Hal Scott delivered an unwelcome holiday gift to Securities and Exchange Commission (SEC) Chairman Jay Clayton recently.
Scott, who represents a trust that holds Johnson & Johnson (J&J) shares, submitted a proposal to J&J that would strip investors of their ability to bring claims in court and would instead force all shareholder disputes into arbitration.
{mosads}If Chairman Clayton were to greenlight Scott’s request, it could mark the beginning of the end of American investors’ right to seek justice from publicly traded companies that violate federal securities laws.
Johnson & Johnson is seeking “no action” relief from the commission to exclude the issue from its proxy ballot, thus preserving shareholder rights. This is relief that the commission has granted at least three times in the past when other companies were faced with similar proposals.
Chairman Clayton, who has repeatedly expressed his desire to avoid the issue, will now have to decide whether to affirm long-standing commission policy banning forced shareholder arbitration or slam the courthouse door on defrauded investors.
Contrary to Scott’s disingenuous claims, forced arbitration has nothing to do with where investor claims will be heard and everything to do with whether they will ever be heard at all. That’s because denying investors the ability to bring their claims in court also denies them the ability to band together in class actions.
Given how costly it is to pursue securities fraud claims, only the largest of institutional investors would retain any ability to seek justice, and they would have to think twice before taking on such costs.
It is not just defrauded investors who are harmed when shareholder fraud cases are curtailed. SEC leaders from both parties have long maintained that private lawsuits serve as an essential supplement to the commission’s enforcement actions, both as a mechanism for compensating the victims of fraud and as a deterrent to violating the law.
As former SEC Chairmen William Donaldson and Arthur Levitt and former Commissioner Harvey Goldschmid wrote in a joint amicus brief:
“Private cases, so long as they are well-grounded, are an important enforcement mechanism supplementing the SEC in the policing of our markets. Most often, the larger the frauds, the greater investors must rely on private cases to recover their losses.”
By threatening that dual system of public and private enforcement, forced shareholder arbitration would weaken deterrence and undermine market integrity.
The good news for investors is that Chairman Clayton has previously pledged in writing to members of Congress that any decision to change SEC policy in this area would be made not by staff but at the commission level and only after conducting an open and deliberative process.
Failure to grant Johnson & Johnson the no action relief it is seeking would clearly violate that pledge.
Permitting forced shareholder arbitration would be bad for investors, bad for the markets and bad for the economy as a whole.
The SEC has an opportunity to protect shareholders instead of unscrupulous actors who would try to evade accountability by hiding behind forced arbitration clauses. The decision rests squarely in Chairman Clayton’s hands.
Barbara Roper is the director of investor protection at the Consumer Federation of America. Roper is a member of the SEC’s Investor Advisory Committee, FINRA’s Investor Issues Group and the CFP Board’s Public Policy Council.