NOWHERE TO RUN, NOWHERE TO HIDE: THE IMPACT OF SARBANES-OXLEY ON SECURITIES ARBITRATION

St. John's Law Review, Winter 2007 by Pierre-Louis, Lydie Nadia Cabrera

This Article continues my scholarship of loopholes in market regulation,18 which certain entities or individuals exploit for their own self-interest, and which often, if not always, results in a fraud on the market or on small investors. This article generally explores the loopholes in the application of the U.S. Bankruptcy Code to the securities market. More specifically, Part II of this Article provides an overview of securities arbitration. Part III provides an overview of bankruptcy law. Part IV examines the relevant changes that Sarbanes-Oxley has made to the U.S. Bankruptcy Code, in particular, the substantive changes to § 523(a)(19), which makes a finding of a debtor's fraudulent intent a condition precedent to a non-dischargeability of a claim in bankruptcy. Part V proposes an amendment to NASD Rules & Regulations to require arbitrators to make a finding of fraud in arbitral awards when the fraud has been pled and proven during the proceeding for purposes of § 523(a)(19). In Part VI, this Article concludes that as the securities market continues to expand and loopholes within the law are exploited, the regulatory framework which governs the markets will by necessity continue to develop to remain in tandem with the ever-changing securities markets.

I. SECURITIES ARBITRATION IN A NUTSHELL

When will mankind be convinced and agree to settle their difficulties by arbitration?

-Benjamin Franklin19

A. A Brief History of U.S. Securities Arbitration

In June 1987, the United States Supreme Court decided the landmark case Shear'son /American Express, Inc. v. McMahon,20 which forever altered securities arbitration into the conflict resolution process that currently exists. In Shearson, the Supreme Court upheld pre-dispute arbitration as a valid and appropriate manner for settling disputes. Prior to that time, securities arbitration was not viewed as a legitimate alternative to litigation.21 As the Court stated initially: "Recognizing the advantages that prior agreements for arbitration may provide for the solution of commercial controversies, we decide that the intention of Congress concerning the sale of securities is better carried out by holding invalid such an agreement for arbitration of issues arising under the [1933 securities] Act."22

To understand the importance of Shearson, it is crucial to understand the legal terrain regarding securities arbitration prior to the decision. We begin at the beginning. The first securities arbitration system was established at the New York Stock Exchange in 1817.23 The system was designed to provide a forum for disputes between member firms. In 1872, more than fifty years later, the NYSE established a securities arbitration forum for disputes between customers and member firms. It was not until 1935 that the sec issued a release encouraging its members to "offer customers a standard arbitration agreement."24 To further complicate the legal arena in 1947, Congress passed the Federal Arbitration Act ("FAA"),25 which established a strong national policy favoring arbitration as illustrated by numerous Supreme Court cases.26 The Federal Arbitration Act is viewed by many commentators as having a dampening effect on securities arbitration.