What's Happening With The Shareholder Proposal For Mandatory Arbitration Bylaws?
In 2018, a Harvard law professor submitted (on behalf of a related trust/shareholder) a shareholder proposal to Johnson & Johnson requesting that the board adopt a mandatory arbitration bylaw. After receiving a no-action letter from Corp Fin, J&J excluded the proposal, and the professor then sued J&J. A decision has just been rendered dismissing the complaint. But that's not necessarily the end of the shareholder's proposal to J&J for mandatory arbitration. Background. In what seemed to be an odd role reversal, a Harvard professor and a related trust that was a J&J shareholder submitted a proposal requesting that the board adopt a mandatory arbitration bylaw applicable to "disputes between a stockholder and the Corporation and/or its directors, officers or controlling persons relating to claims under federal securities laws in connection with the purchase or sale of any securities issued by the Corporation." The bylaw would also prohibit class actions and include a five-year sunset provision unless re-approved by the shareholders. Curiously, J&J sought to exclude the proposal from its proxy statement. Among other things, J&J's request to Corp Fin contended that the proposal, if implemented, would violate state law. In its request, J&J included a letter from the Attorney General of the State of New Jersey, the state's chief legal officer, advising the SEC that the proposal was excludable under Rule 14a-8(i)(2) because "adoption of the proposed bylaw would cause Johnson & Johnson to violate applicable state law. Longstanding principles of New Jersey law limit the subject matter of corporate bylaws to matters of internal concern to the corporation. Under New Jersey law, as under Delaware law, forum-selection provisions relating to claims under the federal securities laws do not address matters of internal concern, and bylaw provisions purporting to dictate the forum for such claims-including but not limited to mandatory arbitration provisions-are void." But the issue of mandatory arbitration bylaws has been something of a hot potato. In its no-action letter granting relief to J&J if it relied on Rule 14a-8(i)(2) (violation of law) to exclude the proposal, the staff gave plenty of special weight to the NJAG-in fact, the staff's letter rode entirely on the back of the NJAG: "When parties in a rule 14a-8(i)(2) matter have differing views about the application of state law, we consider authoritative views expressed by state officials...We view this submission [by the NJAG] as a legally authoritative statement that we are not in a position to question." The issue was so fraught that then-SEC Chair Jay Clayton felt the need to issue a statement supporting the staff's hands-off position and advocating, in effect, that the parties seek a binding answer in court-which is exactly what happened. (See this PubCo post.) SideBar As discussed here, the concept of mandatory arbitration of shareholder claims has been run up the flagpole a few times in the past. The idea took hold in the late 1980s, when SCOTUS concluded that stock brokers could enforce mandatory arbitration agreements with customers. However, in subsequent encounters, the SEC has not been particularly receptive to the idea. When a private equity fund sought to go public in 2012 with a provision in its partnership agreement requiring mandatory individual arbitration of any disputes, including disputes under the federal securities laws, Corp Fin advised that it would not accelerate effectiveness of its registration statement, and the provision was withdrawn. Then, in an interesting turn of events, binding shareholder proposals were submitted at several companies seeking to amend their bylaws to include mandatory shareholder arbitration provisions. (If this seems counterintuitive, the argument submitted by the proponent was that the costs of frivolous class action litigation were ultimately borne by the shareholders, and preventing these suits would therefore benefit shareholders.) One of these companies, attempting to exclude the proposals from its proxy statement, contended that it should be excludable under Rule 14-8(i)(2)- on the basis that implementation would cause the company to violate applicable law-because implementation would violate Section 29(a) of the Exchange Act. Section 29(a) declares void any provision "binding any person to waive compliance with any provision of this title or of any rule or regulation thereunder.." Since the bylaw prohibited claims subject to arbitration from being brought in a representative capacity, that is, in class actions, the company argued, the provision effectively waived shareholders' abilities to bring claims under Rule 10b-5. The SEC allowed exclusion of the shareholder proposal, agreeing that there was some basis for the view that implementation of the proposed bylaw amendment would cause the company to violate the federal securities laws. The professor took Clayton's advice and, in March 2019, filed this complaint in the New Jersey Federal District Court, seeking a declaratory judgment that J&J violated Section 14(a) of the Exchange Act by excluding the mandatory arbitration proposal from its proxy materials, as well as an injunction requiring J&J to issue supplementary proxy materials that included the proposal, stating that the proposal was legal under federal and New Jersey law, and preventing J&J from excluding proposals of this sort from future proxy materials. (See this PubCo post.) J&J moved to dismiss. Because the subject matter of the proposal-and perhaps the persistence of the proponent in pursuing it-was apparently viewed as an instance of the camel's nose getting under the tent, two public employee pension funds then intervened in the action and filed, separately from J&J, a motion to dismiss the complaint. As discussed here, the funds argued that "[t]his case comes before the Court in a strange posture. [A]s things stand, this litigation presents a truly anomalous scenario: Johnson & Johnson is the only party defending shareholders' right to bring a class action against Johnson & Johnson. Meanwhile, the only shareholder party-a trust that owns 1,050 Johnson & Johnson shares-has chosen to advocate a position that is contrary to other shareholders' interests." But there is more to it than just the "strange posture" of the parties in the case-the funds signalled that they wanted to use the opportunity to make their case against bylaws of this nature. (See this PubCo post.) Then, a stay of the case was issued pending resolution of Salzberg v. Sciabacucchi, a Delaware case that the parties had extensively briefed in support of their respective positions. In Sciabacucchi, the Delaware Chancery Court had taken the position that an exclusive federal forum bylaw was illegal, thus favoring the arguments of J&J; that court held that a corporation could adopt a forum selection bylaw to regulate "internal affairs claims brought by stockholders qua stockholders," but not "to regulate external relationships," and that a Securities Act claim was an external claim that fell outside "the scope of the corporate contract." However, the Delaware Supreme Court reversed, unanimously holding that charter provisions designating the federal courts as the exclusive forum for '33 Act claims were "facially valid" and permitted under the "broadly enabling" provisions of Section 102(b)(1) of the Delaware General Corporation Law. Exclusive federal forum provisions were not "external," as the Chancery Court had held. Rather, the Delaware Supreme Court maintained, forum selection provisions related to neither "external" claims, such as personal injury or breach-of-contract claims, nor strictly internal affairs matters. Rather, there was "a category of matters that is situated on a continuum"-intra-corporate claims-that are "in what might be called Section 102(b)(1)'s 'Outer Band,'" an area outside of internal affairs, but still encompassed by Section 102(b)(1). Exclusive federal forum provisions, the Court held, fell into this category and, as a result, were facially valid. (See this PubCo post.) The reversal meant that the case no longer supported J&J's argument. New Jersey District Court decision. Following the Sciabacucchi decision, the J&J matter was reopened in June 2020, and the professor filed an amended complaint, adding only that the Sciabacucchi decision supported his claim by eliminating any basis for asserting that his shareholder proposal for mandatory arbitration was contrary to state law and that Johnson & Johnson had advised him that it would no longer exclude the proposal from its proxy materials if the proposal was resubmitted the proposal for a future meeting. Because, although the professor was no longer seeking injunctive relief, he was still seeking declaratory relief that (1) J&J had violated Section 14(a) by excluding the proposal in 2019, (2) that J&J would not violate NJ or federal law if it amended its bylaws as the proposal requested and (3) that any NJ law that purported to prevent a company from requiring its shareholders to arbitrate their federal securities law claims was contrary to the Federal Arbitration Act. And, he said, he wanted the declaratory relief prior to submitting a new proposal to J&J. The Court swiftly disposed of the complaint. The Declaratory Judgment Act requires that there be an "actual controversy" that is justiciable under Article III, meaning that there must be an action that is "concrete and ripe." According to the Court, prior to "deciding a declaratory judgment case, a court must ask 'whether the facts alleged, under all the circumstances, show that there is a substantial controversy, between the parties having adverse legal interests, of sufficient immediacy and reality, to warrant the issuance of a declaratory judgment.'" With regard to the 2019 violation of Section 14(a), the Court held that the request was moot because declaratory relief is prospective only and is not available to remedy "past wrongs." With regard to the second request for a declaration that J&J would violate the law if it amended its bylaws as requested, the Court held that the request was not ripe "because any controversy with respect to a proposal that the [plaintiff] might submit in connection with future shareholder meetings is hypothetical at this juncture and contingent on future events," particularly as the plaintiff indicated that he did not want to resubmit the proposal before a judicial declaration as to the legality was issued. On the third request for a declaration that the Federal Arbitration Act preempts any NJ law that might seek to prevent arbitration of federal securities law claims, the Court likewise denied relief; federal courts have no jurisdiction to render advisory opinions about what the law would be under a hypothetical state of facts. Accordingly, the Court dismissed the complaint, but granted plaintiffs "one final opportunity to file an amended complaint," by 7/14/2021. Time will tell whether the professor makes another attempt at an amended complaint or just submits his proposal to J&J, which has already said that yes, it would include the proposal in its proxy statement. The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.