Washington D.C.-based alternative asset manager The Carlyle Group, which is planning an IPO, announced on January 10 that prospective shareholders will have no right to sue the company in court.Â Instead, investors will be forced into individual, confidential arbitration proceedings in a forum chosen by the company.Â This may increase the cost to shareholders of seeking a legal remedy if Carlyle violates the law, and may prevent them from effectively coordinating their claims as class actions.
Carlyleâ€™s move appears custom-designed to test the limits of a growing trend favoring strict enforcement of arbitration agreements, including those thatâ€”like Carlyleâ€™sâ€”completely forbid consumers from joining their claims together for class treatment.Â Critics say that arbitration clauses can block consumers from legal relief and effectively give big businesses a license to break the law, while supporters contend that the clauses allow for more efficient, cost-effective dispute resolution and discourage frivolous lawsuits.
The trend toward favoring arbitration clauses picked up steam in April 2011 with the U.S. Supreme Courtâ€™s decision in AT&T Mobility, LLC v. Concepcion.Â In Concepcion, the Court held by a narrow 5-4 margin that the Federal Arbitration Act prohibits state laws that automatically invalidate arbitration clauses providing no class action rights to consumers.Â So far, most lower courts have read Concepcion as a virtually complete block on state legislation designed to make arbitration clauses harder to enforce against consumers.
On January 10â€”the same day as Carlyleâ€™s SEC filingâ€”the court issued its opinion in CompuCredit Corp. v. Greenwood.Â In that case, the Court held by an 8-1 margin that credit counseling firms can force consumers to arbitrate claims under the federal Credit Repair Organizations Act, despite the fact that the CROA requires businesses to inform consumers of their â€śright to sue.â€ťÂ Greenwood signals that in order to guarantee consumers the right to sue in court for claims under a federal law, the law must explicitly state that such claims cannot be forced into arbitration against the consumersâ€™ wishes.
The recent legal trend favoring mandatory arbitration has been largely confined to consumer contractsâ€”two-party agreements between companies and those who buy their products and services.Â Carlyleâ€™s bid to force shareholders into arbitration seeks to ride the arbitration wave into the completely separate arena of federal securities law.Â Up until now, class actions in federal courts have been the legislatively-favored method of resolving securities cases.Â If successful, Carlyleâ€™s IPO could represent a sea-change in the field.
Carlyleâ€™s path to mandatory arbitration is far from clear.Â The SEC must approve Carlyleâ€™s registration statement before the company can go public.Â In the past, the SEC has refused to approve the few IPOs that tried to bar shareholders from suing companies in court.Â However, those cases all involved corporations, whereas Carlyle is a limited partnership.Â Limited partnerships have historically enjoyed more discretion than corporations in limiting various types of shareholder rights.
But the SECâ€™s review of Carlyleâ€™s registration papers will happen against a backdrop of increasing scrutiny of venture capital firms.Â The Obama administration has called for increased regulation and taxation of such firms.Â Venture capitalists are favorite villains of the Occupy Wall Street populist movement.Â Perceived distrust of venture capitalism has even made its way into normally business-friendly Republican politics, with former presidential candidate Rick Perry leveling accusations of â€śvulture capitalismâ€ť at competitor Mitt Romney, who once helmed private equity giant Bain Capital.
Despite all this, Carlyle may be able to use the recent wave of pro-arbitration decisions by the Supreme Court as leverage to convince the SEC to approve its novel approach to shareholder relations.Â However, even if the SEC allows Carlyleâ€™s IPO to go forward as planned, a new round of litigation over the legality of forcing shareholders into arbitration is sure to follow.Â Such litigation will most likely end up back in the Supreme Court, which will have yet another opportunity to define the outer boundaries of a companyâ€™s ability to keep its customers from their day in court.