The Fair Funds for Investors Provision of Sarbanes-Oxley: Is It Unfair to the Creditors of a Bankrupt Debtor?

In the wake of the stock market decline in early 2000, many major corpo-rations announced fraudulent accounting errors, sought bankruptcy pro-tection, or both. In rapid response, Congress enacted the Sarbanes-Oxley Act of 2002 in order to strengthen the Securities and Exchange Commission and enhance penalties for violations of securities laws.In its haste, Congress overlooked an important conflict between Sar-banes-Oxley and the Bankruptcy Code. The Fair Funds for Investors provision, contained in section 308(a) of Sarbanes-Oxley, allows the SEC to place a civil penalty obtained from violators of the federal securities laws into a disgorgement fund to be distributed to injured investors. On the other hand, section 510(b) of the Bankruptcy Code subordinates investors’ securities-related claims to those of all other creditors.As a result, the SEC and common stockholders may work an end-run around section 510(b) of the Bankruptcy Code and elevate the stockhold-ers’ claims by resorting to the Fair Funds for Investors provision. Fur-ther, as corporate malfeasance increases public outrage, the SEC will face increasing pressure to divert funds to defrauded investors, leaving creditors to collect from a depleted bankruptcy estate. The author con-cludes that Congress should address this conflict by amending section 308(a) of Sarbanes-Oxley to comport with section 510(b) of the Bank-ruptcy Code and maintain its established distributional scheme.

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