Skip to main content
MENU
Subscribe
  • Sign Up Free
  • LOGIN
  • Subscribe
  • Topics
    • Alternatives
    • Artificial Intelligence
    • Consultants
    • Defined Contribution
    • ESG
    • ETFs
    • Face to Face
    • Hedge Funds
    • Industry Voices
    • Investing
    • Money Management
    • Partner Content
    • Pension Funds
    • Private Equity
    • Real Estate
    • Regulation
    • SECURE 2.0
    • Special Reports
    • Washington
    • White Papers
  • Rankings & Awards
    • 1,000 Largest Retirement Plans
    • Top-Performing Managers
    • Largest Money Managers
    • DC Money Managers
    • DC Record Keepers
    • Largest Hedge Fund Managers
    • World's Largest Retirement Funds
    • Best Places to Work in Money Management
    • Excellence & Innovation Awards
    • WPS Innovation Awards
    • Influential Women in Institutional Investing 2023
    • Eddy Awards
  • ETFs
    • Latest ETF News
    • Fund Screener
    • Education Center
    • Equities
    • Fixed Income
    • Commodities
    • Actively Managed
    • Alternatives
    • ESG Rated
  • ESG
    • Latest ESG News
    • The Institutional Investor’s Guide to ESG Investing
    • ESG Sustainability - Gaining Momentum
    • ESG Investing | Industry Brief
    • Innovation in ESG Investing
    • 2023 ESG Investing Conference
    • ESG Rated ETFs
    • Divestment Database
  • Defined Contribution
    • Latest DC News
    • The Plan Sponsor's Guide to Retirement Income
    • DC Money Manager Rankings
    • DC Record Keeper Rankings
    • Innovations in DC
    • DC Plan Design: Improving Participant Outcomes
    • 2023 Defined Contribution East Conference
  • Searches & Hires
    • Latest Searches & Hires News
    • Searches & Hires Database
    • RFPs
  • Research Center
    • The P&I Research Center
    • Earnings Tracker
    • Endowment Returns Tracker
    • Corporate Pension Contribution Tracker
    • Pension Fund Returns Tracker
    • Pension Risk Transfer Database
  • Careers
  • Events
    • View All Conferences
    • View All Webinars
  • Print
Breadcrumb
  1. Home
  2. GOVERNANCE
January 21, 2014 12:00 AM

Arbitration threatens to wipe out shareholder rights

Jay Eisenhofer and Michael Barry
  • Tweet
  • Share
  • Share
  • Email
  • More

    A new movement would push companies to adopt provisions that could limit shareholders' ability to protect and enforce their rights in courtrooms across the country.

    These terms would require all shareholders — including pension funds and other institutional investors — to submit to arbitration any claims they have involving their investment, or impose outright bans on shareholders participating in class actions. More than just limiting litigation, such provisions threaten to undermine the integrity of our financial markets by removing judicial oversight not only of corporations' compliance with federal securities laws, but also of corporate directors' compliance with their fiduciary obligations to shareholders.

    A pair of U.S. Supreme Court decisions — AT&T Mobility LLC vs. Concepcion et ux. (2011), and American Express Co. et al. vs. Italian Colors Restaurant et al. (2013) — have enabled corporations to avoid liability in any class action simply by including a forced arbitration clause in a service agreement, employment agreement or other contract. By upholding class waivers, these decisions override state laws demanding accountability of corporate fiduciaries and make no exception for federal statutory rights.

    Corporations have begun to seize on arbitration provisions as a way to limit shareholder rights. Because bylaws establish the contractual terms that govern a corporation, these provisions fit within the framework for forced arbitration created by recent Supreme Court precedent. And because these provisions have been adopted unilaterally by boards without shareholder approval, they represent a threat to sound corporate governance that balances the rights of shareowners against the responsibility of managers to run the business.

    The seriousness of this threat cannot be overstated. In Corvex Management LP et al. vs. CommonWealth REIT et al., shareholders of a real estate investment trust brought an action last February, arguing the company's board breached its fiduciary duty by taking unlawful actions to prevent or delay a shareholder vote on a takeover bid. The REIT's bylaws contained a mandatory arbitration provision and ban on class actions, including shareholder derivative suits, or legal actions brought by shareholders on behalf of a corporation, often against directors or executives and alleging improper management, the corporation hasn't pursued.

    On May 8, a Maryland circuit court, citing the Supreme Court precedent on a forced arbitration agreement, dismissed the litigation holding that shareholders' claims had to be submitted to arbitration even though the REIT's board unilaterally adopted the bylaw without shareholder approval.

    On July 1, in Sandalwood Debt Fund A LP et al. vs. KPMG LLP, the Appellate Division of the Superior Court of New Jersey forced investors into arbitration based on provisions in a hedge fund's engagement letters with its auditor. The plaintiffs — limited partners of feeder funds for Bernard Madoff — brought suit against KPMG after being advised that the funds had lost substantially all of their value. Holding that the claims were derivative, the court dismissed them as being subject to an arbitration provision in the fund's engagement letter with KPMG, despite the fact that the limited partners had no say in retaining KPMG and did not consent to the terms of engagement.

    The Delaware Court of Chancery might unwittingly have aided the movement to eliminate judicial oversight. In Boilermakers Local 154 Retirement Fund and Key West Police & Fire Pension Fund vs. Chevron Corp. et al., Chancellor Leo Strine last June upheld the enforceability of bylaws, unilaterally adopted by boards, which required all litigation relating to the internal affairs of the corporations be conducted in Delaware.

    If Delaware law allows boards, through the adoption of bylaws, to dictate the forum for resolution of all shareholder disputes, this may allow directors of Delaware-incorporated corporations to designate arbitration as the exclusive forum through a bylaw adopted without shareholder approval. Once it is established that boards are empowered under state law to designate a forum for resolving shareholder disputes, directors can rely on federal law to designate arbitration as the only available forum. By creating a contractual right for boards to adopt forum selection clauses in corporate bylaws, Mr. Strine might have opened a Pandora's box.

    Forced arbitration clauses containing class-action waivers in bylaws or corporate charters will have the effect of disallowing shareholders to pursue any legal remedy. Institutional investors will have no access to the courts at all. And individual investors will have no way of pursuing any claims since collective action is the only available option for them. This would effectively immunize companies and their directors and officers from class-action claims. Class actions under Rule 10b-5 of the Exchange Act of 1934 could be eliminated as well.

    The availability of judicial review of director misconduct is essential to the integrity of our public markets. If judicial oversight is eliminated, corporate law — and the existence of the fiduciary standard — no longer would be developed by judges in the public eye, but would be written in secret by arbitrators who might not have any particular expertise, and whose decisions are unreviewable. The Supreme Court has essentially encouraged corporations to create a one-sided arbitration system that deprives investors of meaningful access to justice, while shielding corporate directors from being held publicly accountable for breach of fiduciary duties.

    It is also important that shareholders maintain a private right of action as a companion to SEC enforcement. Consider the comments of Harvey Goldschmidt, former SEC commissioner: “It would be a shocking turning back to say only the commission can bring fraud cases. Private enforcement is a necessary supplement to the work that the SEC does. It is also a safety valve against the potential capture of the agency by industry.”

    Private actions supplement the SEC's enforcement efforts by providing deterrents to corporate wrongdoing in the form of litigation subject to public review. Mr. Goldschmidt was right. Compared to regulatory action, private litigation is a much more effective means of returning value to investors injured by corporate fraud. In the past three years, the SEC has recovered $2.73 billion in penalties, disgorgement and other relief in litigation stemming from the financial crisis, according to a report, “SEC Enforcement Actions, Addressing Misconduct That Led To or Arose From the Financial Crisis,” citing key statistics through Sept. 1. Private litigation during this same time period resulted in judgment or settlements of more than $16 billion, according to a March 5 report.

    Arbitration is not an equivalent remedy to judicial oversight. Appeals and other litigation procedures are unavailable in arbitration. The secretive nature of arbitration is a boon to defendants, and eliminates a key device for shareholders to force change. As for class-action waivers in bylaws, disallowing the right of shareholders to proceed collectively means the end of any legal remedy for many investors and will shield defendant companies and their directors and officers.

    Investors need to stand up and take action to prevent corporations from eliminating judicial oversight of wrongdoing. State legislatures should bar companies incorporated in their states from permitting directors to adopt arbitration bylaws without explicit shareholder approval. Federal lawmakers should make clear that eliminating the ability of individuals to protect their statutory rights is inconsistent with our nation's securities laws.

    Jay Eisenhofer and Michael Barry are directors of the law firm of Grant & Eisenhofer PA, which represents public pension funds and other institutional investors in shareholder and corporate governance legal matters.

    Related Articles
    Carlyle's lawsuit ban may entice followers
    Carlyle drops class-action lawsuit ban amid opposition
    J.P. Morgan loses arbitration to American Century
    AIG reaches $960 million settlement on class-action lawsuit
    Recommended for You
    paycheck 1550_i.jpg
    CEO compensation hits second highest level – AFL-CIO tracker
    Securities_and_Exchange_Building_i.jpg
    Investor groups defend SEC's proxy authority
    Calculator
    Tracker offers investors new information on pay vs. performance
    Sustainability Strategies: Evolving Perspectives
    Sponsored Content: Sustainability Strategies: Evolving Perspectives
    Sponsored
    White Papers
    What a Fed pivot and ‘higher for longer’ mean for emerging markets
    A Guide to Home Equity Investments: The Untapped Real Estate Asset Class
    How to Modernize a School District Retirement Plan
    Q4 2023 Credit Outlook: Price Is What You Pay, Value Is What You Get
    There's More Than One Way to Be a Climate Investor
    Exploring the Commercial Application of Artificial Intelligence
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today
    October 23, 2023 page one

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    130 E. Randolph St.
    Suite 3200
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Custom Content
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2023. Crain Communications, Inc. All Rights Reserved.
    • Topics
      • Alternatives
      • Artificial Intelligence
      • Consultants
      • Defined Contribution
      • ESG
      • ETFs
      • Face to Face
      • Hedge Funds
      • Industry Voices
      • Investing
      • Money Management
      • Partner Content
      • Pension Funds
      • Private Equity
      • Real Estate
      • Regulation
      • SECURE 2.0
      • Special Reports
      • Washington
      • White Papers
    • Rankings & Awards
      • 1,000 Largest Retirement Plans
      • Top-Performing Managers
      • Largest Money Managers
      • DC Money Managers
      • DC Record Keepers
      • Largest Hedge Fund Managers
      • World's Largest Retirement Funds
      • Best Places to Work in Money Management
      • Excellence & Innovation Awards
      • WPS Innovation Awards
      • Influential Women in Institutional Investing 2023
      • Eddy Awards
    • ETFs
      • Latest ETF News
      • Fund Screener
      • Education Center
      • Equities
      • Fixed Income
      • Commodities
      • Actively Managed
      • Alternatives
      • ESG Rated
    • ESG
      • Latest ESG News
      • The Institutional Investor’s Guide to ESG Investing
      • ESG Sustainability - Gaining Momentum
      • ESG Investing | Industry Brief
      • Innovation in ESG Investing
      • 2023 ESG Investing Conference
      • ESG Rated ETFs
      • Divestment Database
    • Defined Contribution
      • Latest DC News
      • The Plan Sponsor's Guide to Retirement Income
      • DC Money Manager Rankings
      • DC Record Keeper Rankings
      • Innovations in DC
      • DC Plan Design: Improving Participant Outcomes
      • 2023 Defined Contribution East Conference
    • Searches & Hires
      • Latest Searches & Hires News
      • Searches & Hires Database
      • RFPs
    • Research Center
      • The P&I Research Center
      • Earnings Tracker
      • Endowment Returns Tracker
      • Corporate Pension Contribution Tracker
      • Pension Fund Returns Tracker
      • Pension Risk Transfer Database
    • Careers
    • Events
      • View All Conferences
      • View All Webinars
    • Print