What's So Bad About Carlyle's Ban Against Class Actions?
The American Lawyer
Update: On Friday, The New York Times reported that The Carlyle Group has removed the arbitration clause from its IPO filing.
The business world is buzzing about Facebook's $5 billion initial public offering, which became official on Wednesday with the company's filing with the Securities and Exchange Commission. Investors big and small are clamoring for a piece of the social networking giant. But if a year from now the company's stock price has plunged for some reason, you can bet there will be a wave of shareholder suits.
Now imagine that Facebook had clearly and prominently warned potential investors in its IPO documents that they were giving up their right to sue the company in court for securities law violations. Instead, they'd have to take their grievances individually to arbitration. Would that be fair? Would investors care?
That question is playing out in real life with the pending IPO of The Carlyle Group. As we explained in an earlier article, the private equity company stated in a December filing that all shareholder disputes with the company must be settled by individual, confidential arbitrations conducted in Delaware. That means no class actions in court. And this restriction is clearly spelled out at the top of Carlyle's filing, which you can read here.
It's a bold move. I'm betting that Carlyle and its lawyers at Simpson Thacher & Bartlett were motivated by the U.S. Supreme Court's ruling last year in AT&T Mobility v. Concepcion, in which the court allowed AT&T to enforce a ban on class actions in its consumer contracts over objections that such arbitration clauses are unconscionable. Of course the SEC has to sign off on Carlyle's final prospectus, and it's not at all clear how the agency is going to react to this radical restriction of shareholder rights. But I can't fault Carlyle and its lawyers for trying. What company wouldn't want to get rid of shareholder class actions if it could? (The Committee on Capital Markets Regulation, whose director is Harvard Law School professor Hal Scott, has advocated since 2006 for corporations to make this kind of change to stay globally competitive.)
Although I'm generally an advocate of greater corporate accountability, Carlyle's arbitration provision doesn't bother me that much. That's because investors are clearly informed about what they're getting into. If you don't like waiving your right to sue, then don't invest in Carlyle. Putting your money in the stock market is a risky business. There's no guarantee that you'll make money, and there's no guarantee you won't lose all your money. If Carlyle stock seems even riskier because of this ban on class actions, then stay away.
In fact, I'll argue that a class action ban against shareholder suits is less objectionable than the ban that the Supreme Court upheld in Concepcion. Nobody has to buy Carlyle stock; nearly everyone has to buy a cell phone contract. (You can bet AT&T competitors have similar contract terms.) And Carlyle isn't exempting itself from the securities laws. The SEC can still go after the company--in court--for any violations. And investors can still pursue their rights under federal law, they just have to do it in arbitration, which can often be a good or better alternative to protracted litigation. What about small investors who aren't likely to pursue a case on their own? I'd say that small investors who don't have that kind of sophistication or resources shouldn't be investing in a business as complex as Carlyle. And as it is, a huge chunk of small investors don't step forward to claim their money in class action settlements anyway.
I am concerned, however, that if Carlyle's plan survives scrutiny, then most companies would follow suit and shareholders would lose the right to bring securities class actions altogether. Investors who don't want to give up that right would be shut out of the investing market. But are there that many shareholders--as opposed to plaintiffs lawyers--who really care about the right to bring a future class action at the time they invest?
Let's get back to Facebook. If it had an arbitration provision like Carlyle's, do you think the demand for its stock would be much lower? I don't. In fact, its shares might be seen as more valuable more because the company wouldn't be vulnerable to expensive shareholder litigation. And if investors--who are the ones we're trying to protect--don't assign much value to the right to bring a class action, then should we be upset if it's bargained away?
This article originally appeared in The AmLaw Litigation Daily.