SEC V. Creditors: Why SEC Civil Enforcement Practice Demonstrates the Need for A Reprioritization of Securities Fraud Claims in Bankruptcy

(Excerpt) This Note examines how this tension has motivated the SEC to use receiverships as a preferred vehicle to maximize recovery for defrauded security holders and, in the process, create what amounts to an SEC-run bankruptcy proceeding. The use of these receiverships has triggered a high-stakes race to the courthouse among the SEC and creditors, where mere hours can be the difference between millions in recovery and nothing at all. To end this costly race, this Note proposes a solution that seeks to harmonize securities fraud enforcement with bankruptcy law, which starts with revisiting Bankruptcy Code § 510(b) to reprioritize securities fraud claims in bankruptcy. Part I explains how securities fraud claims are treated in bankruptcy under § 510(b), illustrating when such claims are subordinated and the rationale for doing so. Part II provides an overview of the SEC’s influence in the bankruptcy context from the Agency’s restricted role in the Code to its empowerment by Sarbanes-Oxley. Next, Part III.A explains how Sarbanes-Oxley empowers the SEC to use fair funds to compensate defrauded security holders in bankruptcy. Similarly, Part III.B explains how the SEC acts alternatively, out of bankruptcy, through equitable receiverships to recover for securities fraud victims. Part IV demonstrates how § 510(b) has motivated the SEC to avoid bankruptcy altogether, and instead utilize equitable receiverships as a primary civil enforcement tool to compensate securities fraud victims of insolvent and near-insolvent entities. Part IV further illustrates the SEC’s influence over this process, culminating in receiver distributions that disadvantage creditors. Accordingly, this use of receiverships has started a race to the courthouse between the SEC and creditors. Finally, Part V proposes a solution to harmonize SEC civil enforcement policies with the Code. This Part offers objectives for Congress to better integrate securities fraud claims back into the bankruptcy process. In addition, it suggests practical means to achieve integration like elevating the United States Trustee to allow for more coordination with the SEC and the creation of a receivership-focused SEC position to benefit all securities fraud victims of insolvent entities—security holders and creditors alike