$1.5 Billion May Be Slated For "Fair Funds." What Is It?

In the few days leading up to Christmas, the SEC was either playing the role of Santa Claus or Scrooge, depending upon your perspective.

On Dec. 22 it reached a settlement with the Canadian Imperial Bank of Commerce (CIBC), for its role in Enron's manipulation of its financial statements. As part of the deal, CIBC was ordered to pay $80 million: $37.5 million in disgorgement, a $37.5 million penalty, and $5 million in prejudgment interest. (Related SEC litigation release at right).

The Commission said it intends to direct the money paid by CIBC to Enron fraud victims under the Fair Fund provisions of the Sarbanes-Oxley Act.

The following day, the Commission settled fraud charges against Vivendi Universal, S.A., its former CEO, Jean-Marie Messier and former CFO, Guillaume Hannezo. Under the settlement, Vivendi agreed to pay a $50 million civil penalty. (Also at right).

The settlements also include Messier's agreement to relinquish his claims to a €21-million euro severance package (approximately $26 million U.S. dollars) that he negotiated just before he resigned his positions at Vivendi, and payment of disgorgement and civil penalties by Messier and Hannezo that total over $1 million.

The Commission intends to direct these sums as well to defrauded shareholders under the Fair Funds provision.

FAIR FUNDS

According to Section 308 of Sarbanes-Oxley, if the SEC — in any judicial or administrative action brought under SOX — obtains an order "requiring disgorgement against any person for a violation of such laws or the rules or regulations thereunder, or such person agrees in settlement of any such action to such disgorgement, and the Commission also obtains pursuant to such laws a civil penalty against such person, the amount of such civil penalty shall, on the motion or at the direction of the Commission, be added to and become part of the disgorgement fund for the benefit of the victims of such violation."

What Is The Fair Funds Provision?

Under Section 308(a) of the Sarbanes-Oxley Act (see excerpt at left), the SEC is allowed — but not required — to add penalties to disgorgements, which always went to victims (providing the amount was large enough and there was a way to identify the victims).

Before the Act, by law, all civil penalties were paid into the U.S. Treasury, and, as a result, kept out of the hands of defrauded investors.

Now, however, the Commission has authority, in certain circumstances, to use civil penalties to help make defrauded investors whole.

In addition to CIBC and Vivendi, in recent months the SEC reached settlements with Morgan Stanley for $50 million and Alliance Capital $250 million under the Fair Fund program.

Altogether, the SEC’s staff has filed a Fair Fund motion, or made provision for a Fair Fund in a settlement, in at least 37 actions.

Show Me The Money

Altogether, the funds designated (or to be designated) for Fair Funds in these actions total about $1.525 billion, according to the regulatory agency.

Now, keep in mind that no distributions have yet begun, and it is possible that not all of these funds will prove collectible.

An SEC spokesman says the disgorgements and penalties against banks and securities firms will be collected.

However, the uncertain collections are generally those involving Ponzi schemes where no money is recovered and the respondent can have the penalty waived by demonstrating to the court an inability to pay.

Said SEC chairman William Donaldson in his testimony to the Senate Banking Committee in September 2002: “The "Fair Funds" provision has quickly become an important tool. A significant example of the effectiveness of the Fair Funds provision is in the Commission's case against WorldCom, Inc., where the company has agreed to satisfy its civil penalty obligation by paying $500 million in cash and $250 million in stock to defrauded investors.

Thanks to the Fair Funds provision, all of this amount can be made available to harmed investors.”

So, when will individuals start to receive this dough? It's still not clear yet, the SEC says.

The Global Settlement's $399 million, for example, still has several steps to go. Although the judge approved it Oct. 31, he has not yet appointed a fund administrator.

The $750 million for Worldcom victims has similar processes that must be completed.

The Enron fund, meanwhile, is being held pending the completion of all Enron investigations.