WASHINGTON – A Securities and Exchange Commission change of course that would allow companies to insert forced arbitration clauses in their initial public offerings could threaten the integrity of the market and possibly force states to avoid investing in such companies, several state treasurers told the SEC.

Six treasurers, spearheaded by California’s John Chiang, signed a July 2 letter to SEC Chairman Jay Clayton urging him not to support allowing forced arbitration clauses in IPOs. The other five treasurers were Illinois' Michael Ferichs, Iowa's Michael Fitzgerald, Oregon's Tobias Read, Pennsylvania’s Joe Torsella, and Rhode Island’s Seth Magaziner. They wrote to Clayton in response to reports that the SEC may be considering allowing forced arbitration clauses in an effort to promote more public offerings.

Forced or mandatory arbitration clauses force investors to pursue claims against companies in confidential proceedings before arbitrators and to waive their rights to bring claims of securities laws violations in civil court proceedings.

SEC commissioner Michael Piwowar, in a speech a year ago, encouraged companies to come to the SEC and seek permission to include binding arbitration language in their charters.

California Treasurer John Chiang
California Treasurer John Chiang

The theory underpinning this movement is that forcing investors to waive their rights to court proceedings or to bring class actions would cut down on the number of “frivolous” suits brought against public companies, encouraging more companies to offer shares publicly. Clayton has said he would like to see more companies go public at earlier stages in their development in order to offer more “Main Street” investors the chance to share in the success of its growth.

But the treasurers told Clayton in their letter that mandatory arbitration provisions aren’t consistent with their duties to be good stewards of taxpayer money.

“As investors, we are interested in preserving the ability to redress diminished public funds through private shareholder litigation when violations of the state and federal securities laws occur,” the treasurers wrote. “Forced arbitration directly threatens our ability to meet these responsibilities.”

State money, including public pension fund money, is typically invested in a diversified way that includes not only shares of money market funds but also direct purchases of company stock. A change in SEC policy could force some investors to simply not invest at all, the letter warned.

“Unfortunately, individual police and firefighter pensioners, teachers and municipal workers, and other individual and retail investors simply do not possess the financial size or scale to contest the inclusion of a forced arbitration clause or class action waiver in a company charter or corporate bylaw,” the treasurers wrote. “The choice is either to forego any reasonable hope of accountability in the wake of securities fraud, or to forego the investment entirely.”

Clayton has been noncommittal about the issue of late, telling lawmakers earlier this year that such a move would be hotly debated and is not high on his priorities list. A spokesman for the National Association of State Treasurers said the group has no official position on the matter.

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