Could Mandatory Arbitration Spell the End of Securities Class Actions?

Key Points

The SEC has reversed a longstanding policy under which the agency would not accelerate the effectiveness of a securities registration statement for a company with a mandatory arbitration clauses covering shareholder claims.
The reversal eliminates one obstacle that has deterred public companies from adopting mandatory arbitration provisions, which potentially could curb costly shareholder class action litigation.
But there are potential legal obstacles as well as practical reasons companies may prefer to litigate shareholder claims in court.

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What Changed

On September 17, 2025, the Securities and Exchange Commission (SEC) announced that the presence of a mandatory arbitration provision in a company’s governing documents will not impact the agency’s decisions about whether to approve the effectiveness of a securities registration statement.

The change represents a sharp break with the SEC’s practice. For decades, it took the position that mandatory arbitration clauses could potentially violate federal securities laws by preventing investors from vindicating their rights in the courts, including via class actions. The SEC has now concluded that the federal securities laws do not guarantee the right to pursue claims in court or on a classwide basis. SEC Chairman Paul S. Atkins called the change one step toward delivering on his goal to “make IPOs great again.”

Arbitration agreements that require shareholders to pursue claims in individualized proceedings rather than class actions could help curb abuses of the class action mechanism, where the expense of defending against claims involving thousands of shareholders and the potentially huge exposure to damages can force companies to enter multimillion-dollar settlements even where the claims are meritless.

Factors To Weigh in Deciding Whether To Adopt a Mandatory Arbitration Clause

Some are predicting that the SEC’s decision will prompt more companies to consider adopting mandatory arbitration provisions. But the choice may not be clearcut.

Possible Legal Obstacles

The laws of the state where a company is incorporated could prevent enforcement of a mandatory arbitration provision in a corporation’s charter or bylaws applying to shareholders.

And, while the Supreme Court has held that arbitration provisions in agreements between investors and their financial advisors do not violate federal securities laws, SEC Commissioner Caroline Crenshaw, who was critical of the change in policy, suggested that if provisions governing shareholder claims against companies are draconian (for example, if they eliminate claims, remedies or shorten limitations periods), they might still violate Supreme Court precedent. And some within the plaintiffs’ bar have already opined that companies adopting mandatory arbitration provisions would be “buying a lawsuit.”

Investor Sentiment

Public companies must consider the reaction of investors and, in certain cases, proxy advisory firms. CalPERS has already expressed its opposition to the change in the SEC’s policy and to mandatory arbitration provisions. On the other hand, some investors would prefer to avoid the cost and distraction of shareholder litigation.

Advantages of Litigating in Court

In addition, there are procedural and other benefits to proceeding in court. The Private Securities Litigation Reform Act of 1995 created protections for defendants. For example, no discovery can take place while a motion to dismiss is pending, and the law sets a high bar for complaints. Plaintiffs must spell out their allegations in greater detail than is required for other types of suit, which makes it easier for defendants to win dismissals. Arbitration provisions can, however, be drafted to try to include various protections, including some of those found in the courts.

Moreover, many judges are experienced at adjudicating federal securities law claims and applying a well-developed body of precedent. And courts presiding over securities class actions have in recent years granted motions to dismiss in full (with or without allowing the plaintiffs to refile) 61% of the time.¹

Classwide settlements in court also provide classwide releases, and defending multiple arbitrations could become costly. The cost-benefit analysis will depend on the company, its investor base and the potential claims that may be brought.

Other Reasons

There are other considerations, as well, that might affect the decision calculus. For example: Would a non-appealable arbitration finding of securities fraud compromise insurance coverage or applicable indemnities? Also, can an arbitration provision be drafted to encompass other potential defendants that would be entitled to indemnity from the company, such as directors, officers and underwriters? If not, the company might still be exposed to class action liability indirectly, because it might be forced to indemnify those parties as they defend class actions in the courts while defending itself in arbitrations.

Conclusion

In short, while the change at the SEC could set the stage for companies to install significant new protections to curb abuses of shareholder litigation, boards need to understand that the choice isn’t as simple as it might appear at first. This is not a one-size-fits-all proposition. Each company will have to analyze the factors and weigh the cost-benefit analysis.

View other articles from this issue of The Informed Board

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1 National Economic Research Associates, Inc., Recent Trends in Securities Class Action Litigation: 2024 Full-Year Review, at 17.

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