UK markets open in 1 hour 12 minutes

Why a Harvard professor is asking shareholders to vote away their right to sue

Ethan Wolff-Mann
Senior Writer
Turbotax's parent Intuit, recently rejected an attempt by Hal S. Scott to add a mandatory arbitration clause for shareholders, preventing them from suing the company. (Peter Barreras/AP Images for Turbo Tax)

In late January, Intuit shareholders rejected a curious proposal from a former Harvard law professor, who is now the director of the nonpartisan think tank Committee on Capital Market Regulation.

The proposal would have adopted a mandatory arbitration provision into the company’s bylaws. Mandatory arbitration would have banned shareholders from being able to form a securities law class action against the company. In other words, it would have banned shareholders from suing if they thought the company had defrauded them. 

Intuit (INTU) is a business and financial software company that owns TurboTax among other products.

In an interview with Yahoo Finance, professor Hal S. Scott explained why it might be a good idea for a shareholder to give up the right to sue.

“It’s costing them money,” he said. “The major shareholders and corporations are holding their shares in index funds, and they sue themselves and the lawyers take 20%.”

Scott said most retail investors don’t get much money back from class action shareholder lawsuits anyway, and his research shows that people don’t even bother collecting the small damages.

“This is damaging the company. The only justification is really deterrence and there's plenty of deterrence,” Scott said.

Scott says that the rise in shareholder suits has helped create a market in which companies don’t want to go public. Scott cites a survey of executives from 2006 in which said lawsuits were a factor that made the American market less attractive.

According to Cornerstone Research, the lawsuits are getting more common. There has been a spike in federal class action securities fraud lawsuits – up 20% in 2019 since 1997.

In 2018, Scott, who is a trustee for a fund that owns shares, proposed a similar bylaw for Johnson & Johnson. However, the company asked and received permission from the SEC to leave it off a proxy vote, as it might have violated New Jersey state law. In 2012, Pfizer excluded a similar shareholder proposal in 2012.

Intuit’s vote

These arguments didn’t sway Intuit shareholders, who voted 213.2 million to 5.3 million to reject it.

Scott says the company didn’t recommend a vote against it not because it wasn’t a good idea, but because it’s untested. He even says he doesn’t disagree with the large institutional shareholders that voted against his proposal, but wants to clarify the law now as to whether this would be permitted in a company’s bylaw.

Johnson & Johnson products are displayed in Orlando, Fla. (AP Photo/John Raoux, File)

Proxy advisory firm Institutional Shareholder Services recommended a vote against Scott’s proposal, because the rules “would curtail shareholders’ right to select the forum of seeking redress of securities law violations and that there isn’t great data showing that it would curb the company’s litigation costs. Furthermore, it said that state laws in New Jersey (Johnson & Johnson) and Delaware (Intuit) make it unclear whether this is currently legal.

Intuit’s board said the adoption of a bylaw like Scott’s has never been a “significant shareholder concern,” and adoption could lead to “unnecessary litigation” around this bylaw. 

“I totally understand why the shareholders voted against this,” Scott said. “If you look at why — legal uncertainty, the novelty.”

In recent years, there has been a sharp movement from consumer advocates to reject a rise in mandatory arbitration, which is often considered to be advantageous to companies instead of consumers. 

Paul Bland, executive director of Public Justice, a consumer group that often fights forced arbitration, said: “Intuit shareholders rightly recognized that it is in no one’s interest to immunize companies who defraud people out of their savings. Scott’s proposal threatened to shake investor confidence, undermine Intuit’s reputation and put the savings of shareholders at greater risk.”

For Scott, the mere fact that the company voted on his proposal — unlike in the case of Johnson & Johnson — isn’t a win in his book. He said his next step is work to clarify the law. 

“The only win for me is companies doing this,” he said. “That’s what I’m trying to accomplish.”

--

Ethan Wolff-Mann is a writer at Yahoo Finance focusing on consumer issues, personal finance, retail, airlines, and more. Follow him on Twitter @ewolffmann.

Read the latest financial and business news from Yahoo Finance

Follow Yahoo Finance on TwitterFacebookInstagramFlipboardLinkedIn, YouTube, and reddit.