Fair Fund

In several jurisdictions, including Chile, there has been some discussion about the so‑called Fair Fund. As is well known in the United States, the SEC (U.S. Securities and Exchange Commission) can distribute amounts obtained as sanctions to the harmed investors in a truly compensatory manner. 

Under the Sarbanes‑Oxley Act, the SEC acquired a new power that, like any authority, leaves room for discretion. In a way, it seeks to constitute a public remedy, complementary to or exclusive of other private remedies (civil and commercial actions). 

The Federal Account for Investor Restitution Fund allows, at the SEC’s discretion, directing sanction monies to investors instead of the Treasury. The idea is that, in any judicial or administrative proceeding (prior to the SEC v. Jarkesy precedent of 2024, the SEC could choose to bring civil actions in federal courts with juries or before its internal administrative judges) related to financial law rules enforced by the SEC (the SEC must participate, even if investors intervene as parties), if a person (the violator) is ordered to return assets for breaching those rules, or agrees to return assets (not in the technical sense of a civil action for restitution as used in some civil law jurisdictions) by settlement within those proceedings, and the SEC obtains a civil penalty against the violator, the amount of that penalty is added, upon request of the affected investor or at the SEC’s direction, to the Fair Fund to benefit the victims of the violations. 

Legally, this requires deep analysis, for which we do not have space here, especially to coordinate it with jurisdictional actions. Civil actions, which for example are used in Chile, particularly in arbitration, should be considered. Add to this, although little known in Latin America, securities class or collective actions that seek similar compensation. 

On the other hand, we must not lose sight of other regulator powers similar to this mechanism. One is disgorgement, the SEC’s remedy to compel violators who profited from conduct contrary to financial law to relinquish any benefit obtained as a result of that conduct. Disgorgement therefore prevents unjust enrichment and discourages conduct contrary to these rules by removing its profitability.

Now then, the Fair Fund as compensation only makes sense where we fully know the source of the resources. Thus, answering who is sanctioned and who pays the fine is answering what the source is. It may be a fund manager (AGF), the executives, auditors, issuers, among others. 

The latter certainly matters. In financial law, especially in securities markets, the circularity of compensation is highly debated. If the manager, the AGF, or the issuer is responsible for paying compensation, it is their shareholders or contributors who ultimately bear the cost during the fine payment. In other circumstances, however, circularity does not necessarily exist — for example, if the fine is charged to the infringing company’s directors. Even a diversified investor might receive compensation while at the same time bearing it if they remain the holder of the financial instrument. 

We should also consider the D&O insurance of those who are ultimately sanctioned. This implies that, somewhere in the investment chain, the cost of the insurance is passed on to contributors, shareholders, and, more generally, to any investor in the sanctioned entity. Therefore, if the insurer covers the fine, it is conceivable that the secondary market ultimately bears that cost. The same applies to agreements where institutions cover the costs of fines imposed on their directors. It should be borne in mind, however, that D&O policies today are very restrictive. Likewise, regulators and the law limit agreements between financial institutions and their directors concerning payment of fines, often prohibiting them. 

Along the same lines, the incentives of regulators endowed with the power to create Fair Funds to determine both the sanction and the compensation have been debated. Indeed, notwithstanding that an impartial third party — the judge — may eventually intervene, the fine is determined by the SEC. That decision, even if the law supplies it with more or less objective elements, always contains a subjective component. Thus, to reach a sanction the regulator must pronounce, even briefly, on amounts or transactions it specifically claims from the violator. Those pronouncements, even if not labeled as compensation or restitution, will be essential when the total amount is determined in judicial proceedings. The regulator may ultimately determine, or at least influence, sanction and compensation in one way or another, and that could be problematic. 

The regulator’s role of deterring misconduct and safeguarding market confidence can also clash with the role of seeking compensation. In its compliance policy the regulator weighs competitive considerations: the size of the violator, deterrence, the sophistication of the harmed party, systemic risks, and other factors that affect enforcement. Therefore, compensation cannot always take precedence. This becomes even more contentious if the regulator can reach settlements (especially in judicial settings).

We want to focus on the status of investors in light of insolvency rules. Fair Funds are often established in parallel with the liquidation or reorganization proceedings of the offending institutions, so this aspect must also be carefully coordinated, especially in the liquidation of funds. But here is a very interesting point. Insolvency proceedings make it possible to see who is who. Investors are not consumers or creditors; they are owners of a share, of a unit (according to Professor Carlos Peña they would be creditors, a debated issue), or holders of a debt instrument. In that capacity, they have no priority over the creditors of the business’s estate (the company, the segregated estate, retained earnings, etc.). Investors assume a risk: the price they pay, together with accrued amounts, is what must cover that risk. If things go wrong, it is not possible to bypass the natural order of commercial claims. 

The investor, and we must not forget this, falls into different categories depending on the financial instrument. Ownership (shares and units) is always somewhat more precarious than debt or provisions. The important thing is that, at the time of investing, the investor prices in that risk. 

Finally, remember that the regulator does not look after returns, management, or any factor other than the minimum compliance with certain information formalities, behavioral standards, and the solvency of regulated actors. It is not an insurer of profitability. The investor should try to price in, at the time of investing, any allowance for potential problems, always bearing in mind that every investment carries risk.