Update: J&J Defeats Move For Annual Meeting Vote on Mandatory Shareholder Arbitration

By Shannon Collins

Harvard Law School Professor Emeritus Hal Scott filed a complaint in a New Jersey federal court against health care giant Johnson & Johnson on behalf of a shareholder trust seeking to force J&J to hold a shareholder vote on barring arbitration in disputes between the company and its stockholders.

The U.S. Securities and Exchange Commission had previously issued a no-action letter that allowed J&J to exclude the provision from proxy materials based on a New Jersey law interpretation.

Scott, on behalf of the Doris Behr 2012 Irrevocable Trust, alleged that J&J violated federal securities laws by excluding the proposal he sent the company in November, on behalf of the trust, from its proxy materials for the shareholder meeting, scheduled for this week.

The complaint sought declaratory judgment stating that J&J violated the federal securities laws, in addition to injunctive relief under which J&J would be required to submit supplementary proxy materials to the shareholders, including Scott’s original proposal.

The injunction would have allowed a vote to go forward at the April 25 shareholders meeting, and also include a statement from J&J affirming that Scott’s proposal violates neither federal nor New Jersey laws. The injunction also requested that  J&J be prohibited from excluding any future, similar proposals.

U.S. District Court Judge Michael Shipp, of Trenton, N.J., denied the trust’s order to show cause on March 29 in an unpublished opinion, letting the SEC letter and J&J action stand.  (Available here.)

But Prof. Scott, joined by two law firms in his work on behalf of the trust, may have tapped into a future use for mandatory arbitration.  For background, see Shannon Collins, “Mandatory Shareholder Arbitration: J&J View Passes SEC’s Test,” CPR Speaks blog (March 18). The blog post  discusses the back and forth between Scott and J&J over Scott’s shareholder proposal. The controversial proposal advocates for a change to the J&J by-laws requiring all disputes brought by shareholders against the company to go through individual arbitration.

Per J&J’s request, the SEC issued the no-action letter stating the agency would not act against J&J if the company excluded Scott’s proposal from the proxy materials for its annual shareholder meeting.

In a brief supporting a “Motion for Order to Show Cause Why a Preliminary Injunction Should Not Issue,” Prof. Scott and the trust argued that J&J violated federal securities laws by excluding Scott’s shareholder proposal from the proxy materials.

Under 17 C.F.R. § 240.14a-8, all shareholder proposals must be included in the proxy materials unless they fall under one or more of several statutory exceptions. One of these exceptions, 14a-8(i)(2), allows exclusion of a proposal if it “would, if implemented, cause the company to violate state, federal, or foreign law to which it is subject.”

The SEC premised its no-action letter in large part on a statement from the New Jersey Attorney General Gurbir Grewal, who concluded that the proposal would violate state law. (Johnson & Johnson’s headquarters is in New Brunswick, N.J.) Grewal contended that recent changes to New Jersey law voids by-laws with forum-selection clauses regarding federal securities law claims. He also relied on the Delaware Chancery Court case Sciabacucchi v. Salzberg, 2018 WL 6719718 (Del. Ch. Dec. 19, 2018), holding that by-law amendments generally only relate to matters of internal concern, and forum selection is an external concern.

The trust’s main focus in its suit was the legal validity of its 2018 proposal. The trust argued that the arbitration-requirement proposal violates neither federal nor state law.  It also argued that the N.J. Attorney General’s opinion predicting state courts are likely to follow Delaware Chancery law prohibiting mandatory individual shareholder arbitration is not dispositive on the issue.

The trust relied principally on the Federal Arbitration Act, and the recent Supreme Court case of Epic Systems Corp. v. Lewis, 138 S. Ct. 1612 (2018), as support for the legality of its proposal. The trust asserted that N.J. Attorney General Grewal did not identify any New Jersey statutory language or court decision that expressly applied to shareholder arbitration concerning federal securities law claims, and thus the proposal would not cause the company to violate state law.

The trust further bolstered its claim by declaring that even if New Jersey state law were to prohibit such a proposal, that state law would be preempted by the FAA, which would permit the proposal.

The FAA mandates that contractual arbitration provisions must be enforced. The trust argued that corporate by-laws are contracts between shareholders and the corporation, citing several New Jersey cases. It follows then that arbitration agreements in company by-laws should be enforced under the FAA just as they would in express contracts.

Therefore, following the Epic Systems case—which permitted predispute mandatory arbitration provisions with waivers of class processes as a condition of employment–shareholder arbitration of federal securities claims do not violate federal law. The trust stipulates that agreeing to arbitrate federal securities laws in no way waives compliance with the 1934 Securities Exchange Act. Waiver of compliance is prohibited by § 29(a).

Arbitrating securities law claims still preserves a shareholder’s right to enforce securities laws, the trust argued, it just does so through a specific proceeding.

The trust strongly advocated against the deference given to Sciabacucchi by the N.J. Attorney General, stating that it is not the law of New Jersey and that corporations are free to ignore it until it is. It also attempted to distinguish Sciabacucchi from the present situation by pointing out that Sciabacucchi concerns a forum-selection clause. Arbitration, the trust contended, is an entirely different matter because it is protected by the FAA.

Furthermore, the trust maintained that Sciabacucchi cannot be extended to another state regarding arbitration because the Sciabacucchi holding only applies to a subset of contracts; corporate by-laws and certificates of incorporation. Under the FAA, rules that forbid enforcement of arbitration agreements must apply to every contract in the state equally. Therefore, applying Sciabacucchi and treating contracts unequally would run afoul of the FAA.

Sciabacucchi held that corporate by-laws will only apply to internal affairs. Securities claims have been held to be external by the Delaware court, so J&J countered that including the proposal in its by-laws would be unenforceable.

J&J additionally consulted Pennsylvania law and concluded that New Jersey would likely follow corporate precedent from the state decision Kirleis v. Dickie, McCamey & Chilcote P.C., 560 F.3d 156 (2009). The Pennsylvania Kirleis court held in this case that arbitration clauses in corporate by-laws would not be enforceable unless shareholders expressly consent to the arbitration provision.

The trust points out, however, that the court recognized that it is generally assumed that shareholders and directors have knowledge of and accept the corporate bylaws. Emphasizing this, the trust pointed out that Pennsylvania has not affirmatively ruled that express agreement trumps the presumptive consent of by-laws by shareholders.

But J&J predicts that Pennsylvania would require express consent over a presumption of consent, and further predicts that New Jersey would use Pennsylvania as persuasive authority and follow suit. Once again, the trust pointed out that while the arbitration clause may be unenforceable, including an unenforceable provision in corporate by-laws is in no way a violation of state or federal law.

Prof. Scott’s brief criticizes the New Jersey Attorney General’s reliance on recent amendments to New Jersey corporate law by pointing out that that N.J. Stat. Ann. § 14A:2-9(5)(a), while authorizing certain forum-selection clauses in corporate by-laws, does not prohibit arbitration provisions and so the proposal does not violate any state law.

In response to the trust’s motion, Johnson & Johnson attorney Andrew Muscato, counsel to Skadden, Arps, Slate, Meagher & Flom in New York, wrote in a March 27 letter to U.S. District Court Judge Michael Shipp, in Trenton, N.J., that the trust failed to satisfy a single prong of the four-part test for a preliminary injunction.

Muscato particularly highlighted the trust’s lack of irreparable harm, pointing out the ample time the trust had to bring its claim against the company. Muscato posited that if the trust truly suffered irreparable harm, it would not have waited more than four-and-a-half months to bring suit.

The trust defended this delay in a letter also dated March 27 by claiming that it would not have had sufficient Article III standing prior to the release of the proxy materials. Up until the actual distribution of the proxy materials, the trust’s only injury was the potential for future harm, the letter stated.

The trust insisted that standing questions can be raised at any point during litigation and it refused to take the risk of bringing suit too early only to have its claims subject to rejection as premature several years down the line.

Muscato rebutted the standing issue introduced by the trust by citing several cases in which shareholders brought suit prior to the distribution of proxy materials.

Muscato insisted the reason for emergency relief was undue delay by the trust. If the trust had taken action sooner, then the complex matter could have been resolved.

Judge Shipp ultimately declined the order sought by the Trust for failure to show irreparable harm, agreeing with Muscato and J&J. (Linked above.)

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Historically, courts have favored arbitration, but the shareholder arbitration requirement proposals faces a volatile moment for the alternative dispute resolution process. SEC Chairman Jay Clayton seems to be open to the idea of shareholder arbitration in a publicly traded company. But groups like Secure Our Savings have strongly advocated against forced arbitration of shareholders.

The recent #MeToo movement has resulted in a push for repeals of arbitration clauses in employment contracts, specifically as they relate to sexual harassment.

So the potential ramifications of the J&J shareholder proposal could be go beyond the parties and have an effect on corporate governance. If it passes, it even could initiate a domino effect in which company after company implements mandatory individual shareholder arbitration. Should this occur, Congress could decide to step in and create a uniform standard for these clauses . . . or bar them altogether.

Either way, there is doubt about the future of processes to address shareholder disputes.

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The author is a CPR Institute Spring 2019 intern.


Mandatory Shareholder Arbitration: J&J View Passes SEC’s Test

By Shannon Collins

A no-action letter last month put the U.S. Securities and Exchange Commission’s stamp of approval on Johnson & Johnson’s move to bar a shareholder vote at its annual meeting on the use of mandatory arbitration for securities disputes between the company and its shareholders.

Last spring, U.S. Securities and Exchange Commission chairman Jay Clayton discussed the possibility of supporting a mandatory arbitration provision that would bar class actions as part of an initial public offering, according to two Reuters articles. See Alison Frankel, “SEC chair Clayton is in no rush for mandatory shareholder arbitration,” Reuters (April 27, 2018) (available at https://reut.rs/2EJlRX4), and Alison Frankel, “The case against mandatory shareholder arbitration,” Reuters (Aug. 22, 2018) (available at https://reut.rs/2Tmptby).

While arbitration is an invaluable dispute resolution tool, the use of mandatory processes in consumer and employment cases with class-action waivers generated controversy before the Supreme Court signed off on permitting them last year in employment cases, and in 2011 in consumer contracts.

In IPOs, mandatory individual arbitration would eliminate shareholder class actions, which is a mechanism frequently used to prosecute securities fraud suits—often after share price fluctuations following the initial offerings.

The class-action model allows for more shareholders to participate in litigation against fraud and have their voices heard, while individual arbitration may remain confidential and result in varying terms and decisions, according to a coalition of organizations seeking to bar mandatory shareholder arbitration under the securities laws.  See Letter to SEC Chairman Jay Clayton, (Jan. 16, 2018) (available at http://bit.ly/2NJdRJs).

Clayton’s comments caused an uproar from several organizations and resulted in the formation of a consumer-group coalition, Secure Our Savings. SOS comprises the Consumer Federation of America and the Consumers Union, along with attorneys from the American Association for Justice, Public Justice, and Public Citizen, among many others.

Johnson & Johnson has been the center of attention of mandatory shareholder arbitration news. Hal Scott, a Harvard Law professor who represents a trust that owns J&J shares, issued an open letter to the health care giant on behalf of the trust encouraging a shareholder proposal for mandatory dispute arbitration, including disputes involving securities fraud.

Micah Hauptman, financial services counsel at Washington, D.C.’s Consumer Federation of America, wrote in response to an email inquiry that he believes such clauses “would violate the federal securities laws and would be inconsistent with longstanding SEC policy on the matter. In addition, such clauses would violate state law because they would exceed the bounds of the internal affairs doctrine.” See also Barbara Roper and Micah Hauptman, “A Settled Matter: Mandatory Shareholder Arbitration Is against the Law and the Public Interest,” Consumer Federation of America (Aug. 15, 2018) (available at http://bit.ly/2UpR1ZR).

In response to Scott’s proposal, New Brunswick, N.J.-based J&J submitted a request to the SEC asking for a no-action letter that would allow the company to exclude the mandatory arbitration proposal from J&J’s annual meeting proxy statement.

The basis of J&J’s exclusion is 1934 Securities Exchange Act Rule 14a-8(i)(2), which allows for companies to exclude shareholder proposals “if the proposal would, if implemented, cause the company to violate any state, federal, or foreign law to which it is subject.” J&J said it believed that the proposal would cause it to violate federal securities law, as well as New Jersey state law.

J&J claimed in its letter to the SEC that the proposal violates Exchange Act Section 29(a), which voids provisions that “bind[] any person to waive compliance with any [part of the act] . . . or of any rule or regulation thereunder.”

The U.S. Supreme Court has held that Section 29 applies only to waivers of substantive provisions, not procedural provisions. Shearson/American Express v. McMahon, 482 U.S. 220 (1987) (available at http://bit.ly/2ECOyVh). Therefore, J&J could not claim that mandatory arbitration violates Exchange Act Section 27 (granting exclusive jurisdiction of claims under the act to U.S. District Courts).  J&J instead argued that mandatory arbitration would violate Exchange Act Rules 10b and 10b-5 prohibiting securities fraud.

Though J&J noted that the Supreme Court has held that arbitration provisions do not cause a waiver of compliance with substantive Exchange Act provisions, the SEC has allowed for exclusion of arbitration proposals based partially on arguments of Section 29(a) violations. J&J relied on those exclusions as precedent.

J&J also raised public policy concerns, arguing that arbitration agreements should be made on an individual basis rather than by corporate organizational documents.

In contrast, Hal Scott assured in his supporting statement that his proposal in no way violates state or federal law. (See the link above to the J&J letter on the SEC’s website; Scott’s proposal and supporting statement are exhibits.)

He wrote that the Supreme Court has held that mandatory individual arbitration provisions aren’t in conflict with the federal securities laws, and that New Jersey law allows for the provision because the state views corporate bylaws as a contract between corporations and stockholders.

Scott supported his proposal by highlighting the billions of dollars companies can spend on shareholder lawsuits. “We believe arbitration is an effective alternative to class actions,” he wrote. These suits also can be frivolous and result in a waste of both time and money for all parties involved, according to Scott.

After evaluating the parties’ arguments on the complex securities laws, Commissioner Clayton released a Feb. 11 statement backing the J&J request. The SEC response assured that, should J&J exclude Scott’s shareholder proposal, the SEC would not seek enforcement action.

Clayton’s statement emphasized that the no-action response is neither an acknowledgment nor a denial that Scott’s proposal violates Rule 14a-8(i)(2), but rather is just a statement that the proposal will not be enforced.

The New Jersey laws carried the no-action determination. Clayton states that no New Jersey precedent applies to the matter perfectly, but he seemed to be more inclined to believe that the proposal could violate state law.

That view was reinforced by a determination by N.J. Attorney General Gurbir Grewal, who advised the SEC in January that the proposal violates New Jersey law. “We view this submission as a legally authoritative statement that we are not in a position to question,” wrote SEC Corporation Finance Division attorney-adviser Jacqueline Kaufman in the agency’s no action letter.

In a Wall Street Journal article, Clayton indicated that he “wants to avoid a brawl” for now over a topic as divisive as this one, choosing instead to toe the line rather than spark a political fight.

With news of this SEC decision, Hal Scott remains optimistic about the possible future of mandatory shareholder arbitration. He spoke to Reuters about plans to appeal the SEC’s recommendation and discussed his reaction to the filing.

While he is unconvinced the appeal will succeed, he sees opportunity for future proposals like the one he submitted to J&J in the SEC’s deliberate omission of an affirmative statement regarding the legality of mandatory shareholder arbitration in the no-action letter.

This, according to Scott, is the most significant development so far. According to the Reuters article, the move “leaves open the prospect of mandatory shareholder arbitration for corporations based in states whose corporate codes would permit it.”

With the SEC permitting exclusion of shareholder proposals for mandatory arbitration, it raises a question of whether any company undertaking an IPO will be able to implement such a proposal.

The SEC at least appears hesitant to make a ruling on whether it believes mandatory arbitration violates any state or federal laws. If the SEC continues to allow exclusions like J&J’s, however, it may effectively result in the SEC taking the position that these arbitration provisions likely violate state or federal law.

A determination like this may be best left for Congress, rather than the SEC—though Clayton, according to Reuters, has vowed to have the full commission decide the issue of shareholder arbitration and the FAA, rather than piecemeal Corporation Finance Division opinions, when the time is ripe.

Regardless, this is an unsettled area of law that, once resolved, potentially will have immense impact on the landscape of public offerings, corporate governance, litigation and ADR.

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The author, a CPR Institute Spring 2019 intern, is a student at the Benjamin N. Cardozo School of Law in New York.

Supreme Court Oral Argument on NLRB Class Actions vs. Arbitration Policy

By Mark Kantor

The US Supreme Court heard oral argument this morning in the three consolidated cases involving the policy of the National Labor Relations Board (NLRB) prohibiting arbitration clauses in employment agreements that bar class actions (Epic Systems Corp. v. Lewis, Ernst & Young LLP v. Morris and National Labor Relations Board v. Murphy Oil USA).  The transcript of that oral argument will be available here later this afternoon – https://www.supremecourt.gov/oral_arguments/argument_transcript/2017

Many observers believe the Court’s decision in these cases will come down to Justice Anthony Kennedy’s vote.  For what it is worth, Reuters characterized Justice Kennedy’s questions as “pro-employer” (https://www.reuters.com/article/us-usa-court-labor/u-s-supreme-court-divided-over-key-employment-dispute-idUSKCN1C71RP).

Justice Anthony Kennedy, often the swing vote in major cases, asked questions that appeared to favor employers, as did two fellow conservatives, Chief Justice John Roberts and Justice Samuel Alito.

Kennedy indicated that a loss for workers would not prevent them from acting in concert because they would still be able to join together to hire the same lawyer to bring claims, even though the claims would be arbitrated individually. That would provide “many of the advantages” of collective action, Kennedy said.

See also Bloomberg’s take, which picked up on the same Kennedy comment –  https://www.bloomberg.com/news/articles/2017-10-02/justices-suggest-they-will-divide-on-worker-class-action-rights.

Anne Howe, the respected Court-watcher writing on her own blog Howe on the Court and on Scotusblog, started her review of the proceedings with her bottom line; “In the first oral argument of the new term, a divided Supreme Court seemed likely to uphold employment agreements that require an an employee to resolve a dispute with an employer through individual arbitration, waiving the possibility of proceeding collectively.” (http://amylhowe.com/2017/10/02/argument-analysis-epic-day-employers-arbitration-case/, republished at www.scotusblog.com/2017/10/argument-analysis-epic-day-employers-arbitration-case/#more-262296 ).

Not often noted in the analyses of these cases, the NLRB regulatory policy at issue in Epic Systems et al may in any event become moot.  Effective just a few days ago, the Board of the NLRB now has a Republican majority (http://fortune.com/2017/09/26/nlrb-labor-workers-rights-william-emanuel/).  Moreover, the incumbent NLRB General Counsel (a separate position appointed directly by the President, not the NLRB Board, and subject to Senate confirmation), who actually argued the cases for the NLRB, is scheduled to leave his post in November, thereby opening up that position to a Republican nominee who has apparently already been identified (http://www.insidecounsel.com/2017/09/19/peter-robb-trumps-pick-for-nlrb-general-counsel-is).  It would not at all be surprising for Republican control of the NLRB to result in a reversal of this NLRB policy, just as Democratic control of the NLRB led to promulgation of the policy in the first place.  This dispute is a reminder that many aspects of arbitration in the US are now a partisan political issue, with regulatory measures addressing arbitration shifting back and forth as political party control shifts back and forth.

More broadly, for those of you who feel that these individual employment cases (and similar measures by Federal regulators, under general regulatory statutes, preferring class actions in court over mandatory arbitration of individual claims) are not relevant to your commercial or investment arbitration practice, the precedential impact of a Supreme Court ruling overturning the NLRB’s pro-class action policy may extend far beyond employment and consumer-related claims.  Illustratively, for many years, the U.S. Securities Exchange Commission (SEC) has maintained an informal policy of refusing to register public offerings of stock by companies that include mandatory arbitration clauses in their charter documents for disputes between shareholders and the issuing company.  As a result, shareholder law suits (such as shareholder class actions) are brought in the US courts.

In July of this year, Republican SEC Commissioner Michael Piwowar stated publicly that the SEC is now open to the idea of allowing companies contemplating initial public securities offerings to include mandatory shareholder arbitration provisions in their company charter documents.  That idea, if implemented, could arguably kill off shareholder securities class actions in the US courts.  One might think that a Republican majority of Commissioners on the SEC would be amenable to changing the SEC’s shareholder claims policy barring arbitration.  It is not, however, yet clear whether the SEC’s new Republican Chairman Jay Clayton is also receptive to the idea. See  https://www.reuters.com/article/us-otc-arbitration/shareholder-alert-sec-commissioner-floats-class-action-killing-proposal-idUSKBN1A326T .

The SEC’s unwritten policy barring mandatory arbitration of shareholder claims came under interest group pressure in 2006-2007.  It was also the subject of several corporate efforts to cause a change in the SEC’s policy, most notably in connection with a 2012 proposed share offering by the Carlyle Group.  But the SEC policy survived due to inter alia push-back from the Democratic-controlled Congress.  A broad pro-arbitration decision by the US Supreme Court, rejecting the NLRB’s regulatory effort to preserve employment class actions by prohibiting mandatory arbitration, could easily have a significant impact on the SEC’s unwritten policy to deny registration of securities offerings covered by a mandatory arbitration provision in the issuer’s charter documents.

The SEC question is sure to trigger aggressive lobbying by both sides as it arises again – indeed, it has already done so in the blogosphere.  Illustratively:

For shareholder arbitration and against class actions  – http://clsbluesky.law.columbia.edu/2017/08/21/shareholders-deserve-right-to-choose-mandatory-arbitration/

Against shareholder arbitration and for class actions – http://clsbluesky.law.columbia.edu/2017/08/28/mandatory-arbitration-does-not-give-stockholders-a-choice/


Mark Kantor is a CPR Distinguished Neutral and a regular contributor to CPR Speaks. Until he retired from Milbank, Tweed, Hadley & McCloy, Mark was a partner in the Corporate and Project Finance Groups of the Firm. He currently serves as an arbitrator and mediator. He teaches as an Adjunct Professor at the Georgetown University Law Center (Recipient, Fahy Award for Outstanding Adjunct Professor). Additionally, Mr. Kantor is Editor-in-Chief of the online journal Transnational Dispute Management.

This material was first published on OGEMID, the Oil Gas Energy Mining Infrastructure and Investment Disputes discussion group sponsored by the on-line journal Transnational Dispute Management (TDM, at https://www.transnational-dispute-management.com/), and is republished with consent.