Carlyle Group LP, the Washington-based buyout company that’s preparing to go public, is seeking to bar its future shareholders from filing individual and class-action lawsuits.
The firm revised its governing documents last week to say that investors who purchase company shares must settle any subsequent claims against Carlyle through arbitration in Wilmington, Delaware. That could limit the ability of stockholders to win big awards for securities-law violations such as fraud, several attorneys said.
The U.S. Supreme Court has issued a series of rulings in recent years upholding the right of companies to require the use of arbitration to resolve disputes with consumers. Carlyle is seeking to extend this principle to public shareholders, a move that could run up against a bedrock of U.S. securities law, the ability of investors to seek redress in federal court.
“What we are talking about is legally uncharted territory,” said Donald Langevoort, a law professor at Georgetown University in Washington who previously worked for the U.S. Securities and Exchange Commission. “I would be surprised if the courts allow any company to entirely foreclose shareholder rights to sue under federal securities laws.”
Chris Ullman, a spokesman for Carlyle, declined to comment.
At issue are provisions of U.S. securities laws that bar investors from waiving their rights to seek damages.
After the Supreme Court ruled in the late 1980s that this language applied only to substantive rights and not to procedural ones, brokerages began including mandatory-arbitration clauses in their customer contracts, according to a 2006 report by the independent Committee on Capital Markets Regulation. The committee said the court had yet to rule on whether securities litigation against a public company can be brought to arbitration.
“If you really could enforce it, you would see every publicly traded company having that, and you don’t,” said Kevin LaCroix, an executive vice president at OakBridge Insurance Services LLC, a Bloomfield, Connecticut, firm that helps corporations obtain officers’ and directors’ liability insurance. Arbitration clauses have primarily been used in bilateral contracts between companies and their customers, LaCroix said.
The capital markets committee, in a November 2006 report requested by then-U.S. Treasury Secretary Henry Paulson, recommended that public companies be allowed to hold shareholder votes on the use of arbitration to resolve securities law and other claims. The threat of class-action suits was discouraging private as well as foreign companies from going public in the U.S., the committee said.
“Carlyle would be highly sensitive to this question because they have looked at it over and over again in the context of whether to take private companies public,” Hal Scott, a professor at Harvard Law School in Cambridge, Massachusetts and the committee’s director, said in a telephone interview. “There are powerful reasons to do what Carlyle is trying to do.”
The SEC must approve Carlyle’s registration statement before the private-equity firm can sell shares to the public. The agency has historically refused to permit a public offering by a company whose charter mandates arbitration and precludes class actions, John Coffee, a professor at Columbia Law School in New York, said in an e-mail response to questions.
Carlyle may be considered different because it’s a limited partnership rather than a corporation, Coffee said.
“It will be a difficult precedent to contain if the SEC permits this,” he said.
Florence Harmon, a spokeswoman for the SEC, declined to comment.
Carlyle, co-founded by David Rubenstein, William Conway and Daniel D’Aniello, is at least the fifth buyout firm to go public since Fortress Investment Group LLC held an initial public offering in February 2007, followed by Blackstone Group LP, KKR & Co., and Apollo Global Management LLC. Carlyle would be the first to impose an arbitration requirement, according to copies of the limited-partnership agreements the companies have on their websites or in SEC filings.
Blackstone was named in six 2008 lawsuits that were later consolidated into a class-action complaint alleging that the prospectus for the company’s IPO was false and misleading, in part because it overstated the value of the firm’s private-equity and real estate investments. The plaintiffs seek damages and costs, as well as other relief, Blackstone said in its latest quarterly report, adding that the case is “totally without merit” and that the firm intends to “vigorously” defend itself. Blackstone shares trade at about half the company’s June 2007 IPO price of $31 each.
Carlyle Capital Suits
From 2009 through 2011, Carlyle was targeted in lawsuits tied to Carlyle Capital Corp. Ltd., a publicly traded bond fund the buyout firm shuttered at a cost of more than $152 million after its assets plummeted in value. The plaintiffs include Carlyle Capital’s liquidators, who sought $1 billion in damages through four complaints filed in July 2010 in Delaware, New York, the District of Columbia and Guernsey, two of which have since been dismissed.
When Carlyle initially filed for the stock sale in September, the firm said its limited-partnership agreement would require any shareholder lawsuits be filed in Delaware Chancery court, which is known for its expertise in adjudicating such claims. Carlyle revamped the agreement, according to an amended registration filed Jan. 10, to say that arbitration would be the “exclusive manner” for the resolution of any claims, suits, actions or proceedings, including those made under federal securities laws.
Investors won’t be able to bring claims in federal or state court, or file or participate in class-action suits, even through arbitration, Carlyle said in the IPO filing. All proceedings and awards will be confidential, according to the document. Investors who buy Carlyle shares will have automatically agreed to the provision, the filing said.
Requiring the arbitration of individual claims in lieu of class-action lawsuits makes it more expensive for plaintiffs to pursue damages and more difficult to win big awards, said James Hill, who runs the private-equity practice for the Cleveland law firm Benesch LLP. That’s partly because attorneys are limited in their ability to take depositions from senior executives and to demand internal documents that can provide facts to support larger claims, he said.
“If you are on the moneyed side, you would like to put an arbitration clause in every contract,” Hill said in a telephone interview. “It’s a far more limited opportunity for the plaintiff.”
The SEC blocked a 1990 IPO by a Philadelphia savings and loan that had included a shareholder-arbitration clause in its corporate charter, according to Carl Schneider, a former securities attorney who represented the thrift. The SEC said the provision seriously impaired the “deterrent function” of shareholder lawsuits and acted as a “collective waiver of rights” without giving adequate notice to investors who bought shares in the secondary market, according to an article he wrote that year in InSights magazine.
“The commission went ballistic,” Schneider said in a telephone interview. “They refused to let the offering go public” until the clause was removed, said Schneider, who was a partner at the onetime Philadelphia law firm Wolf, Block, Schorr & Solis-Cohen and is now retired.
The business environment has changed since 1990, with the Supreme Court issuing a number of decisions during the past several years favoring arbitration as a means of resolving disputes, according to Schneider. The court ruled in April that an AT&T Inc. unit could bar wireless customers from bringing class-action claims under mandatory-arbitration clauses in their cell-phone contracts.
“It’s the class issue that was important,” said Harvard’s Scott. “Class arbitration is even worse than class litigation” because certain rights, such as the ability to appeal, are more limited, he said.
Publicly traded limited partnerships have also been granted more leeway than corporations in restricting the ability of investors to make claims, said John Olson, a securities attorney in the Washington office of Gibson, Dunn & Crutcher LLP. While these limited partnerships have primarily been in the energy and mineral resources businesses, Olson said buyout firms should be eligible for similar treatment.