We recently wrote about the new policy statement issued by the Securities and Exchange Commission (SEC) “that the presence of an issuer-investor mandatory arbitration provision will not impact decisions whether to accelerate the effectiveness of a registration statement under the Securities Act.” This reverses the agency’s previous position that it would not use its authority to accelerate the effective date of a company’s registration statement when the company’s governing documents contained a mandatory arbitration provision covering disputes under the federal securities laws.
The SEC acknowledged, however, that certain legal issues remain unresolved, in particular the fact that “Delaware recently amended its General Corporation Law in a way that may prohibit certificates of incorporation or bylaws from including an issuer-investor mandatory arbitration provision.” On October 9, SEC Chairman Paul S. Atkins delivered a speech in Delaware urging the state to change its statute to allow shareholder arbitration. He expressed disappointment with the Delaware statute in question (SB 95) because mandatory arbitration has many benefits such as quicker payments to harmed shareholders and reduced litigation costs. “Unfortunately,” he stated, “for public companies that consider mandatory arbitration to be a vital aspect of their dispute resolution strategy, SB 95 has effectively eliminated Delaware as an option for incorporation.” Chairman Atkins characterized this as a “giant step backward” and further emphasized: “I recognize that SB 95 was developed and became law at a time when the Commission had not made its views on mandatory arbitration clear to the public. With the benefit of clarity under the federal securities laws, I hope that the Delaware legislature will revisit the prohibition of … mandatory arbitration … with respect to federal securities law claims. Doing so can help Delaware be a leader in the reform of securities litigation.”
One related issue that Chairman Atkins did not address is whether SB95 is preempted by the Federal Arbitration Act (FAA). In its policy statement, the SEC found this preemption issue to be beyond its purview because “Congress did not authorize the Commission to administer [the FAA].” Nevertheless, it recognized that under U.S. Supreme Court rulings “a state law that ‘target[s] the enforceability of [mandatory] arbitration agreements either by name or by more subtle methods, such as by interfering with fundamental attributes of arbitration’ may be preempted by the [FAA].” As we have previously written, the FAA preempts incompatible state laws that preclude contracting parties from controlling which claims are subject to arbitration or that single out arbitration agreements for special treatment. For these reasons, we believe a strong argument can be made that the FAA preempts SB95.
Not everyone agrees with our position. We will soon be recording a podcast delving deeper into these important issues and will be joined by Professor Mohsen Manesh of the University of Oregon School of Law, who will discuss his theory that a ban on shareholder arbitration in corporate governance documents is not preempted by the FAA because there is no agreement to arbitrate, since the state that chartered the corporation is a party to the contract between the corporation and each shareholder and, by virtue of the Delaware statutory ban on including arbitration in corporate governance documents, did not assent to such arbitration. Our discussion of the recent SEC and Delaware developments could not be more timely. During the podcast, we will also discuss in detail the pros and cons of using arbitration in this context, whether arbitration may be used to resolve shareholder disputes for shares that are purchased in the secondary market and the important disclosure issues that are raised in this context. Alan will also describe his experience with the SEC in handling an IPO years ago when the SEC was anti-arbitration. We will alert you when the podcast is released.