The End of Shareholder Litigation? Allowing Shareholders to Customize Enforcement through Arbitration Provisions in Charters and Bylaws

Article excerpt

Shareholder litigation has been heavily criticized for its inability to compensate harmed shareholders or deter managerial misconduct. While some have suggested abolishing shareholder litigation altogether, this Article takes a more moderate approach. I propose allowing shareholders to enforce charter and by-law provisions that require arbitration of certain disputes. For example, an acquisitive company may require arbitration of merger-related suits while allowing non-merger suits to proceed in court. Likewise, a company in an industry known for volatile stock prices could require a price drop of three or four standard deviations before the suit could be brought in court, rather than arbitration. Because enforcement would be customized on a company-by-company basis, shareholders could set a better balance between costs and benefits than the ham-fisted, one-size-fits-all regime functioning today. This proposal requires no legislative action; it requires only that the SEC bring its statutory interpretation in line with current Supreme Court precedent.

Contents

I. INTRODUCTION ......................................................... 67

II. THE THEORY, CRITICISMS, AND PROPOSED REFORMS OF SHAREHOLDER LITIGATION ......................................................... 69

A. Balancing Shareholder Costs ......................................................... 69

1. The direct costs of fraud ......................................................... 69

2. Collateral costs of fraud ......................................................... 70

3. Costs of preventing fraud ......................................................... 71

B. Shareholder Litigation Theory ......................................................... 72

1. Sources of shareholder litigation ......................................................... 72

2 . Purpose and problems of shareholder litigation ......................................................... 73

a. Compensation theory, pocket-shifting, and welldiversified investors ......................................................... 73

b. Deterrence .........................................................75

c. Other justifications: corporate governance and informed trading ......................................................... 75

d.Costs ......................................................... 78

e. Unintended consequences ......................................................... 79

3. Past proposals for reform ......................................................... 80

III.The Remedy: Freedom to Arbitrate ......................................................... 81

A. Allowing Arbitration ......................................................... 81

1 . Why an arbitration provision will likely be enforceable ......................................................... 81

2. Setting loose the "laboratories of corporate governance" ......................................................... 82

B. Pros and Cons of Arbitration ......................................................... 83

1. Costs ......................................................... 83

a. Procedural costs ......................................................... 83

b. Liability costs ......................................................... 85

c. Feedback between liability costs and procedural costs ......................................................... 86

d. Spillover costs ......................................................... 87

2. Speed ......................................................... 87

3. Expertise ......................................................... 88

4. Customization improves the overall balance ......................................................... 89

5. Advantages over other reform proposals .......................................... …