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

The painful reality is that in a significant number of cases, an investor with a duly obtained award is never paid. Oftentimes, it is because the brokerage firm or broker has filed for bankruptcy protection under the U.S. Bankruptcy Code. As a result, the brokerage firm or broker becomes, in essence, judgment-proof-the arbitration award cannot be enforced against the brokerage firm or broker and, in fact, the arbitration award is dischargeable in the bankruptcy proceeding. The end result is that small investors, having risked their life-savings with an unscrupulous broker or brokerage firm, undergone that arduous and relatively expensive process of arbitrating their claim against the brokerage firm or broker, and been awarded a favorable decision, are nonetheless ultimately denied satisfaction of their award because the U.S. Bankruptcy Code prohibits the payment of any money judgment that is not approved by the Bankruptcy Court. The analysis typically ends at this juncture. The defrauded small investor is left without any further recourse and a much lighter purse. The unscrupulous brokerage firm or broker receives his discharge order from the bankruptcy court, which effectively wipes out all outstanding debts or money judgments against the brokerage firm or broker, and trots off into the sunset emboldened to defraud yet another investor.

C. Dischargeability of securities Arbitration Awards

I mean, the company had a lot of strong cash flows when it went into bankruptcy.

-Kenneth Lay, Former CEO of Enron59

American bankruptcy law promotes its principal policy of allowing individuals to escape the financial and emotional burden of past debt by discharging prior economic liabilities.60 It is important to note that dischargeability differs from the automatic stay,61 which is triggered immediately upon a debtor's filing for bankruptcy protection. Automatic stay is an immediate bar against the commencement or continuation of any proceeding that would require the debtor to pay on an existing debt.62 Amendment to the exceptions from the automatic stay is closely connected to the expanded exceptions from discharge.63

For over a hundred years, courts have agreed that debts are presumptively dischargeable64 and that statutory exceptions to discharge65 must be narrowly construed in order to afford comprehensive relief to honest debtors.66 It was not until the Grogan case that the Supreme Court determined that the burden of proof standard in all § 523(a) cases is preponderance of the evidence.67 Prior to Grogan, the cases had been in complete disarray. The acknowledged importance of the policy favoring discharge had led the majority of lower courts to rule that, at least in some situations, a creditor would have to satisfy a "clear and convincing evidence" standard.68

Whether a debt is discharged is of critical importance to both debtor and creditor alike.69 The importance to an unsecured creditors is huge; if the discharge is granted, the unsecured creditor, which a small investor who has had an arbitration award issued in his favor would be defined in bankruptcy court, will not be paid anything. The disproportionate amount of court time devoted to dischargeability litigation reflects the stakes at risk for all parties. A recent study indicates that dischargeability proceedings under section 523 consume approximately twentyseven percent of the time bankruptcy judges devote to "caserelated" matters and over sixteen percent of their total "workrelated" hours. 70