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Recovering Funds - How individual investors may be able to recover financial losses resulting from securities fraud

How can investors get money back in a fraud case involving a violation of the federal securities laws?

There are a number of ways that investors who have been defrauded may recover some of their financial losses caused by the fraud, depending on the circumstances.

The Securities and Exchange Commission is authorized by Congress to seek a number of remedies, including civil money penalties and disgorgement, from those who commit fraud. (While the Securities and Exchange Commission is a law enforcement agency, only the Department of Justice has authority to seek criminal sanctions, such as imprisonment.) The cases the Commission brings against individuals and companies are all civil or administrative matters – that is, the SEC sues alleged wrongdoers for violations of securities law in federal court or in front of a federal administrative law judge and seeks to obtain remedies, including civil money penalties, disgorgement of ill-gotten gains, injunctions prohibiting future violations of the law, and officer and director bars.

Below is a description of mechanisms injured investors may be able to use in recovering funds, including Receiverships, Fair Funds and Disgorgement Funds, Brokerage Account Customer Protections, Corporate Bankruptcy Proceedings, and Private Class Action Lawsuits. Please note that, in many cases, victims of fraud may recover only a fraction of what was stolen, or, in some cases, may recover nothing at all. Also, the mechanisms described below take some time to develop after the initial fraud is discovered. Make sure you check the SEC’s website for updates in the matter you are concerned about.

Receiverships

In matters where the Commission files a civil court action against an entity or individual, the Commission may ask the judge to appoint a receiver. The purpose of appointing a receiver is to recover and protect funds and other assets the defendants have obtained in connection with the fraud and distribute those assets to injured investors if a determination of liability is made. You can find a list of Commission actions with receivers, as well as disbursement agents and claims administrators (whose functions are, generally speaking, to facilitate the claims and distribution process), here.

Fair Funds and Disgorgement Funds

In civil court actions or in administrative hearings, the defendant (or respondent) can be ordered to pay disgorgement – a measure of the ill-gotten gains from the fraud. Where disgorgement is ordered, the judge or the Commission may also order that any money collected, including fines paid, be placed in a Fair Fund for distribution to investors who were the victims of the violation. Under this process, a plan for the administration and distribution of the funds will be developed. A claims administrator or disbursement agent often oversees the plan.

Commission rules on Fair Funds and Disgorgement Funds are available here. A list of administrative proceedings where the Commission has required a distribution is available here.

Brokerage Account Protection

Customers of U.S. registered broker-dealers benefit from the extensive protections provided by the Commission rules, including the Customer Protection Rule, as well as protection by the Securities Investor Protection Corporation (SIPC). The Commission's Customer Protection Rule requires a broker-dealer to segregate customer cash and securities from a broker-dealer's own assets. More specifically, the rule requires that a broker-dealer keep customer cash and fully-paid securities free of liens and in a safe location. This protects customer assets from claims by a broker-dealer’s creditors. In addition to the Commission's rules that protect securities customers of U.S. broker-dealers, the Securities Investor Protection Corporation also has protections for securities customers. To determine if your broker-dealer is a member of SIPC, or to learn more about the SIPC protections, you can check the SIPC website at www.sipc.org.

Corporate Bankruptcy

Federal bankruptcy laws govern how companies go out of business or recover from crippling debt. A bankrupt company, the "debtor," might use Chapter 11 of the Bankruptcy Code to "reorganize" its business and try to become profitable again. Management ordinarily continues to run the day-to-day business operations but all significant business decisions must be approved by a bankruptcy court.

Under Chapter 7, the company stops all operations and goes completely out of business. A trustee is appointed to "liquidate" (sell) the company's assets and the money is used to pay debts owed to creditors. Shareholders rarely receive any distribution in a Chapter 7 liquidation case.

Bankruptcy laws determine the order of payment. Creditors who take the least risk are paid first. For example, secured creditors take less risk because the credit that they extend is usually backed by collateral, such as a mortgage or other assets of the company. They know they will get paid first if the company declares bankruptcy.

Bondholders have a greater potential for recovering their losses than stockholders, because bonds represent the debt of the company and the company has agreed to pay bondholders interest and to return their principal. Stockholders own the company, and take greater risk. They could make money if the company does well, but they could lose money if the company does poorly. Stockholders are last in line to be repaid if the company fails. Stockholders only recover funds if all creditors have been paid in full and there are assets remaining. In bankruptcy, stockholder fraud claims receive the same priority as ordinary stockholders.

During bankruptcy, bondholders will stop receiving interest and principal payments, and stockholders will stop receiving dividends. Under Chapter 11 if you are a bondholder, you may receive new stock in exchange for your bonds, new bonds, or a combination of stock and bonds. If you are a stockholder, the debtor may ask you to send back your old stock in exchange for new shares in the reorganized company. The new shares may be fewer in number and may be worth less than your old shares. The reorganization plan will spell out your rights as an investor, and what you can expect to receive, if anything, from the company.

The bankruptcy court may determine that stockholders don't get anything because the debtor is insolvent. Solvency is determined by the difference between the value of its assets and its liabilities. If the company's liabilities are greater than its assets, it is insolvent and your stock may be worthless. Contact your local Internal Revenue Service (IRS) office or call 1-800-829-1040 for information about how to report worthless securities as a loss on your income tax return. If you don't know whether your stock has value, and you can't find a stock or bond price in the newspaper, ask your broker or the company for information.

For additional information on bankruptcy issues, see here.

Private Class Actions

A private class action (that is, a legal action brought in court by private persons and not the Commission) may have been filed in a matter on behalf of other injured investors, and a defrauded investor may be eligible to participate in the suit. A partial list of private class actions is available here. More recent class action lawsuits may often be found online by searching the news for the company name involved.

We have provided this information as a service to investors.  It is neither a legal interpretation nor a statement of SEC policy.  If you have questions concerning the meaning or application of a particular law or rule, please consult with an attorney who specializes in securities law.