Shareholders in the San Diego area will be interested in a recent IPO filing with the Securities and Exchange Commission. According to the filing, the Carlyle Group LP is requiring future shareholders to resolve claims through arbitration in the hopes of protecting itself from class-action lawsuits by shareholders.

Now, it is up to the SEC to decide whether such language will undermine shareholders’ rights. If the SEC allows the offering to go public, it would set an extraordinary precedent, encouraging more companies to follow their lead while placing shareholders at risk. This is because arbitration proceedings generally allow less discovery for plaintiffs, and once a decision is made, there are limited opportunities to appeal those decisions.

The long-standing rule by the SEC is that businesses are not allowed to go public if their governing documents limit the ability of shareholders to protect their rights. Carlyle’s arbitration requirement would leave millions of investors at risk if their ability to enforce their rights through class-action lawsuits is limited. Class-action lawsuits by investors have, in fact, been successful in holding corporate executives accountable for their actions.

If the SEC blocks the stock sale, then it is possible that Carlyle will take its case to the Supreme Court, which may disagree with this long-standing SEC ruling. The high court appears to favor arbitration methods for resolving disputes. This may be because arbitration requirements reduce the cost of litigation for all involved, including shareholders. The court may reason that since shareholders generally collect very small amounts from class-action lawsuits, shareholders may actually be better off with an arbitration system.

It is important to note that Carlyle is a limited partnership, and as such it has more flexibility than a regular corporation in the restriction of its fiduciary duties to shareholders, making such a restriction on class-action lawsuits a possibility.

It should also be noted that, if Carlyle succeeds in restricting its shareholders’ ability to file suit, that move will not come without a price tag. The move should affect the price that potential shareholders are willing to pay for such stock. Is this a risk worth taking from a business standpoint? Apparently, Carlyle believes it is.

Source: Bloomberg, “Carlyle Curbing Shareholder Rights Irritates Lawmakers Who See Precedent,” Miles Weiss, Jan. 25, 2012