Public Companies, Private Justice: Will Forced Arbitration Eliminate Investors' Right To Hold Corporations Accountable?

As details continue to emerge of the latest Wall Street scandal -- J.P. Morgan Chase's $3 billion trading loss - many investors would no doubt be surprised to learn that a below-the-radar effort is underway to virtually eliminate their ability to hold corporate management accountable. If this campaign succeeds, it will block investors alleging fraud, insider trading and accounting scams in financial markets from going to court, and force them into a corporate-friendly arbitration system that limits their rights and keeps Wall Street's wrongdoing behind closed doors. Consumers of credit card, cell phone and banking services (which is to say, most Americans) have already lost to forced arbitration their right to use class action lawsuits to hold corporations accountable, thanks to recent Supreme Court decisions. Significant though the consequences would be of adding investors to this list at a time when misconduct on Wall Street dominates the headlines, the effort to replace investor class actions with forced arbitration has received almost no attention in the media.

In recent months there have been several attempts to force investors in certain corporations into arbitration and strip them of the power to hold the companies publicly accountable for fraud, negligence or other misconduct via class action lawsuits. An attempt by The Carlyle Group to force arbitration by investors as part of its initial public offering was withdrawn by the company in the face of opposition from the Securities and Exchange Commission (SEC), the agency charged with regulating the financial markets. In two other cases, the managements of Gannett and Pfizer, to their credit, opposed shareholder proposals seeking to force arbitration, and argued to the SEC that the proposals violated federal securities law. In each case, the SEC agreed. In addition, a similar proposal was made in connection with Frontier Communications; Frontier's board recommended that shareholders vote against the arbitration proposal, and it was defeated.

Although these actions, with the partial exception of Carlyle, received scant coverage even in the business press, supporters of forced arbitration for investors have had access to the conservative media to make their case. In a recent Wall Street Journal op-ed titled “The Alternative to Shareholder Class Actions,” arbitration advocates Hal Scott and Leslie Silverman argue that the SEC should end its opposition to forced arbitration in light of recent Supreme Court decisions favoring the policy. They also argue that whistleblowers, the media and enforcement agencies such as the SEC and Department of Justice provide sufficient deterrence.

The J.P. Morgan Chase scandal serves as a reminder of the need for greater transparency and accountability in financial institutions and markets. Supporters of the forced arbitration such as Scott and Silverman ignore the role class actions play in supplementing these other sources of corporate accountability. As a group of public interest organizations argued to the SEC in opposition to the Carlyle arbitration provision:

Forced arbitration would enable companies to violate federal securities laws with near-impunity. Serious claims, such as those related to breach of fiduciary duty, fraud, self-dealing, waste of corporate assets, insider trading, accounting scams, and inflated or false financial statements, would be forced into private forums orchestrated by Carlyle and others. Due to the secrecy inherent in private arbitration and the fact that companies write the rules for these proceedings, corporate misconduct likely will escape adequate punishment, public scrutiny and the SEC's enforcement or oversight authority.

Shareholder class actions, conducted in courts and overseen by impartial judges, promote transparency and accountability. Arbitration is a private process, conducted in secrecy. Thus, critics argue, it is particularly unsuited for promoting corporate accountability. They note that securities claims, rather than being private disputes between two parties, “often have serious, widespread implications for the integrity of the securities markets and the U.S. economy.”

Supporters of forced arbitration for investors, including Scott and Silverman, rely on the Supreme Court's recent decision in AT&T Mobility LLC v. Concepcion, in which the Court's conservative majority ruled that AT&T could require customers to arbitrate disputes and also ban class actions in those proceedings. Because they allow numerous individuals who are victims of fraud or other injuries to band together to take on broad-based misconduct, class actions have been called “among the most powerful tools to secure justice in America.” Class actions address the common problem of misconduct which [[so widespread as to]] greatly benefits the wrongdoer, but which touches individuals in a relatively limited way, leaving them little incentive to invest the time and money to respond. An example would be a corporate practice that defrauds millions of individual consumers or investors of $30 each. As conservative federal judge Richard Posner has noted: "“The realistic alternative to a class action is not 17 million individual suits, but zero individual suits, as only a lunatic or a fanatic sues for $30.” (emphasis in original).

The sweeping nature of the Concepcion decision, which by enabling companies to force arbitration and prohibit class actions in a large and growing number of contexts, has begun to draw attention to the loss of rights consumers have suffered. A recent study by the public interest organization Public Citizen identified “76 potential class action cases where judges cited Concepcion and held that class action bans within arbitration clauses were enforceable” in the year since the Court decided the case. A recent New York Times article discussed the Public Citizen study, and explained how Concepcion has prevented Matthew Wolf, a captain in the Judge Advocate General Corps of the Army Reserves, from effectively pursuing a claim against Nissan under a law protecting servicemembers from consumer rights abuses.

As the media begins to cover Concepcion and the ways it has stripped consumers of their rights to hold corporations accountable, it should also investigate the spillover effects the decision is having on investors and their rights as well.