The SEC Approves Mandatory Arbitration Provisions in IPO-ing Companies’ Charters and Bylaws: Are They Really Worth Adopting?

1. The SEC Permits Companies To Mandate the Arbitration of Securities Claims 

On September 17, 2025, the SEC announced that it will no longer consider the presence of a mandatory arbitration provision in a company’s charter or bylaws when deciding whether to accelerate the effectiveness of an initial public offering registration statement.  The decision, approved on a 3-1 vote on party lines, permits companies going public to include such clauses in their governing documents to require securities litigants (including class action plaintiffs) to file and pursue their claims in arbitration, rather than in the courts.  

The SEC has historically opposed the inclusion of arbitration clauses in companies’ constituent documents and registration statements, finding their use to be:  (a) antithetical to the public interest – the view being that it is not appropriate to require investors to waive their right to pursue claims in federal or state court in order to participate in the public markets – and; (b) potentially violative of the securities laws’ anti-waiver provisions.[1] 

As of last week, however, that view is no longer prevailing among the SEC’s Commissioners.  According to a Commission Policy Statement on the Impact of Mandatory Arbitration Provisions, agency decisions about whether to accelerate the effectiveness of a registration statement will now focus on the statutory criteria of whether the statement is complete and provides adequate disclosure of material information to the public, and not on whether the company has proposed “good” or “bad” methods for resolving stockholder disputes.  This is a potentially important change.  Companies that cannot accelerate the effective date of their registration statement face potential funding delays, market timing issues, and the potential ruin of their IPO altogether. 

Some speculate that the SEC’s policy change will entice many companies going public to adopt mandatory arbitration provisions to gain procedural advantages over litigious investors (presuming that such arbitration provisions are permitted by the companies’ states of incorporation).[2]  Corporations tend to favor arbitration, where cases are generally adjudicated more confidentially – and potentially more expeditiously and inexpensively – than through the public court system.   As for stockholder litigants, Caroline Crenshaw, the Commission’s lone Democrat who opposed the policy change, notes that arbitration is typically more expensive for individual plaintiffs (who must pay filing fees and potentially share arbitrator fees), less transparent, and occasionally less predictable than in-court litigation, among other things.  Critically, unless the company expressly agrees, mandatory arbitration would deny shareholders the ability to pursue class actions, limiting smaller plaintiffs’ ability to band together to share costs and exert leverage on defendants.  Arbitration proceedings also normally permit less third-party discovery than is available in court proceedings.  Thus, it is easy to see why some companies might favor mandatory arbitration.

2. The Tactical Advantages That Securities Defendants Cede in Arbitration Are Significant

Nonetheless, there are several reasons to question whether the SEC’s about-face will engender the type of sea-change in corporate charters that some predict.  There are several advantages to adjudicating federal securities class actions in court rather than in arbitration that should not be overlooked – including those afforded under the federal Private Securities Litigation Reform Act of 1955 (PSLRA), which was passed to curb frivolous class actions and abusive securities litigation.

1. Automatic Stay on Discovery:

Congress designed the PSLRA in part to deny serial securities plaintiffs the opportunity to leverage strike suits and frivolous class claims to extract sometimes-handsome nuisance settlements from companies.  One strategy a plaintiff may use to gain leverage in such negotiations is to exploit the significant time and expense that defendants must bear in responding to plaintiff’s discovery requests for documents, testimony and information at the outset of most lawsuits.  To correct that imbalance, the PSLRA, where applicable, imposes an automatic stay of discovery in all cases where defendants have filed a motion to dismiss, which ensures that cases that are not well-pled (i.e., that are likely frivolous) are thrown out before they cost the parties substantial sums.  Arbitration, however, has no stated rule or mechanism for staying discovery.  Defendants therefore may be required to pay to meet discovery obligations even when moving to dismiss a frivolous arbitration claim. 

2. Heightened Pleading Standards: 

The PSLRA also heightens the standards that must be met to successfully plead a securities law claim.  For example, in securities fraud suits, the PSLRA requires plaintiffs to plead with particularity each statement alleged to have been misleading – including the reasons why the statements are misleading.  (The normal pleading standard for civil disputes in federal court only requires plaintiffs to provide a short and plain statement demonstrating their entitlement to relief.)  By demanding that plaintiffs plead specific, detailed factual allegations, the PSLRA shields against many spurious causes of action filed by class stockholders.  The PSLRA also requires securities fraud plaintiffs to plead with particularity facts that give rise to a “strong inference” of the defendants’ alleged intent to deceive, manipulate or defraud – a standard that many strike suits cannot meet.  These special pleading standards, however, are not available by rule in arbitration, where panels have discretion to make rulings based on vaguer notions of equity and justice.

3. Finality:

Another distinguishing factor between arbitration and civil adjudications concerns the parties’ ability to obtain a final and lasting judgment at the end of a litigation.  Corporate defendants often benefit from consolidating and addressing similar claims in the same action through class litigation.  When defendants prevail over a class of plaintiffs – e.g., where a court dismisses the class’s claims or refuses to certify a class – they achieve a clear and comprehensive resolution to outstanding claims in a single court proceeding.  Judicial principles of res judicata and collateral estoppel ensure that future litigants cannot sue for the same clams based on issues that have already been adjudicated in court.  Such principles are not required to be applied in arbitration, however, where arbitrators generally address each plaintiff’s claims individually (though some arbitration organizations have rules for “mass actions”).  Even if defendants successfully defend a stockholder’s suit in arbitration, then, they face the prospect of having to relitigate the same claim filed by a different yet similarly situated investor.  Defendants, in theory, face the prospect of adjudicating dozens, if not hundreds, of similar suits piecemeal – an expensive and inefficient way of achieving “finality” as to their legal exposure.

4. Right To Appeal: 

Another benefit of adjudicating class claims in federal or state court is that the parties are afforded a right of appeal.  The adjudicators of any dispute (arbitrators and judges included) do not always rule correctly, but corporate defendants litigating class actions in state and federal court can appeal bad decisions – sometimes with a corresponding stay to the original court’s ability to advance the litigation while the appeal is pending.  Arbitration awards, by contrast, can only be appealed on very narrow grounds, and are almost never overturned. 

5. Arbitral Expense:

While it is generally accepted that arbitration can be faster and more efficient than civil litigation, there are, of course, exceptions to this rule.  As alluded to above, it may be more time-consuming and difficult to dismiss an obviously frivolous securities claim in arbitration than in federal or state court, since parties are not automatically afforded the right to move for an early dispositive motion on the pleadings (i.e., motion to dismiss) in arbitration.  In general, defendants must request permission to file a dispositive motion to dismiss a suit in arbitration, which is not a guaranteed right – and must respond to discovery even in those cases where such a motion is permitted.  Thus, while arbitrations may generally move more quickly, an obviously frivolous claim can often be dismissed with greater speed in federal or state court, which provides a guaranteed procedure for eliminating strike suits at an early stage of the proceedings. 

3. Conclusion

In addition to these procedural and legal considerations, there are other factors that companies should consider before adopting a mandatory arbitration clause.  For example, the relevant state law applicable to a company may affect whether a company can avail itself of the SEC’s change in view.  Further, it remains to be seen whether corporate governance organizations such as Institutional Shareholder Services – which hold sway over many institutional investors – will be supportive of companies that adopt mandatory arbitration provisions.

Overall, the striking opinion issued by the SEC as to mandatory arbitration clauses is sure to lead some companies interested in an IPO to adopt such measures, but only time will tell whether litigating securities claims in arbitration will be more expedient and effective than in federal or state court.  Before taking the plunge and incorporating such mandates, companies and their advisors should carefully account for the advantages that they may forfeit under the PSLRA and other court rules if they opt to defend securities suits before private arbitrators.

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