SEC Move May End Securities Class Action Litigation as We Know It

The Bottom Line

• A recent SEC update will enable public companies to end securities class actions.
• Companies that adopt mandatory arbitration provisions for securities class actions may see lower legal expenses and fewer large settlements.
• Federal legislation and future SEC leadership will determine the long-term impact.

Securities class action settlements totaled $3.7 billion in 2024—bested only by $4 billion the year prior, a historic record. The payments came from a mix of insurance and public company shareholders at the time of settlement (because that is really who pays a company’s settlement). The recipients are primarily former shareholders of those public companies.

A recent move by the Securities and Exchange Commission makes it possible for public companies to end this form of dispute. The SEC voted to allow companies to go public with charters or bylaws that include a mandatory arbitration provision for shareholder claims under the federal securities laws.

This may prompt newly public companies to adopt bylaws that require individual arbitration for securities claims. Companies that are already public also may amend their bylaws to adopt such provisions. If companies do so, they may end shareholders’ ability to file federal securities claims as class actions—eliminating billions per year in liability.

A Big Deal

Over the past decade, $41 billion has changed hands as part of securities class action settlements. Over 90% settle if they survive a motion to dismiss.

Most don’t survive a motion to dismiss, though. In 2024, 57% of securities class actions were dismissed before any discovery takes place. That’s a large percentage; some of us in the defense bar have an even higher rate of dismissal.

These numbers suggest most securities class actions are meritless. This doesn’t mean that those that don’t get dismissed are meritorious. Rather, through aggregating tens of thousands of small individual claims in a class, a securities lawsuit often becomes one of the largest liabilities that a public company will ever face.

Few kinds of lawsuits are more costly in the life of a modern corporation. The liability can be so large that a company may prefer to settle, even for large amounts, rather than take a case to a jury trial and run the risk of a verdict that wipes out a significant portion of the company’s market capitalization.

If someone gives public companies a way to eliminate this liability, they’ll take it.

Updating Corporate Bylaws

But now, with a bylaw amendment, a public company can end securities class actions. A company’s bylaws or charter can contain a provision that requires mandatory arbitration for federal securities claims.

The provision also will prohibit mechanisms that aggregate such claims, such as a class action. Every shareholder will need to sue individually.

Individual litigation of securities claims makes no economic sense. Most shareholders have small holdings, and even if they lost a significant percentage of the stock’s value, the costs of litigation are too high compared with the potential recovery.

The only way these claims make sense to pursue is by aggregation. Once opt-out aggregation becomes unavailable—if a shareholder has to opt in to make a recovery—the likelihood of any claim being brought approaches zero.

If such provisions are successful, the only individual securities claims will be rare—and only by a few large shareholders in exceptional circumstances.

There will be challenges to such arbitration provisions over the next few years—all will fail. For years, courts have allowed mandatory individual arbitration of claims that previously were being aggregated, effectively ending them.

Plaintiffs’ lawyers could argue that such provisions are contrary to the text of the enabling securities statutes—the Securities Act of 1933 and the Securities Exchange Act of 1934. They would lose, after a few years of litigating the anti-waiver provisions of those laws.

If shareholders vote down proposals to adopt such provisions in corporate charters—and proxy advisory services may advise them to do so—boards would still be able to adopt such provisions without a shareholder vote in bylaws. No doubt there will be challenges to the adoption of such bylaws, which also must fail under existing precedent.

Will shareholders really vote out otherwise successful directors over the adoption of such bylaws? I doubt it, because shareholders know who is really paying for enormous securities settlements (they are) and who is gaining from them (my able adversaries in the plaintiffs’ bar).

Some state legislatures may prohibit companies incorporated in those states from adopting such provisions. Section 115(c) of the Delaware General Corporation Law came into effect in August, and some have argued it has prohibited the adoption of such arbitration provisions.

The first Delaware companies to adopt them will likely face court challenges. Based on recent trends, the companies might lose at the Chancery level, but may win at the Supreme Court level, or later in the state legislature. But even if Delaware law remains steadfast against such arbitration provisions, companies can redomicile to Nevada, Texas, or another jurisdiction that is friendly to or silent on the issue.

Why We’re Here

A series of abusive practices by plaintiffs’ lawyers has, over the years, created a negative image of securities class actions among public companies and investors. Punishing and asymmetrical discovery burdens, mischaracterization of confidential witnesses, and plaintiff-favorable procedural standards have all led to a sense that meritless securities class actions are settled for astonishing amounts because of the high risk associated with jury trials.

These practices have often been met with indifference by the bench. With exceptions, judges are often reluctant to act decisively to trim claims at summary judgment, curtail discovery to the truly necessary, or make judgments as a matter of law rather than pushing steadily toward a jury trial that will never occur.

Even though Congress in 1995 began to require judges to perform a Rule 11 analysis in every securities class action, judges have largely ignored this requirement. Securities class actions often involve complex technical or financial issues and require a lot of judicial time, involvement, and understanding of key issues. It isn’t surprising that both trials and orders on summary judgments are rare in securities class actions.

Impact on Stakeholders

Companies that adopt mandatory arbitration provisions for securities class actions will see legal expenses and large settlements drop dramatically.

The early moving companies will have to fight bravely for those that follow. The early law they will help formulate on this topic will matter immensely.

Early adopters will also demonstrate that there is no valuation penalty for adopting arbitration provisions for securities class actions. Companies adopting such provisions won’t see their stock discounted in the market due to the adoption of such provisions, the same way the stock of companies leaving Delaware wasn’t impacted by their reincorporation.

Shareholders who have lost money will lose a potent tool for recovery. But were they entitled to it in the first place? US capital markets aren’t rife with fraud, so securities class actions sometimes have served as a form of investment insurance. However, shareholders who fall victim to instances of true fraud will have one fewer recovery option.

My friends in the defense bar will be quick to point to SEC enforcement actions as another means for victims of securities fraud to recover their losses. But that assumes the SEC will bring enforcement actions, that it will be adequately resourced, and that its policies will align with shareholders’ interests to the same extent that securities class actions were intended to be.

Lawyers stand to lose on both the plaintiff and defense sides. Individual business plans will need to be adjusted. Not planning for a world in which mandatory arbitration clauses exist or hoping to suppress them by judicial fiat won’t be a realistic path. The defense bar should embrace this new tool eagerly, rather than consider it a threat. The plaintiffs’ bar should also consider substantive reform of the class action system so that it is a viable alternative to arbitration on an individual basis.

Insurance carriers also may lose. After all, they run lucrative businesses insuring companies and their officers and directors against shareholder lawsuits. If such insurance weren’t profitable, it wouldn’t exist.

Finally, the state of Delaware will have to decide whether opposing such arbitration provisions, and maybe even slowing their adoption for a while, would be worth the significant risk of companies migrating to other states that permit arbitration clauses.

The End of Securities Class Actions?

All that being said, I will make one last prediction: The death of the securities class action will be temporary.

The instrument has emerged over decades as a powerful means of monetary recovery, and it clearly has a market. Just because the SEC’s current leadership will allow companies to become public even with such an arbitration provision in their constitutive documents doesn’t mean future leadership will do the same.

Federal legislation will be more impactful and longer-lasting than SEC pronouncements. The elimination of securities class actions by arbitration clauses likely will prompt congressional backlash and adoption of legislation empowering a collective private right of action for securities claims that isn’t subject to arbitration. Defense lawyers who decry the current system might then long for the days when the securities class action was a byproduct of judicial rulings alone.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Doru Gavril, a securities and investigations defense lawyer, is a partner at Freshfields in Silicon Valley.

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