The Carlyle Group LP, a US buyout firm preparing to go public, has amended its registration statement to include a mandatory arbitration provision that would prevent shareholders from filing lawsuits. The registration statement provides: “Our partnership agreement will contain provisions that require individual arbitration of any disputes arising out of or relating in any way to our partnership agreement or the common units, including those under the federal securities laws of the United States. Accordingly, you will not be permitted to bring any such claim in court or as part of any representative or class proceeding and your cost of seeking and obtaining recoveries may be higher than otherwise would be the case.”
Obviously, this curtails the rights of shareholders. While they can still sue under state and federal law, they cannot bring a class action lawsuit, and they cannot file any claim in a court of law. If the SEC, which reviews all IPO filings, allows the provision, some fear that it may be a watershed moment leading to the erosion of shareholder rights.
The arbitration clause is not the only way The Carlyle Group is restricting stockholder rights. Because the company is taking the unusual measure of going public as a Delaware limited partnership, rather than a corporation, it has been able to remove the fiduciary duties of the directors, and the voting rights of the stockholders.
The IPO is Setting Up a Potential Showdown Between the SEC and the Supreme Court
In 1990 the SEC blocked the IPO of a Philadelphia corporation that tried to go public with a less restrictive arbitration clause. And it seems likely the regulatory commission will continue that precedent in an effort to protect consumers. However, in recent decisions, the Supreme Court has consistently upheld expanding applications of arbitration clauses.
Those opposed to public companies’ use of mandatory arbitration clauses fear shareholders loss of an important check on director power will result in less efficient corporations. Another concern revolves around transparency–arbitration proceedings are generally private, whereas court proceedings are generally open to the public. Some fear that this lack of transparency will result in an unhealthy increase in corporate power.
The Market as a Potential Solution
One response to those whom oppose public companies’ use of mandatory arbitration clauses is: investors don’t have to put their money into companies with limited shareholder rights. For some, it comes down to an issue of freedom of contract, and people’s ability to vote with their money. If consenting adults agree to purchase an interest in the Carlyle Group knowing that they have very limited rights, why should the government stop them? Of course, the SEC’s fear is that investors will fail to adequately inform themselves. Assuming investors know their rights when they purchase stock, they could effectively end this restriction on shareholder rights by simply refusing to purchase stock of companies that extensively limit shareholders rights.