Statement Summary
The recent SEC policy shift to allow mandatory arbitration clauses for public companies is criticized for undermining investors’ rights, particularly for small shareholders. The policy mandates that disputes must be resolved privately, stripping the ability for collective legal action, which could deter individual investors from pursuing justice due to high costs. Critics argue that this move will lead to reduced market integrity, lower accountability for corporate misdeeds, and less transparency, as arbitrations lack public oversight. Furthermore, changes to the SEC’s Rules of Practice limit the procedural rights of those contesting these provisions, effectively silencing investor voices in regulatory matters. Advocates for investor protection see this as a significant regression in safeguarding shareholder interests and a violation of due process.
Original Statement
Good morning. Before I begin, I want to thank the staff in the Division of Corporation Finance, the Office of General Counsel, the Division of Economic and Risk Analysis and The Division of Investment Management for their work. And thank you to the operations staff who made today’s meeting possible. Also, I would like to thank Cicely LaMothe for her service as Acting Director. For those of you who don’t know Cicely, she is a public servant in the best sense of those words. She is dedicated, hard-working, thoughtful and committed to her staff and to the public good. And she does it all with a smile and unflappable composure. She has taken on this very large task—probably for longer than she anticipated—and for that we are grateful. Thank you, Cicely.
Today the Commission finds another way to stack the deck against investors—this time primarily small, retail shareholders in public companies. We do so by opening the floodgates to something called mandatory arbitration.
What is Mandatory Arbitration?
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. While, in theory, arbitration could cut costs for companies, there are real downsides for investors. 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. If that collection of things transpired in a courtroom without a party’s consent, judges would not hesitate to call it what it is: a violation of due process.
Practical Consequences of the Policy Statement
First, small shareholders will be prevented from vindicating their rights. Cases involving offering frauds, accounting misstatements or other types of public company malfeasance are usually complex, and require extensive litigation resources, multiple experts, and services that require upfront fees. For these types of claims, most shareholder investments are too small, and the costs of arbitration too high, to incentivize individual shareholder suits—even if the collective losses would more than justify the expense of litigation through class action. As one court put it,
“The realistic alternative to a class action is not 17 million individual suits, but zero individual suits, as only a lunatic or a fanatic sues for $30.”
Indeed, the primary defense of mandatory arbitration is that it provides cost savings to companies. But if every single member of a class sued in arbitration individually, there likely would not be great cost savings. Part of the reason that companies will save money is precisely because many investors will decide not to sue in the first place.
Second, the markets will go under-policed. If we erode private rights of action, not only are shareholders uncompensated for the wrong perpetrated on them, but the wrongdoers get off scot-free. There are two ways to remedy wrongdoing in our markets—(i) by governmental enforcement action or (ii) by private lawsuit. Private lawsuits can be a more efficient remedy than government action in terms of investor recompense. In 2024, securities class action settlements brought by shareholders returned approximately $3.7 billion to harmed investors. By contrast, over a similar period, Commission enforcement returned only $345 million to investors.
This may also explain why mandatory arbitration is so appealing – some companies would rather keep their ill-gotten gains than return them to harmed investors. If we chisel away at private actions, then we lean more heavily on the Commission to police the markets. But that crutch is faltering. The staff of the Commission has shrunk by approximately 16% since the beginning of the current fiscal year. But our markets have grown.
One might expect that, as we deregulate and seek less government intervention, we would lean more into an individual’s freedom to pursue her own recovery; not less. But that is apparently not the case.
Third, mandatory arbitration undermines deterrence. Deterrence is subverted, not only because wrongdoers are not held to account, but also because arbitration claims and awards are non-public. Parties bear the burden of compelled silence. 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 account, there is also no deterrence to other would-be wrongdoers.
This lack of deterrence will lead not only to more brazen misconduct, but it will also reduce the integrity of our markets. It lays the groundwork for less accurate disclosures, less reliable financial statements, and executives who are incentivized to cut corners. Less accurate market information is a solution to a problem that I don’t think exists.
Market Transparency and Integrity
Judicial resolution of shareholder disputes provides a public good. Arguments about the costs of litigation often leave out the tremendous benefits being provided. Private litigation allows the law to develop. Many seminal federal and state securities law cases have developed from private litigation. Where case law is allowed to develop, it provides for consistent and predictable outcomes for market participants. On the contrary, there is no consistency in arbitration.
This means that similarly situated investors—victims of the same mass fraud—may face significantly divergent outcomes in arbitration. That is bad for our markets, which thrive on consistency and predictability.
Finally, allowing companies to mandate arbitration squelches investor choice. It is worth pointing out the dissonance in allowing companies to strip investors of the choice to litigate in court, while touting the primacy of investor choice in other contexts—for example, in the Commission’s push to open the private markets to retail investors. This raises the unsavory specter that “freedom of investor choice” is only a Commission priority when that choice serves the goal of lining the pockets of favored business interests.
Conclusion
All of this is to say, there are compelling reasons that mandatory arbitration provisions are against the public interest and at odds with protecting investors. They deprive shareholders of fundamental rights, fundamental choices, and they fly in the face of market integrity, fairness and efficiency. And perhaps that is why today’s action is so out of step with our agency’s history. The Commission has never—either expressly or implicitly—granted permission to a public company to force their shareholders into mandatory arbitration.
To be clear—the legal analysis that staff puts forward in the Policy Statement does not demand the conclusion that we reach. Today’s actions are a matter of policy and not a matter of law. Certainly, the Supreme Court has interpreted the scope of the Federal Arbitration Act to allow for greater enforcement of arbitration agreements. But, neither the Supreme Court nor Congress has ever adjudged that the FAA requires enforcement of mandatory arbitration provisions tucked away in governance documents of public companies.
Absent unequivocal mandates from the courts or Congress to enforce forced arbitration provisions, the Commission should enforce the securities laws, which provide unequivocally that any attempt to require a shareholder to waive her rights is void.
