## Facts

- In 2002, Congress enacted the Sarbanes-Oxley Act, including a “Fair Funds” provision authorizing the SEC to distribute civil penalties (and disgorgement) to injured investors rather than sending the money to the U.S. Treasury.
- WorldCom, Inc. engaged in a major accounting fraud, overstating income by about $11 billion and assets by about $75 billion.
- The fraud caused estimated shareholder losses of up to $200 billion.
- After the wrongdoing became public, WorldCom filed for bankruptcy protection.
- The SEC brought a civil enforcement action against WorldCom and proposed a settlement that included a $750 million civil penalty.
- The SEC planned to distribute the penalty proceeds to WorldCom’s shareholders using the Sarbanes-Oxley Fair Funds mechanism.
- In setting the penalty, the SEC weighed the seriousness of the misconduct, deterrence goals, and the practical limits created by WorldCom’s ongoing bankruptcy case.
- The district court reviewed the proposed settlement, including whether directing penalty money to shareholders conflicted with 11 U.S.C. § 510(b), which generally subordinates shareholder securities-fraud damages claims below general unsecured creditor claims in bankruptcy.

## Issues

1. Whether the court should approve the SEC’s proposed consent judgment as fair, reasonable, and adequate and consistent with the public interest.
2. Whether distributing the SEC civil-penalty proceeds to shareholders through Sarbanes-Oxley Fair Funds was barred or rendered improper by Bankruptcy Code § 510(b)’s subordination rule.

## Decision

- The court approved the SEC settlement and entered the consent judgment.
- The court found the proposed relief—including the $750 million penalty—fair, reasonable, and adequate in light of the magnitude of the fraud and the constraints of WorldCom’s bankruptcy.
- The court permitted the SEC to use Sarbanes-Oxley Fair Funds to distribute civil-penalty proceeds to harmed investors and shareholders.
- The court concluded that this distribution plan did not violate or improperly circumvent 11 U.S.C. § 510(b) because the SEC was exercising its regulatory enforcement authority, not paying private shareholder claims ahead of creditors through the bankruptcy claims process.

## Legal Principles

- A federal court reviewing an SEC consent judgment examines whether the settlement is fair, reasonable, and adequate and serves the public interest.
- Sarbanes-Oxley’s Fair Funds provision authorizes the SEC to distribute civil penalties (and disgorgement) to investors who were harmed by securities-law violations.
- Bankruptcy Code § 510(b) subordinates private claims for damages arising from the purchase or sale of a debtor’s securities, but that subordination rule does not automatically bar the SEC from obtaining or allocating civil penalties in an enforcement action.
- When a defendant is in bankruptcy, the court may consider the practical effects of the proposed penalty and settlement structure, including deterrence objectives and the risk of harming innocent stakeholders through an unworkable sanction.

## Conclusion

SEC v. WorldCom approved an SEC consent judgment imposing a $750 million civil penalty for WorldCom’s accounting fraud and allowed the SEC to distribute the penalty to shareholders through Sarbanes-Oxley Fair Funds, holding that the settlement was fair and that the planned distribution did not conflict with Bankruptcy Code § 510(b)’s subordination of private shareholder securities claims.


SEC v. WorldCom, Inc., 273 F. Supp. 2d 431 (2003)