October 09, 2017 Practice Points

Treasury Suggests Arbitration of Securities Actions

By Mark Kantor

On October 7, 2017, the U.S. Department of the Treasury issued a report entitled "A Financial System That Creates Economic Opportunities Capital Markets." The report makes proposals and recommendations for changes in the regulation of the US capital markets. At pages 35 and 204, the Treasury made the following recommendation:

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 report does not further discuss the arbitration recommendation. Immediately before making the recommendation, however, the Report takes direct aim at shareholder class actions, thereby indicating what motivates the arbitration recommendation:

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. Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder, create a private right of action for investors to sue a securities issuer for the issuer's misrepresentations or omissions. 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.63 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).64 The majority of class action securities lawsuits resolved since 1996 have settled before going to trial. Since 1996, 55% of completed class action securities lawsuits were settled for an amount totaling over $90 billion.65 Of the settled cases since 2007, approximately 27% were settled before the first hearing on motion to dismiss, while approximately two-thirds were settled after a ruling occurred on motion to dismiss, but prior to summary judgment.66 Only 21 cases since the adoption of the Private Securities Litigation Reform Act of 1995 have gone to trial.67 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.68 Thus, securities class actions can significantly benefit attorneys at the expense of shareholders.

In parsing the words of the recommendation, it is 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, too) and that the Trump Administration is interested in reducing or eliminating securities class actions.

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.

Mark Kantor is a member of the College of Commercial Arbitrators in Washington, D.C.

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