO registration statements confidentially.
Then things got extreme. In 2017, then-SEC Commissioner Michael Piwowar floated the radical idea of letting IPO-bound companies require shareholders to take disputes to arbitration, not court. We called this a “potentially Earth-shaking development,” because, as Bloomberg explained, historically the SEC “has considered the right to sue a crucial shareholder protection against fraud.” In fact, the SEC (along with investors and lawmakers) pressured the Carlyle Group to drop a mandatory arbitration provision from its IPO materials back in 2012.
But with widespread reports that the SEC was considering the idea, the battlefield appeared to be set. The inevitable fights over the mandatory arbitration of shareholder disputes, it seemed, would take place in the context of an IPO.
That’s where the J&J plot twist comes in. An arbitration proponent named Hal Scott (he’s also a Harvard professor representing certain J&J stockholders), decided to press the issue in the form of a shareholder proposal. Scott’s proposal would have forced a vote by J&J’s stockholders on a plan to funnel all shareholder suits against the company into private arbitrations.
His attempt to make J&J a test case failed, however, when the SEC allowed the company to exclude the proposal from its proxy ballot. In so doing, the SEC bought at least part of J&J’s argument that the proposal, if voted forward, would have violated federal and state law. The SEC said it ruled for J&J on the ground that New Jersey state law would prohibit mandatory arbitration. Meanwhile, the commission sidestepped a ruling on the proposal’s legality under federal law. Chairman Clayton applauded that approach given “the unsettled and complex nature of this issue, as well as its importance.”
Michael Piwowar’s statements from a year and a half ago notwithstanding, SEC leadership now recognizes the mandatory arbitration issue as something of a hot potato. Clayton told the Wall Street Journal “he wants to avoid a brawl over a subject that would pit business groups against investors and likely splinter his agency along party lines.” That’s consistent with the statement he put out in which he said “[a] court is a more appropriate venue to seek a binding determination” on the mandatory arbitration proposal.
The courts may be the ultimate venue for the fight over arbitration of shareholder disputes. Hal Scott, for his part, noted that he can appeal the SEC’s decision to a federal court.
Wherever this battle is held, and whenever it comes, one has to wonder whether some drama has gone out of it. Despite the best efforts of Clayton’s SEC, the incentives for going public are trending in the wrong direction, at least temporarily. A Goldman Sachs report just concluded that due in part to the availability of private investment, over the last two years the biggest new public companies would have created more value by staying private.
Even so, we expect that loyal viewers will be very interested to see how the long-running mandatory arbitration drama finally plays out.