Stockholder Adoption of Mandatory Individual Arbitration for Stockholder Disputes
Scott, Hal S., Silverman, Leslie N., Harvard Journal of Law & Public Policy
INTRODUCTION I. THE SHORTCOMINGS OF CLASS ACTIONS A. The Uncertain Benefits of Securities Class Actions 1. Compensation of Plaintiffs 2. Deterrence B. The High Costs of Securities Class Actions II. THE CASE FOR MANDATORY INDIVIDUAL ARBITRATION A. Benefits of Arbitration B. Responses to Critics of Arbitration 1. Majority Can Bind Minority and Future Stockholders through By-law Amendment 2. Individual-Only Arbitration is Permitted by Federal Arbitration Act 3. Mandatory Individual Arbitration of Securities Claims is Not Unfair 4. Mandatory Arbitration Denies Stockholders a Right to Litigate 5. Mandatory Individual Arbitration Does Not Violate the Securities Laws 6. The Need for Adequate Notice and Other Procedural Protections C. An Alternative CONCLUSION APPENDIX 1: DRAFT STOCKHOLDER RESOLUTION Stockholder Resolution Supporting Statement APPENDIX 2: BY-LAW AMENDMENT
Federal Rule of Civil Procedure 23 and the Private Securities Litigation Reform Act of 1995 (PSLRA) 1 together govern securities class actions. These regimes provide that a class representative may bring a claim against a corporation on behalf of all investors who owned a security at a time when there was an alleged misstatement or failure to disclose a material fact that caused loss. By default all potential members of a class--all investors who owned the security during the relevant time (before the misstatement or omission was corrected)--are included in the class unless they take the affirmative step of opting out. Inertia, therefore, works to expand the class.
Allowing stockholders to vote to adopt mandatory individual arbitration gives them a choice whether to accept the uncertain benefits and high costs of securities class actions. Securities class actions have two principal rationales: compensation and deterrence. (2) The case for compensation is weak and generally rejected by commentators. Long-term stockholders end up suing themselves while recoveries are offset by plaintiff attorneys' fees amounting to 25-35% of the settlement (3) and defense costs in the same range. (4) At the same time, choosing which short-term stockholders recover and which pay is decidedly random, given that shares are held on average for just slightly longer than one year. (5) Further, securities class actions generally do not provide redress to smaller stockholders. Indeed, smaller investors often do not bother to collect their settlements because they are so small--we have all experienced throwing class action notices in a wastebasket. Courts left with unclaimed funds often give them to the parties that filed claims in a second round of pro-rata distribution and even sometimes to charity.
The case for deterrence is ambiguous at best. First, private securities class actions supplement the United States' robust system of public civil and criminal enforcement through the actions of the Department of Justice (DOJ), the Securities and Exchange Commission (SEC), and state attorneys general and securities enforcement officials. (6) Second, the settlements and
We are grateful for the substantial contributions of Andrew G. Coombs (Associate, Cleary Gottlieb Steen & Hamilton LLP), Eric M. Fraser (former Executive Director for Research, Committee on Capital Markets Regulation), and Pamela L. Marcogliese (Partner, Cleary Gottlieb Steen & Hamilton LLP). The views expressed in this paper should not be taken as the views of Cleary Gottlieb Steen & Hamilton LLP or the Committee on Capital Markets Regulation. judgments primarily impact stockholders, not management. Managers seeking short-term profits from stock performance are unlikely to be deterred by the later possibility of class actions whose impact will fall on all stockholders. …