An Excerpt from "Rule 10b-5 and the Unfitness Question"

An excerpt from Professor Jayne Barnard’s article "Rule 10b-5 and the 'Unfitness' Question" (Arizona Law Review 2005) is below.  For the full article, please click here.


A key provision of the Sarbanes-Oxley Act (Sarbanes-Oxley or “the Act”) creates a new standard for the imposition of a lifetime bar order against a defendant found liable for violations of the federal securities laws. Under the Act, any person who is found to have violated the antifraud provisions of either the Securities Act of 1933 or the Securities Exchange Act of 1934 may be barred from serving as an officer or director of a public company, “if the person’s conduct demonstrates unfitness to serve.”

The Act, of course, was an effort to restore public confidence in the securities markets after a series of scandals that began with Enron’s implosion in the fall of 2001 and continued with shocking announcements at Global Crossing, Adelphia, WorldCom, Tyco, and Xerox in the spring and summer of 2002. At the heart of the Act are provisions designed to ensure accuracy and transparency in financial reporting, timeliness in disclosure of insider transactions, the elimination of insider loans, and increased oversight of corporate activities by directors and other gatekeepers. In other words, the Act represents a comprehensive effort to improve corporate executives’ accountability to their shareholders and to stimulate those shareholders to continue to invest in the capital markets. Through its forfeiture provisions and enhanced criminal penalties, the Act also seeks to punish those executives who violate the law. The provision permitting debarment of officers and directors is a part of this potent legislative mix.

The question that underlies the debarment provision is what conduct demonstrates “unfitness to serve?” Does every Rule 10b-5 violation satisfy the “unfitness” standard? No, it does not. So how can courts meaningfully identify those violators who are deserving of a lifetime bar order? Stated another way, how can courts determine when a Rule 10b-5 violator is “unfit”?

This Article sets out a useful test for courts to employ in deciding the “unfitness” question. It draws on case law developed under a predecessor statute to Sarbanes-Oxley. It also considers the issue of executive unfitness as it has developed in bankruptcy law, employment law, banking law, and the regulation of securities professionals.

The Article considers what is meant by “unfitness” specifically as it is applied to top corporate executives. Is an executive who orchestrates a violation of the securities laws any more “unfit to serve” than an executive who orchestrates a violation of the antitrust laws? The environmental laws? Health and safety laws?
Congress apparently believes the answer is “yes.” But what is it precisely about a violation of the securities laws—and about the violator himself—that renders the violator “unfit to serve”? I suggest that a matrix of factors, described in detail below, can be helpful in answering that question.

Before setting out the matrix, however, this Article will do three things. It will briefly review the legislative and judicial history that preceded enactment of the Sarbanes-Oxley Act in July, 2002; it will survey the law of executive unfitness in several disciplines that are germane to the Sarbanes-Oxley inquiry; and it will consider the utility of the Federal Sentencing Guidelines in structuring an inquiry under the Act. In Section V of the Article, I will set out a roadmap for deciding the question of executive unfitness.

Context is important here. A finding of unfitness is unquestionably stigmatizing. It also may have profound economic consequences. But there is more to a lifetime bar order than merely enjoining misbehavior or assessing a fine—even a substantial fine. A lifetime bar order goes to the heart of fundamental issues of identity. Corporate executives uneasily refer to a lifetime bar order as a kind of “death penalty.” Pete Rose has poignantly described his lifetime exclusion from baseball as a “prison without bars.”

Blacklisting of any sort imposes profoundly transformative limitations on people who, in many cases, regard their work as their life. Memoirs of writers and actors who were blacklisted in the 1950s, for example, repeatedly recount stories of ruined marriages, substance abuse, depression, anger, and despair. Studies of white-collar layoffs during the 1980s and 1990s similarly report the trauma and pain experienced by executives when they cannot find work commensurate with their skills.

I am not suggesting that serious offenders ought not to answer for the harm that they do. Of course they should, through the full panoply of criminal and civil proceedings available under the securities laws. Nor am I suggesting that there is a “right” to executive employment that is somehow infringed upon by the Sarbanes-Oxley Act. I merely seek to emphasize that the lifetime bar order is a severe sanction. Given that fact, and remembering that a lifetime bar order is a creature of civil enforcement, not criminal prosecution, courts should approach the question of “unfitness” guided by principle and with humility. What follows is an effort to shape that process.