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

In February 2004, the SEC approved various NASD rule amendments intended to make it more difficult for brokerage firms or brokers to avoid their arbitration payment obligations.52 Additionally, in June 2004, the SEC approved NASD by-law amendments that would allow NASD to institute suspension hearings within two years against a former broker seeking to reenter the securities industry when that broker has failed to pay awards.53 The NASD adoption of a rule prohibiting defunct broker-dealers from enforcing pre-dispute arbitration clauses cures a great deal of the unfairness in imposing on investors a compulsory process with a predictable outcome of non-payment. In approving the rule, however, regulators stated that defunct firms had a "significantly higher incidence of non-payment of arbitration awards than do active firms."54

II. INTERSECTION OF BANKRUPTCY LAW AND secURITIES ARBITRATION

Bankruptcy is a sacred state, a condition beyond conditions, as theologians might say, and attempts to investigate it are necessarily obscene, like spiritualism. One knows only that he has passed into it and lives beyond us, in a condition not ours.

-John Updike55

A. A Bankruptcy Law Primer

Bankruptcy law is a construct of federal law. The basic purpose of bankruptcy law is to create a reasonable and fair agreement between the debtor, the individual or corporate entity seeking bankruptcy protection, and the debtor's creditors, individuals, or corporate entities who are owed money by the debtor. Every individual bankruptcy case has two goals: resolving creditors' claims against the debtor and giving the debtor a "fresh start." A bankruptcy case is commenced automatically at the moment that the debtor files a petition for bankruptcy protection or, in an involuntary case, at the moment a petition is filed by the creditors against the debtor. The petition must specify whether the filing is a chapter 7 or chapter 11 filing. Chapter 7 of the Bankruptcy Code governs liquidation. Chapter 11 governs the reorganization of the debtor and the development of a plan to satisfy creditors. By far the most common form of bankruptcy is chapter 7, also known as a straight liquidation bankruptcy.

The primary purpose of a chapter 11 case is to rehabilitate and financially re-organize the debtor. After bankruptcy is filed, an independent third party, referred to as the bankruptcy trustee, collects and manages the debtor's bankruptcy estate, liquidates the assets, and distributes the proceeds to the debtor's creditors. When, however, a debtor files for chapter 11 restructuring, rather than having a court-appointed trustee who would manage the debtor during the bankruptcy proceeding, the debtor's management may continue to operate and manage the debtor on daily basis. A debtor who remains in control of the management and daily operations of a corporate entity is referred to as a "debtor-in-possession." At the moment a debtor files a bankruptcy petition, all property of the debtor becomes property of the bankruptcy estate.