Nowhere to Run, Nowhere to Hide: The Impact of Sarbanes-Oxley on Securities Arbitration

Article excerpt

Securities arbitration is a "rigged system" that is unfair to investors.

-William F. Galvin, Massachusetts secretary of the Commonwealth1


A. A Hollow Victory

We won. For over two years, we won appeal after appeal in the New York state courts against a former Schwab and Co. independent investment advisor. The arbitration award in favor of our clients was not large by Wall Street standards. It represented our clients' life savings, however, and an opportunity for them to rebuild their lives. Our clients are immigrants from Pakistan with very little education, money, or business savvy. They had no business investing in high risk technology stocks. In fact, they had no idea their investment advisor invested in technology stocks. How could they? They did know what technology stocks were and did not read English very well. Their unscrupulous investment advisor lost their entire $45,000 investment, and he lost it within six months. The National Association of securities Dealers'2 arbitrators had no difficulty finding that the investment advisor committed fraud and awarded our clients a full recovery plus interest and fees. Sometimes the system does work. Within weeks, the investment advisor filed not one but two appeals alleging a laundry list of sundry state and federal illegalities. We fought every allegation. Finally, after two years, the New York Court of Appeals affirmed the arbitration award and dismissed the investment advisor's allegations as unsubstantiated. It was over. The students informed our clients that we won, and they could begin collection proceedings against the investment advisor. Our clients' gratitude was overwhelming, and it inspired the students to continue working for the less fortunate in our society.

Our euphoria was short lived. Unbeknownst to anyone, the unscrupulous investment advisor filed for bankruptcy during the pendency of the Court of Appeals decision. I held in my hand an order from the Eastern District of New York Bankruptcy Court instructing me to cease and desist from any litigation, administrative proceeding, or collection action against the investment advisor and to attend a meeting of all creditors. For a moment, time really did stand still; then I smiled. We would go, and we would fight. All I needed to know was whether the law was on our side.

B. The Rise of the Sarbanes-Oxley Act of 2002

What is lacking in the U.S. is a culture of shame. No C.E.O. in the U.S. is considered a thief if he does something wrong. It is a kind of moral cancer.

-Guido Rossi, former chairman of Telecom Italia3

In 2001, a wave of highly publicized scandals broke at prominent public corporations such as Enron,4 WorldCom, and Tyco. The scandals followed closely on the heels of the now infamous bursting of the technology bubble. The corporate structure of the U.S. economy changed ever since the Enron scandal emerged.5 Thousands of investors and Enron employees lost their savings and pensions because Enron misrepresented its finances.6 Before Enron's stock crashed, the company's top executives pulled out their investments, but its employees were not allowed to move their pension funds from Enron stock to a money-making investment.7 The refusal of many Enron executives to testify about their company's demise, and the existence of conflicts of interest between Enron directors and outside consultants are among the primary reasons Congress adopted the Sarbanes-Oxley Act.8 The Act was an effort to protect against bad governance and reassure investors that it was safe to invest.9

Sarbanes-Oxley is a broad package of federal legislation intended to rein in corporate executives run amok and restore investor confidence.10 Unlike most of the federal initiatives that preceded it, Sarbanes-Oxley established some mandatory rules governing the internal affairs of publicly listed corporations. In particular, Sarbanes-Oxley includes changes to many different areas of the law: (1) accounting and auditing procedures, (2) financial disclosures, (3) corporate tax law, (4) securities law, and (5) bankruptcy law. …