Academic journal article Fordham Journal of Corporate & Financial Law

Securities Fraud, Officer and Director Bars, and the "Unfitness" Inquiry after Sarbanes-Oxley

Academic journal article Fordham Journal of Corporate & Financial Law

Securities Fraud, Officer and Director Bars, and the "Unfitness" Inquiry after Sarbanes-Oxley

Article excerpt


In early 1988, Ratilal Patel and Dilip Shah were executives of two successful and related pharmaceutical companies.1 Patel was a founder, director, and officer of Par Pharmaceuticals; Shah was the president of Par's subsidiary Quad Pharmaceuticals.2 Par and Quad were rising stars in the generic drug industry, and long-term investors in Par were undoubtedly delighted by the steady gains in the company's stock price.3 In the summer of 2008, however, the good times came to an abrupt end when federal prosecutors indicted Patel and Shah for their roles in bribing and defrauding the Food and Drug Administration ("FDA"), acts that had resulted in the distribution of untested and unapproved versions of the companies' drugs to consumers.4 The market for Par stock reacted swiftly: the price dropped from $17.37 to $10.12 in the course of three months.5

The scandal went far beyond what prosecutors initially thought had occurred. Not only had Shah and Patel sabotaged the mechanisms that were designed to ensure the safety of their drugs, they had also begun selling their Par stock prior to the public announcement of their misconduct with the FDA.6 Consequently, the Securities and Exchange Commission ("SEC") sued, alleging fraud, and sought to have both men permanently barred from serving as managers of any publicly traded company.7 In both cases, however, the courts ultimately held that the managers' misconduct did not justify such a remedy.8

At this moment, Shah and Patel may be in a boardroom, managing a company owned by widely dispersed members of the public. Why would any rational person invest in a company run by someone like Shah or Patel? In some cases, public investors have no meaningful choice in the matter because they do not know of the current management's prior wrongdoing.9 In other cases, shareholders are the direct beneficiaries of corporate misconduct and thus have no incentive to oust misbehaving management.10 Why would the government allow such a person to continue serving in a position of public trust? Simply put, it does not allow it.11

For many years, the SEC has sought to bar corporate managers and others whose illegal misconduct shows contempt or disregard for the nation's scheme of securities regulation.12 Federal securities regulation is designed to promote free and efficient capital markets by ensuring that up-to-date information flows freely from corporate issuers to the public.13 By introducing untrue or misleading information into the market, fraud undermines this freedom and efficiency.14 Securities fraud is a serious violation and violators are subject to a variety of securities law sanctions, including monetary penalties, disgorgement, occupational bars, and imprisonment.15 The SEC has used the officer and director bar particularly to prevent perpetrators of fraud from serving as fiduciaries to the public.16

This Note examines the federal courts' inconsistent and problematic interpretations of the officer and director bar statutes and proposes a solution that satisfies Congress's intent and that is fair both to the SEC and to the defendants in enforcement proceedings. Part I reviews the history of the officer and director bar as a remedy for securities fraud violations. It concludes by explaining how Congress responded to cases like Shah and Potei in the Sarbanes-Oxley Act of 2002 ("SarbanesOxley"). Part II categorizes and discusses the various approaches that federal courts have taken in interpreting and applying the officer and director bar after Congress amended the bar statutes in Sarbanes-Oxley. So far, few courts have demonstrated a clear understanding of the amended statutes. Part III draws from the history of the officer and director bar, including the events leading up to the passage of SarbanesOxley, to propose a solution that is consistent with the legislative purpose of the amended statutes and the past seventy years of securities enforcement. …

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