February 18, 2014
Fair Funds Forever
Posted by Urska Velikonja

The SEC has long had the authority to distribute monetary penalties collected from securities violators to harmed investors. Initially, the SEC could distribute only ill-gotten profits that defendants gained from securities violations, but not any additional civil fines that the SEC ordered defendants to pay. Section 308(a) of the Sarbanes-Oxley Act allowed the SEC to add civil fines to disgorgements and distribute both through fair funds. The SEC could distribute the civil fine only if that defendant also paid disgorgement. Section 929B of the Dodd-Frank Act removed that requirement, so now the SEC can distribute civil fines even in cases where the defendant does not profit from the violation (e.g., J.P. Morgan paid a $200 million civil fine to the SEC for misrepresentations related to the London Whale fiasco, but no disgorgement, and the full amount will be distributed through a fair fund).

Most people know next to nothing about fair funds. Even securities law professors tend to know very little, mostly assuming that fair funds are the smaller, feebler version of securities litigation. I wanted to find out whether the perception matched reality, so I looked at all fair funds created to date (236). The funds are in the process of distributing $14.33 billion since 2002, which is more than the SEC's budget for the same period, but less than securities class action settlements ($60 billion). The largest fair funds were created in accounting fraud cases (AIG, Fannie Mae, Time Warner), as were the largest class action settlements (WorldCom, Enron, Tyco). So far, reality seems to confirm perception.

While the evidence suggests that fair funds are indeed smaller than securities litigation, they are not a version of securities litigation. Securities litigation overwhelmingly compensates investors for accounting fraud (90% of settlement dollars). Not so for fair funds. 44.1% of distributed monetary sanctions compensate investors for accounting improprieties. Of that amount, individual and secondary defendants (auditor and investment banks) paid 19.6% out-of-pocket. Other large fair fund categories include investment advisor cases, broker-dealer violations and securities offering cases (e.g., CDO-related misrepresentations). The table below provides more detail.

Table
 

I will have a separate post about parallel private litigation. But to preview, securities class actions were filed in 65.4% of fair fund cases and settled for non-zero monetary damages in 45.6% of cases. Most of those were in accounting fraud cases. Not only are class actions much more often filed in accounting fraud cases than in all other cases, they are also far more likely to survive the motion to dismiss. So there are really two types of securities violations: accounting frauds and all others. Stay tuned for more details.  

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