Bankruptcy's Protection for Non-Debtors from Securities Fraud Litigation

Article excerpt

ABSTRACT

Given the recent economic climate, the judiciary faces an all too familiar challenge: navigate through the web that is bankruptcy and securities fraud. So far, bankruptcy has evolved into a tool to resolve mass tort litigation, like securities fraud. However, this Article explores bankruptcy as a tool to resolve securities litigation against non-debtors, those that never file for bankruptcy protection. The protection the Bankruptcy Code provides to non-debtors, like officers and directors, goes largely unnoticed, much to the detriment of securities fraud victims. Mindful that we now are in the midst of another financial crisis and that attention will slowly turn to the courts to pick up the pieces, this Article explores the significant protection non-debtors obtain from their debtor-company's bankruptcy filing and the adverse consequences it has for securities fraud litigants seeking recovery from these non-debtors.

I. INTRODUCTION

Bankruptcy has evolved into a tool to resolve mass tort litigation, like securities fraud. However, this Article explores bankruptcy's effect on securities litigation against non-debtors, those that never file for bankruptcy protection. The protection the Bankruptcy Code ("the Code") provides non-debtors, like officers and directors, goes largely unnoticed, much to the detriment of securities fraud victims. Mindful that the recent economic climate will force the judiciary to navigate the web that is bankruptcy and securities fraud,1 this Article explores the significant protection non-debtors obtain from their debtor-company's bankruptcy filing and the adverse consequences it has for securities fraud litigants seeking recovery from these non-debtors.

This Article first discusses the general concept of investor recovery under the securities laws and the Code.2 Next, it explores bankruptcy's implications for securities fraud suits against non-debtors.3 The Article discusses how the automatic stay is used to protect directors and officers from securities litigation and affect a defacto release from liability.4 It shows that a company's bankruptcy can impose duplicative discovery costs on plaintiff-investors and even influence the certification of a class action outside of bankruptcy against non-debtors.5 Furthermore, the Article demonstrates that in a company's bankruptcy, the bankruptcy court can release non-debtors from liability outright.6 It then argues that the Code's proposed remedy for investor-fraud, the bankruptcy trustee, is inadequate.7 The trustee likely lacks standing to sue on behalf of plaintiff-investors, and may be barred from recovering applicable insurance proceeds. The Article concludes that bankruptcy's unnoticed protection for non-debtors from securities fraud impedes investor recovery for fraud.

II. THE BANKRUPTCY CODE AND THE SECURITIES LAWS

Both bankruptcy and private securities fraud class actions are collective devices that pool the congruent interests of multiple claimants to a single fund.8 Apart from this common design, bankruptcy petitions and securities fraud allegations often go hand-in-hand as economic downturn causes corporations to miss earnings expectations or default on debt, fueling both securities litigation and bankruptcy.9 Filing rates for business bankruptcies and securities lawsuits between 2007 and 2009 evidence this correlation. Business bankruptcies increased dramatically as a result of the financial market turmoil caused by the subprime mortgage crisis in 2008 and 2009. 10 According to the Administrative Office of the United States Courts, at the end of September 2009, business bankruptcies increased by fifty-two percent from a year earlier.11 Securities litigation likewise spiked.12 Interestingly, many of the companies that file bankruptcy are named in securities fraud suits (seventy-seven percent of the large public companies that filed for bankruptcy between 2007 and 2008).13 This Part explores the Code's effect on investor recovery, private rights of action for securities fraud, and how a company is protected in bankruptcy from securities litigation. …