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The Future of U.S. Securities Class Actions – at Risk? The Rise of Forced Shareholder Arbitration

Posted by Erick Stern on Oct 3, 2018 5:23:27 PM

History and expansion of arbitration in the United States

The U.S. Federal Arbitration Act (FAA) was passed on 1925. Since then, the Supreme Court has interpreted it on a number of cases, finding that the FAA prevents state legislation from prohibiting or limiting the use of arbitration clauses in all sort of contracts, even those designed to protect workers’ rights (Epic Systems Corp. v. Lewis 584 U. S. ____ (2018)), or consumer’s rights (AT&T Mobility v. Concepcion, 563 U.S. 333 (2011)). Consequently, arbitration clauses have become more common. It has become almost impossible to challenge arbitration clauses, even if they hinder access to justice and while challenges may still be brought, the arbitration panel itself must examine them.

Securities law and arbitration

Claims based on the Securities Act of 1933 have been particularly immune to this arbitration trend because Section 14 of the Act voids any “condition, stipulation, or provision binding any person acquiring any security to waive compliance with any provision of this title or of the rules and regulations of the Commission.”  However, due to precedent favoring the FAA, it is not clear that such anti-waiver provisions are absolute. To date, it has been the SEC’s informal policy that mandatory shareholder arbitration provisions violate the anti-waiver section of Section 14. In fact, the SEC has successfully convinced companies going public not to include such clauses in their bylaws (Carlyle Group, Pfizer, Gannet and Google), by delaying approval of their IPOs. On February 22, 2012, the SEC sent a letter to Pfizer expressing that: “The proposal would amend the bylaws to provide that certain controversies or claims, including those arising under the federal securities laws, shall be settled by arbitration…We note that there appears to be some basis for your view that implementation of the proposal would cause the company to violate the federal securities laws”. However, it is unclear what the outcome would be if the issue were to be litigated, and alternatives such as a “class arbitration” have never been discussed.


SEC stance

The current SEC chairman has shifted from the SEC’s previous stance of openly opposing mandatory shareholder arbitration, to expressing uncertainty about whether such clauses would be appropriate. This change is surprising, since corporations would rather have one class action instead of 100 different arbitral proceedings, which increase both the money and time costs.


Investors’ stance

On May 1, 2018, 133 organizations, including investment firms, consumer protection organizations and State entities, sent a letter to the SEC’s chairman stressing the importance of securities class actions as a means of safeguarding the rights of the investor public. On August 21, 2018, the Consumer Federation of America, a group comprising almost 300 consumer protection organizations, published a white paper on which similar points were argued. According to both documents, both retail and institutional investors benefit from a system that allows them to band together and keep a closer look at corporate misconduct.



Recent legislative developments have protected banks and financial institutions from class action lawsuits. In July 2017, the CFPB issued rules prohibiting mandatory arbitration clauses for consumer financial products and services. These rules played a pivotal role in forcing Wells Fargo into a class action brought by shareholders seeking compensation for the loss of the company’s value following the explosion of the scandal related to the illegal creation of millions of unauthorized consumer savings accounts.  However, just four months later, on November 2017, Congress repealed the mandatory arbitration prohibitions using the powers provided to it by the Consumer Review Act and opening the door to mandatory arbitration. Furthermore, the Senate is currently studying the so-called Financial CHOICE Act, which purports to eliminate Section 1028 of the Dodd-Frank act, which restricts mandatory pre-dispute arbitration for consumer financial products or services. As a result of the November rollback, Equifax, the consumer credit reporting agency that compromised the data of almost 150 million clients, was able to avoid a class action.  This prompted Richard Cordray, the head of the CFPB, to step down. To add insult to injury, on May 16, 2018, Andrew M. Smith, lawyer for Equifax, was appointed to head the Federal Trade Commission’s Consumer Protection Unit.


The recent developments at the SEC and the Supreme Court indicate that mandatory arbitration clauses for securities cases may soon receive green light, even over the objections of investors. Whether shareholders will meet the fate of other consumer groups and lose the ability to pursue class actions, remains to be seen.

Topics: U.S. Securities Class Actions, Arbitration