SEC Grants Preference to IPO Issuers Seeking Exemption from Class-Action Lawsuits
The United States Securities and Exchange Commission (SEC) has made a controversial decision to allow companies seeking to go public to require investors to resolve claims of fraud or false statements through arbitration, rather than court litigation. The decision, made in a 3-1 vote along party lines, has sparked a heated debate among various stakeholders.
In a policy statement, not subject to public notice and comment, SEC Chair Paul Atkins clarified that the commission is not a merit regulator that decides whether a company's method of resolving disputes with its shareholders is good or bad. Atkins' statement follows the SEC's decision to reverse a long-standing but unwritten policy that previously blocked the Wall Street debuts of companies that want to ban shareholder class action lawsuits.
The change has been met with criticism from some quarters. Ann Lipton, a former class action litigator at the University of Colorado law school, argued that the change would be damaging to the public interest. Consumer advocates and plaintiffs' lawyers share this sentiment, stating that court action helps hold companies accountable, gives small investors the chance to recover damages they otherwise couldn't, and gives the public access to evidence and legal reasoning that helps build case law and inform public policy.
On the other hand, corporate interest groups and Republicans have long complained about what they see as the frivolous filing of shareholder class action suits. Erik Gerding, former director of the SEC's division of corporation finance, expects a "sudden upsurge" in companies seeking to benefit from the change. Companies likely to benefit from the new rule are those that seek to avoid lengthy, costly legal battles and prefer faster, confidential dispute resolution.
This includes startups, media companies with investor agreements, and firms involved in complex financing structures with arbitration clauses. Examples include LegalTech startups offering digital arbitration platforms and companies with fail-fast clauses that benefit from streamlined conflict resolution. CalPERS, the California public pension fund, has voiced concerns that forced arbitration would "diminish the deterrent effect" of class actions.
In a separate matter on Wednesday, the SEC extended for a second time the deadline for private investment funds to comply with Biden-era regulations requiring enhanced disclosures. The SEC's decision could also impact established public companies looking to reduce litigation exposure. Caroline Crenshaw, the commission's lone remaining Democrat, criticized the new policy, stating it would "open the floodgates" to mandatory arbitration and deny many shareholders their rights. If harmed investors cannot band together in a class action, they may not sue at all due to the high cost of individual legal action, according to Crenshaw.
The issue first gained prominence in 2012 with the private equity fund Carlyle Group's planned IPO, which sought to require future shareholders to resolve disputes in arbitration. The SEC's decision is a significant shift in policy and is expected to have far-reaching implications for the corporate world.
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