Overview
Last month, the US Securities and Exchange Commission (SEC) reversed its long-standing practice of prohibiting companies registering for IPOs from requiring arbitration of federal securities law claims in their governing documents.
While initial press reports emphasize that this shift allows securities issuers to limit their exposure to shareholder class action lawsuits, the risk-benefit analysis of arbitration for securities issuers is less straightforward and requires case-by-case risk assessment. In this update, we address some considerations for securities issuers.
SEC Policy on Mandatory Arbitration Provisions
For decades, the SEC considered mandatory arbitration provisions for federal securities law claims to be contrary to the public interest and the protection of investors. In line with this unwritten policy, the SEC delayed the IPOs of companies who forced arbitration of all shareholder disputes, refusing to accelerate the registration statement of those companies until such provisions were removed.
But last month, the SEC reversed course, announcing in a Policy Statement that "the presence of an issuer-investor mandatory arbitration provision will not impact decisions whether to accelerate the effectiveness of a registration statement under the Securities Act."1 When considering requests to accelerate, SEC staff will now focus on "the adequacy of the registration statement's disclosures, including disclosure regarding issuer-investor mandatory arbitration provisions."2
The Policy Statement passed in a 3-1 party-lines vote. SEC Commissioner Hester M. Pierce characterized the change as the SEC "acknowledging the limits of our authority" based on Supreme Court precedent and allowing the market to decide whether such provisions are "value-maximizing, and thus good for shareholders."3 The lone dissenting Democrat, Caroline Crenshaw, criticized the policy shift as "another way to stack the deck against investors."4
Considerations for Issuers
At first blush, the SEC policy change seems to pave the way for companies to require arbitration of shareholder claims. But companies wishing to include mandatory arbitration provisions in their governing documents need to be aware of the following considerations:
- The law of the place of incorporation: The law of the state or foreign country where a company is incorporated governs whether mandatory arbitration provisions are permitted. For example, in August of this year, Delaware effectively prohibited mandatory arbitration by requiring corporations to guarantee shareholders access to at least one Delaware court for "intra-company claims."
- Investor sentiment: Companies preparing for an IPO need to be aware of investor sentiment towards mandatory arbitration. Because many investors view mandatory arbitration provisions as limiting their rights, their inclusion has the potential to alienate investors, thus affecting the pricing and marketability of an offering, particularly to certain large institutional investors. Investors' rights activists and other advocacy groups have long opposed mandatory arbitration clauses, and the recent change has already sparked commentary. The Council of Institutional Investors has noted that the move is "inconsistent with CII membership-approved policy."5 The American Association for Justice derided the change as a "radical policy change" that will "inject chaos into US markets."6
For public companies that wish to amend their bylaws to add a mandatory arbitration provision, investor sentiment will be even more crucial. The Policy Statement does not address whether public companies will be permitted to amend their bylaws to add a mandatory arbitration provision, but doing so would, under existing state law, require shareholder approval in the vast majority of corporate structures. Whether investors will be willing to vote in favor of such an amendment requires careful messaging to ensure investors understand the potential cost savings of avoiding time consuming, expensive class actions. Even with such messaging, advocacy groups are likely to seek to get involved in proxy contests or other challenges to leadership for companies that seek to amend their bylaws. Glass Lewis, a leading proxy advisory firm, characterizes bylaws requiring arbitration as limiting “the ability of shareholders to pursue full legal recourse” and recommends that shareholders vote against governance committee members when a board amends its bylaws to require arbitration of shareholder disputes.7
- Litigation over the enforceability of mandatory arbitration provisions for Federal securities law claims: While the SEC announced that it believes that mandatory arbitration clauses for federal securities class actions would not violate the anti-waiver provisions of the federal securities statutes, courts may disagree. Early adopters of mandatory arbitration provisions need to be aware of the risk of litigation over the enforceability of such provisions. Public companies that can amend their bylaws to include such provisions may still face litigation risk from investors who voted against such an amendment.
- Arbitration vs. litigation: Arbitration is generally less costly for companies, provides for greater confidentiality and privacy, and involves less time consuming and expensive discovery than a securities class action in court. Arbitration also allows for disputes to be litigated before arbitrators who may have more specialized knowledge than some federal judges. Nonetheless, there are some advantages to litigating in federal court that companies should consider, including the ability to file a motion to dismiss as of right, including the high pleading standards and automatic discovery stay that apply to federal securities claims, and the broad right to appeal an unfavorable outcome, unlike an arbitration where challenges to a final award are limited. Finally, arbitration does not prevent large, institutional or individual shareholders from joining together to bring arbitration proceedings asserting substantial damages under the federal securities laws. Arbitration clauses could also lead to the phenomenon of "mass arbitration," in which a large number of individual claims are brought by a single law firm or group of law firms, in an effort to overwhelm the defendant. Issuers should bear all of these risks in mind when deciding whether to adopt mandatory arbitration for federal securities claims.
- Shifting political tides: The Commissioners' party line vote on the Policy Statement demonstrates the potential for future change in SEC policy. The Democratic response to the Policy Statement has been highly negative, with many Democrats calling the change detrimental to investors and their ability to hold public companies accountable. Given this procedural background and the uncertainties inherent in electoral politics, a company considering an IPO that wants to include a mandatory arbitration clause should consider that this policy could change after a future election cycle.
Key Takeaway
In all, the SEC's Policy Statement on mandatory arbitration has the potential to bring about a sea change in the viability of securities class action lawsuits, but early adopters of such provisions should be prepared for challenges and should bear in mind the risks inherent in arbitration. While arbitration can be an attractive option, several considerations may counsel against mandatory arbitration in this context, including litigation that may arise from the usage of mandatory arbitration.
Steptoe's securities litigation and commercial arbitration teams will continue to track developments in this area, and we remain ready to guide our clients on these issues.
1 https://www.sec.gov/files/rules/final/2025/33-11389.pdf.
2 Id.
5 https://www.cii.org/ev_calendar_day.asp?date=12%2F4%2F25&eventid=250
7 https://resources.glasslewis.com/hubfs/2025%20Guidelines/2025%20US%20Benchmark%20Policy%20Guidelines.pdf
