The SEC Reverses Course on Mandatory Arbitration: What are the Implications for Institutional Investors

October 28, 2025

On September 17, 2025, the Securities and Exchange Commission (SEC) issued a policy statement reversal that allows companies seeking to “go public” to include provisions in their governing documents that attempt to force shareholders into arbitration in the event those companies violate the federal securities laws. Proponents of the change argue it will discourage the frivolous filing of shareholder class action suits as well as improve efficiency and speed in resolving disputes by avoiding lengthy court procedures and appeals, while reducing costs for all parties. But opponents insist it will undermine confidence and stability within U.S. capital markets and threaten investors’ longstanding rights to recover losses on a class-wide basis in a proceeding that provides them with full due process. What’s going on?

[“Going public” refers to the process by which a privately held company becomes a publicly traded company by offering its shares to the public through a stock exchange, typically by means of an Initial Public Offering (IPO). Prior to this recent action, the SEC had a long-standing but unwritten policy in which the agency blocked efforts by companies to ban shareholder class action lawsuits in the newly public company’s charter and bylaws by mandating that shareholders pursue arbitration instead.

As SEC Commissioner Caroline A. Crenshaw (D) explained in her dissenting vote on the new policy, such mandatory arbitration “forces harmed shareholders to sue companies in a private, confidential forum, instead of a court and without the benefit of proceeding in the form of a class action,” with what she referred to as “real downsides for investors.” For example, she underscores that arbitrations are “typically more expensive for individual shareholders; they are not public; they have no juries; they lack consistent procedures; arbitrators are not bound by legal precedent; arbitration precludes collective action among shareholders; there are limited rights of appeal; and, ultimately, there is no assurance that two identical investors would get the same outcome.”]

Technically, Crenshaw explained, the SEC took two steps in its September 17^th action. First, she said, the Commission issued a policy statement dictating that staff make public-interest findings without considering whether a corporation has forced its shareholders into mandatory arbitration.

As a recent post in the Harvard Law School Forum on Corporate Governance by Emily Drazan Chapman, Neil McCarthy, and James Palmiter with DragonGC elaborates, this means that a company’s inclusion of a provision requiring mandatory arbitration will no longer create a “regulatory uncertainty that previously deterred companies from including arbitration provisions in their corporate documents.” That is, SEC staff will now focus instead solely on the adequacy of disclosures when evaluating an “acceleration request” — a written request from a company and its underwriters to the SEC to make its registration statement effective on a date earlier than the standard 20-day waiting period, thus allowing an IPO to launch sooner by speeding up the process.

In short, such an acceleration request will no longer be denied solely because the company uses mandatory arbitration, with the SEC staff focusing instead on adequate disclosure of that provision, including proper disclosure of any arbitration provision itself. As the authors of the Harvard item explain, this means that “companies can now confidently include mandatory arbitration provisions without concern that they will delay or complicate the registration process for future securities offerings.” [DragonGC offers a platform designed to streamline shareholder communication, compliance, and corporate governance to support public company legal teams by helping public and pre-IPO companies improve their transparency, efficiency, and compliance.]

The second part of the SEC’s action, Crenshaw said, was to amend the SEC’s Rules of Practice “to ensure that no Commissioner or third party can effectively intervene to challenge those public-interest findings.”

Indeed, SEC Chair Paul Atkins (R) stressed in his statement on the Commission’s action that the Commission’s “statutory criteria in deciding whether to accelerate the effectiveness of a registration statement is to ensure complete and adequate disclosure of material information to the public.” “In other words,” Atkins said, “the Commission is not a merit regulator that decides whether a company’s particular method of resolving disputes with its shareholders is ‘good’ or ‘bad.’” Therefore, he underscored, “the Commission should not participate in a debate on whether mandatory arbitration provisions are ‘good’ or ‘bad’ for companies and their shareholders,” but should instead “focus on ensuring complete and adequate disclosure of material information concerning a company’s mandatory arbitration provision, if one exists.”

Finally, it should be noted that the SEC’s action in issuing a policy statement, rather than a formal rule, means it is not subject to public notice and comment.

This action by the SEC – and the fact it was done without a formal rulemaking — has raised concerns with institutional investors and the securities litigation firms that help them recover damage when securities laws have been violated. For example, the Council of Institutional Investors (CII) has reiterated that for over a decade, it has “stood firmly against the use of forced arbitration clauses in corporate charters and bylaws,” arguing that such provisions “undermine shareholder rights by restricting access to judicial forums.”

Specifically, CII points to section 1.9 (Judicial Forum) of its Corporate Governance Policies, that states: “Companies should not attempt to bar shareowners from the courts through the introduction of forced arbitration clauses.”

The California Public Employees’ Retirement System (CalPERS), a valued NCTR retirement system member, has also strongly registered its opposition to the SEC action. On the eve of the Commission’s consideration of the policy change, CalPERS filed a letter with the SEC, asking that it be included in the official record of the Commission’s open meeting scheduled for September 17^th. In the letter, CalPERS’ Chief Executive Officer Marcie Frost said CalPERS was “deeply concerned that such a policy change would undermine the rights of investors to seek collective redress in court, weaken market discipline, and erode the protections that are fundamental to the integrity of U.S. capital markets.”

Specifically, Frost emphasized that “[w]hen companies break the law, shareholders need the right to join together to hold them accountable in court and recover their losses.” She also stressed that forced arbitration would not only reduce recoveries for harmed investors but also “diminish the deterrent effect that class actions provide.” For example, she pointed out that in 2024 alone, “private securities class actions returned approximately $2.74 billion to investors, compared to $345 million distributed through SEC enforcement actions,” underscoring “the critical role that private litigation plays in complementing government enforcement and ensuring meaningful compensation for investors harmed by violations of securities laws.”

CalPERS also expressed its belief that at a minimum, “any change of this magnitude should proceed only through a formal notice-and-comment rulemaking process that allows for robust input from investors, companies, and the public.” Finally, Frost reiterated that CalPERS “will continue to advocate for strong governance and will encourage companies considering IPOs to reject forced arbitration provisions that erode investor rights,” stressing that forced shareholder arbitration “has no place in the registration documents of a well-governed public company.”

Will such a warning have an impact on future IPOs? According to Hannah Ross, a partner with valued NCTR Commercial Associate member Bernstein Litowitz Berger & Grossmann LLP, her firm is “coordinating” with Bleichmar Fonti & Auld LLP and Robbins Geller Rudman & Dowd LLP and other firms who are also valued NCTR members in a response to the SEC’s actions. In it, the point will be made that “companies will not benefit from forced arbitration” as this will “give rise to immediate legal challenges and impose significant costs and, over the longer term if allowed to stand, lead to numerous, time-consuming, and costly individual arbitrations.”

These multiple arbitrations “will inevitably inconvenience corporate executives who will have to respond to seriatim [taking one subject after another in regular order; point by point] discovery requests and provide live testimony in tens if not hundreds of separate depositions, with no efficient mechanism for class-wide resolution or finality, and often without the right to appeal an adverse judgment,” their draft letter to the SEC states.

In the item by DragonGC, noted earlier, the potential benefits of implementing mandatory arbitration provisions are described as “substantial and multifaceted.” For example, companies “can realize significant cost savings through streamlined arbitration processes that typically resolve disputes more quickly and with greater predictability than court litigation,” their Harvard submission notes. “The elimination of class action exposure for securities law claims represents perhaps the most significant benefit, as class action settlements can reach tens or hundreds of millions of dollars even in cases with questionable merit,” it is noted.

In short, from a risk management perspective, mandatory arbitration provisions “can help companies avoid the substantial costs and reputational risks associated with high-profile securities class actions.” However, DragonGC also observes that the implementation of mandatory arbitration provisions “carries meaningful risks that must be carefully evaluated.” For example, they point out a significant potential for negative shareholder reactions. “Institutional investors have increasingly viewed limitations on legal remedies as contrary to good governance principles, and many have adopted policies opposing such provisions,” it is pointed out.

Finally, what is referred to as “the broader stakeholder capitalism movement and increasing focus on corporate accountability” may also influence how investors and other stakeholders view mandatory arbitration provisions. Therefore, it is recommended that companies “must consider whether such provisions align with their public commitments to transparency and stakeholder engagement, particularly in an environment where corporate governance practices are under increasing scrutiny.”

In summary, DragonGC states that companies considering the implementation of mandatory arbitration provisions should consider engaging in comprehensive risk management planning to cover:

Legal risks, including ensuring compliance with applicable state laws, preparing for potential challenges to provision enforceability, and maintaining adequate disclosure to meet SEC expectations.
Reputational risks involving managing negative publicity and stakeholder reactions, addressing proxy advisor concerns and recommendations, and maintaining consistency with broader corporate governance principles and ESG commitments.
Operational risks, including ensuring that arbitration procedures are fair and accessible to investors, maintaining adequate resources to manage arbitration proceedings, and developing internal expertise in arbitration administration.
Financial risks encompassing the costs of arbitration administration and proceedings, potential impacts on stock valuation and investor interest, and the need to maintain appropriate insurance coverage for arbitration-related risks.

Therefore, it is unclear whether mandatory arbitration will be widely adopted in new IPOs, at least initially. In the meantime, institutional investors may wish to consider whether and how to register their opposition.

For example, forcing shareholder cases into arbitration is seen as contrary to the interests of investors because forced arbitration “cannot come close to matching the deterrent effect of litigation,” securities litigation firms argue. Forced arbitration proceedings are private, they point out, and do not provide for consistency in the law, as arbitrators are not bound by legal or judicial precedent, nor do they publish judicial opinions.

Erin Woods, Director of Institutional Investor Relations at Bleichmar Fonti & Auld LLP and the head of the firm’s Claims Filing Team agrees. “Requiring thousands of individual arbitrations is an inefficient process that will drag on for many years – much longer than a typical securities class action,” she warns, pointing out to NCTR that different arbitrators will issue varying decisions that will remain confidential, thereby preventing transparency and accountability. “This process will reduce investor confidence in the integrity of the U.S. markets and may ultimately discourage investment,” Woods concludes.

SEC Commissioner Crenshaw also underscored in her remarks on the Commission’s actions that deterrence is subverted, “not only because wrongdoers are not held to account, but also because arbitration claims and awards are non-public.” She stresses that defrauded investors who are not part of an arbitration “may not know they have been defrauded, nor may the markets, paving the road for the same company to inexpensively engage in the same misconduct again in the future.” And, where there is no public accountability, “there is also no deterrence to other would-be wrongdoers,” she emphasizes.

“This lack of deterrence will lead not only to more brazen misconduct, but it will also reduce the integrity of our markets,” Crenshaw warns, saying it “lays the groundwork for less accurate disclosures, less reliable financial statements, and executives who are incentivized to cut corners.”

Furthermore, as Hannah Ross pointed out to NCTR, “if companies start adopting forced shareholder arbitration clauses, investors will lose millions in recoveries from fraud, and there will be little to no enforcement of state and federal securities laws.” Specifically, she notes that in the 30 years since the Private Securities Litigation Reform Act was adopted, private securities class actions have recovered approximately $100 billion for harmed investors, particularly for absent class members. “This dwarfs recoveries for harmed investors by the SEC in the same period,” she points out. Also, the SEC is now facing significant funding and staffing constraints regarding its enforcement efforts. (For more in this regard, see the “NCTR FYI” for August 11, 2025, entitled “Challenges to Trustee Management of Plan Assets.”)

Regardless of your views concerning securities litigation, shareholder legal actions are seen as critical in order for all investors to recoup losses from fraud. Furthermore, most investors benefit as absent class members, receiving recoveries passively each year through established claims filing systems, securities litigators point out. With forced arbitration, investors will be compelled to individually bring their own arbitration action in order to obtain any possibility for recovery of investor losses.

The consequences of the new SEC action can therefore be significant for public pension plans and the integrity of their investments. NCTR members may want to pay careful attention as the reactions to this change – described by DragonGC as a “watershed moment in securities regulation that will likely influence corporate governance practices for years to come” – play out.