ISS SCAS Says Mandatory Arbitration Will “Supercharge” Securities Litigation
The recent decision by the Securities & Exchange Commission (SEC) to permit companies making initial public offerings (IPOs) to adopt provisions in their charters or bylaws requiring investors to bring any securities law claims in arbitration as opposed to court is NOT “a stake in the heart of securities class actions,” but will serve instead to “supercharge” securities cases, according to a recent “White Paper” by ISS Securities Class Action Services (ISS SCAS), a provider of fully outsourced global claims filing, portfolio monitoring, and research. To learn more about the implications of the SEC’s action, there is still time to register for NCTR’s members-only webinar on this important subject this Thursday afternoon, December 11, at 3:00 p.m. (ET).
“While intended to curb frivolous lawsuits, the shift may spark a surge in individual claims, disrupt insurance markets, and create new opportunities for investors and litigation funders,” according to Donald Grunewald Director of Litigation Analysis for ISS SCAS.
The ISS SCAS White Paper begins by discussing how the Private Securities Litigation Reform Act (PSLRA), passed in 1995 to also curb frivolous lawsuits, was seen as a potential “death knell” for securities class actions. However, as the ISS SCAS paper explains, while the PSLRA provisions seemed Draconian — and the “future seemed bleak for plaintiffs” – in fact, in the years after the law, “securities litigation in fact burgeoned.”
Why did this happen? The White Paper notes that institutional investors soon realized that they routinely had larger losses than retail investors and that now they had sixty days to properly evaluate whether claims were meritorious before acting. “It was no longer a race to the courthouse but now one for law firms to marshal the best facts and pick the strongest cases,” the White Paper stresses. Also, public knowledge of settlements permitted the public to “see which settlements could provide significant recoveries” and as a result institutional investors’ active participation and filings “expanded dramatically.”
Next, the White Paper discusses why it is “unlikely that the option to arbitrate will end securities class actions as we know it.” For example:
- There are a number of legal obstacles. First, Delaware, “still the chosen place of incorporation for the bulk of public companies,” currently prohibits such clauses. Also, shareholders could argue that these clauses are not contracts and so “cannot bind them with respect to secondary market transactions.”
- Shareholders might not ratify such clauses or might enjoin boards from adopting such provisions.
Also, the White Paper argues that if all (or most large) U.S.-listed companies adopted such provisions, “securities litigation could emerge stronger.” That is, issuers would “risk responding to multiple arbitrations, perhaps thousands, providing more opportunities for investors, opposed to the finality of a class action in court.” Also, any recoveries in arbitration would be confidential, but the White Paper suggests PSLRA’s requirement to publicly disclose settlement terms “seemingly was intended to protect defendants.” Finally, it is noted that attorneys’ fees in class actions have to be approved by the court; “plaintiffs proceeding individually can choose what they pay.”
The White Paper then discusses a process whereby Investors assign their claims to a foundation or other special purpose vehicle, known as a “Stichting,” which occurs in the Netherlands. “In a universe where securities class actions cease to exist, deep-pocketed litigation funders could buy the claims of many large investors in a large securities case and then fund arbitrations on behalf of consolidated bundles of claims, potentially even offering to take a contingent stake in the claims,” the White Paper suggests. However, this process does not appear to be catching on in the U.S., and it is unclear whether it would.
Also, the White Paper suggests plaintiffs in arbitrations may push for much higher percentages of their damages, noting that the “increased speed and informality of arbitration may also spur plaintiffs to push farther.” As a result, the White Paper suggests defendants and their insurers might actually pay more rather than less. The White Paper therefore warns that “in a world where insurers will also have a much harder time obtaining information about settlements to properly price policies and set reserves,” the directors and officers (D&O) insurance market will become “much less efficient economically.” And therefore more costly?
In summary, the ISS SCAS White Paper emphasizes that issuers and defense attorneys “should not necessarily be gleeful at the possibility of adopting arbitration clauses for securities claims.” After all, it is pointed out, the PSRLA “appeared to be a master stroke against securities class actions, affording only the most meritorious claims a means of succeeding.” But securities litigation actually blossomed.
The White Paper concludes that, as arbitration becomes a potential forum for the resolution of securities claims, “it is important to remember that institutional investors that manage billions or even trillions of dollars are savvy, as is the plaintiff’s bar.” Accordingly, the “only thing that is certain about the future is that no matter what the situation, those that adapt will succeed” and “[a]s history shows with the PSLRA, no one can ignore the law of unintended consequences.”
Will NCTR’s distinguished panelists agree? Is there nothing to really be concerned about? To find out, don’t miss NCTR’s webinar this Thursday at 3:00 p.m. (ET). Remember, NCTR understands governmental retirement systems and always tailors its presentations to be sure to reflect the unique environment in which public plans must operate.