Intuit Shareholders and Directors Reject Forced Arbitration Proposal

ATTORNEY: JARED M. SCHNEIDER | POMERANTZ MONITOR MARCH/APRIL 2020

While ardent disputes between investors and management about conducting securities litigations might not be newsworthy, their rare agreements are. One such agreement occurred at the meeting of Intuit’s share­holders on January 23, 2020. Harvard Law’s Nomura Professor Emeritus Hal Scott, an activist for forced securities arbitrations, filed a shareholder proposal (as trustee of the Doris Behr 2012 Irrevocable Trust) that would have waived the right to bring class action claims against the company. Professor Scott wanted Intuit’s shareholders to be required to submit individual claims to mandatory arbitration in the event that Intuit violated the securities laws, instead of being able to file a class action in court.

Despite the proposal’s assurances that “arbitration is an effective alternative to class actions” that “can balance the rights of plaintiffs to bring federal securities law claims with cost-effective protections for the corporation and its stockholders,” Intuit’s board of directors ultimately recom­mended voting against the proposal, finding it “not in the best interest of Intuit or its shareholders.” Over 97.6% of Intuit’s shareholders agreed.

The overwhelming rejection of the mandatory arbitration proposal by Intuit’s board and shareholders makes sense. Forced arbitration is not the grand balancing of interests between these two groups that its supporters claim it to be, and instead harms shareholders, the broader market, and even the companies themselves.

For an individual investor, prosecuting a fraud claim against a public company is a remarkably expensive, risky, and time-consuming proposition. Under the Federal Rules of Civil Procedure, an ordinary plaintiff’s complaint is only required to contain a “short and plain statement” explaining why the plaintiff is entitled to relief. However, since 1995, the pleading requirements to allege a claim for securities fraud have favored management’s interests. To state a claim under the management-endorsed Private Securities Litigation Reform Act of 1995, victims of se­curities fraud must allege specific, particular facts about (a) which statements were false or misleading (including who made the statements, when they were made, and in what context they were made); (b) why those statements were false; and (c) a strong inference—at least as com­pelling as any competing inference—that the maker of the false statements knew, or was reckless in not knowing, that they were false.

By itself, establishing sufficient particular facts to allege that a statement is false presents a significant challenge. But requiring the investor to uncover additional facts es­tablishing that the company knew the statement was false, without the benefit of reviewing the company’s internal documents or speaking with its current employees, makes this challenge a high hurdle bordering on clairvoyance.

Prosecuting a securities fraud action is frequently a years-long, multi-million-dollar endeavor. Thus, if shareholders who were subject to forced arbitration became victims of a company’s securities fraud, only the company’s larg­est shareholders (i.e., its closest and most sophisticated investors) would be able to recover their losses through individualized mandatory arbitrations.

Beyond providing a way for investors to recover losses due to fraud, securities class actions are prophylactic, protect­ing both current stockholders and the broader market. Re­search indicates that, with all else being equal, a person is more likely to lie when there is a lower chance that they will be caught lying, or when the probable punishment (financial or reputational) is slight. A system that provides account­ability, like the current one for class action securities litiga­tion that enables private persons to uncover and prosecute fraud as well as recover their losses, serves as a deterrent and increases the likelihood of bringing fraudsters to justice over a system that does not (such as individualized manda­tory arbitration). Similarly, the specter of a damages judge­ment that encompasses the losses in all of a company’s public shares will act as a better deterrent than damages based off of a small percentage of those shares.

Aside from the enhanced deterring effect of class actions above individualized mandatory arbitrations, the nature of public litigation and the potential for appellate review forces judges to issue written and, ideally, well-reasoned decisions. These decisions form the body of law for securi­ties-fraud claims and help to define the contours and limits of permissible conduct. Private arbitrators, who are usually not subject to appellate review and issue confidential deci­sions, do not have the same motivation to issue reasoned decisions or to form precedence. Forced arbitration need­lessly increases uncertainty and risk in markets that are already uncertain and risky.

In various interviews, Professor Scott supposes that class actions for securities fraud actually hurt shareholders because such lawsuits merely move money from one group of shareholders to another. This sophistic analysis, however, is both wrong and misguided as it ignores the significant societal goods that attend a robust practice of litigating claims of securities fraud. Securities fraud suits are not the cause of the harm to the company’s current shareholders. The company’s fraud causes the harm and resulting destruction in value, not the subsequent efforts to recover investors’ losses caused by that misconduct. Moreover, as explained above, the threat of pri­vate litigation to enforce the securities laws helps to keep capital markets honest.

The market’s understanding that bad actors will be punished for their misdeeds translates to in­vestor confidence in the integrity of the market for public securities. Conversely, if the market understood that toothless mandatory arbitration provisions would allow public companies and their insiders to commit fraud with impunity, investors’ confidence in those companies—and the market in general—would be curtailed. Thus, refusing mandatory arbitration makes sense from management’s perspective as well. Why would investors want to invest in a company that was allowed to defraud them?

The market’s exploration of mandatory arbitration provi­sions is developing. Aside from Intuit, only one other Amer­ican company, Johnson & Johnson, has considered such a provision (also brought by Professor Scott). After Johnson & Johnson refused his attempt to include a mandatory arbi­tration shareholder proposal in the company’s proxy state­ment, Professor Scott sued. Pomerantz has been retained by the Colorado Public Employees’ Retirement Associa­tion to intervene in the Johnson & Johnson proxy litigation to ensure that investors’ rights are protected. Pomerantz Partners Marc I. Gross and Michael Grunfeld discussed this litigation in the May/June 2019 issue of the Monitor.

Even prior to intervening in the Johnson & Johnson proxy litigation, Pomerantz was no stranger to the fight against forced arbitration. When the SEC and U.S. Treasury de­partment signaled a potential policy shift toward forced arbitrations, Pomerantz took action. The Firm organized an international coalition of institutional investors to meet with SEC Chairman Jay Clayton and congressional staff, to caution against allowing forced arbitration/class action waiver bylaws. As a result of Pomerantz’s advocacy, ten Republican State Treasurers, in a letter co-authored by the State Financial Officers Foundation, urged the SEC to maintain their existing stance against forced arbitration. “It is a significant and unusual step to have ten Republican Treasurers publicly take a position contrary to two Repub­lican SEC Commissioners and the Treasury Department,” wrote partner Jennifer Pafiti in an article on the subject in the November/December 2018 issue of the Monitor. Look for updates on the fight against forced arbitration in future issues of the Monitor as the issue is analyzed by the courts.

Look for updates on the fight against forced arbitration in future issues of the Monitor as the issue is analyzed by the courts.