Can Companies Force Arbitration on Shareholders?

A private equity fund preparing for an initial public offering with the Securities Exchange Commission (SEC) is attempting to shake the securities boat. Within the registration statement, The Carlyle Group has included a mandatory arbitration clause.

This clause would remove a shareholder's right to file class actions and pursue securities litigation in court. Instead, the provision requires implementation of individual arbitration to consider any allegations of wrongdoing.

Arbitration is an alternative dispute resolution process that applies its own set of procedures. And, many studies have found arbitration companies are biased in favor of the companies that hire them. As a result, shareholders considering purchasing during Carlyle's IPO are concerned that they will not be properly shielded from wrongdoing.

Generally, the SEC is not fond of such provisions and has rejected similar proposals in the past. The company is likely attempting the offering based on two theories:

  • Support provided by AT&T Mobility v. Concepcion
  • Partnership not a corporation

AT&T Mobility v. Concepcion was a 2011 Supreme Court decision that essentially stated courts could not refuse to enforce a mandatory arbitration provision. In addition, the structure of the company may also play a role. Generally, the use of arbitration has not been supported for corporations, but this company is a partnership. Partnerships sell partner interests that already have a great deal more limitations compared to a normal shareholder's rights.

Update on Arbitration Clause Inclusion

It appears pressure from both legislatures and investors won. According to the New York Times, The Carlyle Group recently chose to remove the controversial arbitration clause.

If included, the SEC may not have allowed the IPO to proceed. Ultimately, the 2010 Dodd-Frank Act permits the SEC to "prohibit, or impose condition or limitation on the use of, agreements that require customers or clients of any broker, dealer, or municipal securities dealer to arbitrate any future dispute."

Although shaking the boat can be a good business strategy, no corporation wants to navigate through troubled waters. Determining the best strategy for each unique company can be very difficult, especially when the law is continually adjusted by new court rulings. Discussing your business goals with an experienced securities litigation attorney can help ensure a smooth ride for your company.