In its determination to reverse a two-decade slump in U.S. stock listings, a regulator might offer companies an extreme incentive to go public: the ability to bar aggrieved shareholders from suing.
The Securities and Exchange Commission in its long history has never allowed companies to sell shares in initial public offerings while also letting them ban investors from seeking big financial damages through class-action lawsuits. That’s because the agency has considered the right to sue a crucial shareholder protection against fraud and other securities violations.
But as President Donald Trump’s pro-business agenda sweeps through Washington, the SEC is laying the groundwork for a possible policy shift, said three people familiar with the matter. The agency, according to two of the people, has privately signaled that it’s open to at least considering whether companies should be able to force investors to settle disputes through arbitration, an often closed-door process that can limit the bad publicity and high legal costs triggered by litigation.
A change to the SEC’s stance would be the most significant move yet by Chairman Jay Clayton to make going public more appealing, which he’s laid out as one of his highest priorities since taking over Wall Street’s top regulator last year. It would also hew to the Trump administration’s goal of dismantling government policies that it blames for hurting economic growth.
But allowing companies to shield themselves from shareholder lawsuits would almost certainly enrage investor advocates and Democratic lawmakers, a combination that helped defeat a 2012 attempt by private-equity giant Carlyle Group LP to prohibit investor suits as part of its IPO.
SEC spokeswoman Judith Burns declined to comment.
Clayton, a former deals lawyer who worked on Alibaba Group Holding Ltd.’s record U.S. IPO, is trying to turn around a trend that’s existed since the tech bubble burst in the early 2000s. While corporate lobbyists blame regulation for stifling IPOs, others point to an abundance of investments from venture capital firms and additional sources for many companies shunning stock listings.
The best year for U.S. listings was 1996 when 949 companies sold shares, according to data compiled by Bloomberg. This decade, the high-water mark was 2014, when 450 companies went public. In 2017, there were 237 U.S. IPOs, compared with more than 2,000 on foreign markets.
Kevin P. Kennedy, a partner at law firm Simpson Thacher in Palo Alto, California, said he’s heard instances of SEC staff encouraging companies to come forward with proposals that would require shareholders to use arbitration to resolve shareholder grievances. That would allow the regulator to review whether the plans pass muster, he said.
“It’d be a real sea change,” Kennedy said. “One of the major inhibitors that’s concerned companies as they think about going public is the risk of what a lot of companies view as frivolous shareholder litigation. I think the idea that you could eliminate that risk is pretty significant.”
In October, the Trump administration weighed in when it recommended that the SEC consider letting companies and shareholders use arbitration to settle disputes. In a report, Treasury Secretary Steven Mnuchin and his counselor Craig Phillips said the change could be a way to “reduce costs of securities litigation for issuers in a way that protects investors’ rights and interests.”
Clayton hasn’t commented publicly on the matter since taking over as SEC chairman in May. Though he has taken several steps aimed at bolstering the attractiveness of going public.
In June, he announced that the SEC would let all companies that are preparing to IPO file documents confidentially to the agency laying out the proposed structures of their share sales. The objective was to let companies work out any kinks without alerting the broader market to their plans to eventually sell shares. Previously, only small businesses could submit their IPO documents confidentially to the SEC.
Clayton also tapped William Hinman, a former Simpson Thacher partner based in Silicon Valley who also worked on Alibaba’s share sale, to lead the SEC unit that oversees corporate disclosures. Hinman’s division, which reviews the filings that companies must submit ahead of IPOs, would play a key role in deciding whether to allow firms to include mandatory arbitration clauses in their registration documents, one of the people said.
“The question is who is going to be the first company because they’re going to be the lightening rod of criticism,” said Hal Scott, a professor at Harvard Law School who has long argued that shareholder lawsuits should be reined in. “It would definitely be controversial, there’s no doubt about it. But, it’s something they should endure the controversy over because it’s worth it.”
Scott added that if the SEC allowed one company to prohibit lawsuits, a “landslide” of others would follow.
The issue has stoked heated rhetoric. The Council of Institutional Investors, a trade group whose members include state pension funds, warned in 2013 that forced arbitration represents “a potential threat to principles of sound corporate governance that balance the rights of shareowners against the responsibility of corporate managers to run the business.”
Meanwhile, the U.S. Chamber of Commerce, the nation’s biggest business lobby, has said that class-action lawsuits are devastating for the economy because they impose huge costs on companies. The chamber also contends that the main beneficiaries are plaintiff’s lawyers, with individual shareholders rarely pocketing much money at all. There are signs those arguments are making traction.
Last year, Republican lawmakers killed a regulation that would have restricted companies from including mandatory arbitration clauses in contracts for credit cards and other financial products.
In July, SEC Republican Commissioner Michael Piwowar, who served as acting chairman last year, signaled that the agency’s views on arbitration clauses could be changing.
“For shareholder lawsuits, companies can come to us to ask for relief to put in mandatory arbitration into their charter,” he said at an event at the conservative Heritage Foundation in Washington. “I would encourage companies to come and talk to us about that.”