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December 11, 2017 Articles

NLRB Dynamics and the Potential Impact on Securities Class Actions

By Mark Kantor

On October 2, 2017, the U.S. Supreme Court heard oral argument in the three consolidated cases involving the policy of the National Labor Relations Board (NLRB) prohibiting arbitration clauses in employment agreements that bar class actions (Epic Systems Corp. v. Lewis, Ernst & Young LLP v. Morris, and National Labor Relations Board v. Murphy Oil USA).

Many observers believe the Court's decision in these cases will come down to Justice Anthony Kennedy's vote. Reuters characterized Justice Kennedy's questions as "pro-employer."

Justice Anthony Kennedy, often the swing vote in major cases, asked questions that appeared to favor employers, as did two fellow conservatives, Chief Justice John Roberts and Justice Samuel Alito.

Kennedy indicated that a loss for workers would not prevent them from acting in concert because they would still be able to join together to hire the same lawyer to bring claims, even though the claims would be arbitrated individually. That would provide "many of the advantages" of collective action, Kennedy said.

Bloomberg picked up on the same Kennedy comment:

Anne Howe, the respected Court-watcher writing on her own blog Howe on the Court and on Scotusblog, started her review of the proceedings with her bottom line; "In the first oral argument of the new term, a divided Supreme Court seemed likely to uphold employment agreements that require an employee to resolve a dispute with an employer through individual arbitration, waiving the possibility of proceeding collectively."

Not often noted in the analyses of these cases, the NLRB regulatory policy at issue in Epic Systems et al may in any event become moot. The board of the NLRB now has a Republican majority. Moreover, the incumbent NLRB general counsel (a separate position appointed directly by the president, not the NLRB board, and subject to Senate confirmation), who actually argued the cases for the NLRB, is scheduled to leave his post in November, thereby opening up that position to a Republican nominee. It would not at all be surprising for Republican control of the NLRB to result in a reversal of this NLRB policy, just as Democratic control of the NLRB led to promulgation of the policy in the first place. This dispute is a reminder that many aspects of U.S. arbitration are now a partisan political issue, with regulatory measures addressing arbitration shifting back and forth as political party control shifts back and forth.

Potential Impact on Securities Class Actions
More broadly, the precedential impact of a Supreme Court ruling overturning the NLRB's pro-class action policy may extend far beyond employment and consumer-related claims. For many years, the U.S. Securities Exchange Commission (SEC) has maintained an informal policy of refusing to register public offerings of stock by companies that include mandatory arbitration clauses in their charter documents for disputes between shareholders and the issuing company. As a result, shareholder law suits (such as shareholder class actions) are brought in the U.S. courts.

In July of this year, Republican SEC Commissioner Michael Piwowar stated publicly that the SEC is now open to the idea of allowing companies contemplating initial public securities offerings to include mandatory shareholder arbitration provisions in their company charter documents. If implemented, that idea could arguably kill off shareholder securities class actions in the U.S. courts. One might think that a Republican majority of commissioners on the SEC would be amenable to changing the SEC's shareholder claims policy barring arbitration. It is not, however, yet clear whether the SEC's new Republican Chairman Jay Clayton is also receptive to the idea.

On October 6, the U.S. Department of the Treasury weighed in on the issue in a report, "A Financial System That Creates Economic Opportunities Capital Markets," making proposals and recommendations for changes in regulation of the U.S. capital markets. The treasury made the following recommendation at pp. 35 and 204:

Treasury recommends that the states and the SEC continue to investigate the various means to reduce costs of securities litigation for issuers in a way that protects investors' rights and interests, including allowing companies and shareholders to settle disputes through arbitration.

The Treasury Report did not further discuss the arbitration recommendation. Immediately before making the recommendation, however, the report took direct aim at shareholder class actions, thereby indicating exactly what motivated the arbitration recommendation (footnote citations omitted):

Concerns on Class Action Litigation
The potential for class action securities litigation may discourage companies from listing their shares on public markets and encourage companies that are already public to "go private" rather than face the cost and uncertainty of securities litigation. . . . The number of securities class action lawsuits filed in the U.S. has steadily increased from 151 in 2012 to 272 last year, though this total is significantly below the recent peak in 2001, when 498 securities class action lawsuits were filed. In the first nine months of 2017, 317 such lawsuits have been filed. This increase in lawsuits is particularly notable given the smaller number of public companies, meaning that securities issuers face a greater likelihood of lawsuits. In 2016, a record 3.9% of exchange-listed companies faced a class action securities lawsuit (not including additional securities lawsuits related to mergers and acquisitions or Chinese reverse mergers). . . . Some observers have argued that securities class action lawsuits are a means for shareholders to hold company managers accountable and potentially deter future securities law violations. However, class action securities lawsuits have been criticized as an economically inefficient way to address securities law violations. Because judgments and settlements are funded from corporations' assets or their insurance policies, the shareholder plaintiffs' recovery is funded indirectly from the investments of other shareholders. Transaction costs are also high, as plaintiffs' and defendants' legal fees in securities litigation have totaled billions of dollars over the last 20 years, reducing payments to shareholders. Thus, securities class actions can significantly benefit attorneys at the expense of shareholders.

It seems clear that the treasury recognizes this is a matter within the competence of the SEC (and, for "blue sky" regulation by the 50 states of securities offerings, the states to the extent not preempted by federal securities law). It also seems clear that the prospect of overturning the SEC's unwritten policy is on the Trump administration's radar screen.

The SEC's unwritten policy barring mandatory arbitration of shareholder claims came under interest group pressure in 2006–2007. It was also the subject of several corporate efforts to cause a change in the SEC's policy, most notably in connection with a 2012 proposed share offering by the Carlyle Group. But the SEC policy survived due to inter alia push-back from the Democratic-controlled Congress. A broad pro-arbitration decision by the U.S. Supreme Court, rejecting the NLRB's regulatory effort to preserve employment class actions by prohibiting mandatory arbitration, could easily have a significant impact on the SEC's unwritten policy to deny registration of securities offerings covered by a mandatory arbitration provision in the issuer's charter documents.

The SEC question is sure to trigger advocacy as it arises again—indeed, it has already done so in the blogosphere. We can certainly anticipate an aggressive lobbying campaign on all sides directly implicating shareholder class actions and the extent to which existing federal and state securities laws protect the use of courts for such proceedings.

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