Federal Statutory Bankruptcy Alternatives: A Roadmap
Legal Sidebari
Federal Statutory Bankruptcy Alternatives: A
Roadmap
March 2, 2023
In most cases, a bankrupt entity will either liquidate or reorganize under the U.S. Bankruptcy Code, and
the U.S. bankruptcy courts will administer those proceedings. There are, however, certain entities, such as
banks and brokerages, that follow a different path when they become insolvent.
This Legal Sidebar presents an overview of federal restructuring regimes that operate alongside the
Bankruptcy Code. Some of these regimes have been in place for decades, such as those operated by the
Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA)
Board, and the Securities Investor Protection Corporation (SIPC). The Orderly Liquidation Authority
(OLA), a product of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank
Act) is a newer and untested system. This Sidebar also discusses the subchapter of the Bankruptcy Code
that deals with commodities brokers, which incorporates laws and rules from the Commodity Futures
Trading Commission (CFTC). For each of these regimes, this Sidebar explains how they differ from a
traditional bankruptcy. There also are legal mechanisms under each state’s law that govern the resolution
of insurance company insolvencies, but this Sidebar discusses only federal bankruptcy alternatives. This
sidebar concludes with brief considerations for Congress on how a bankrupt or distressed crypto company
may fit into these statutory regimes.
The SIPC – A Unique Trustee Program for Brokerage Firms
The Bankruptcy Code provides for the liquidation of a stock brokerage, yet these firms have another way
to liquidate. The Securities Investor Protection Act of 1970 (SIPA), codified at 15 U.S.C. §§ 78aaa-111,
created the SIPC. The SIPC is a nonprofit, private-membership corporation consisting of most brokers
and dealers registered under Section 15(b) of the Securities Exchange Act of 1934. As of December 2021,
more than 3,400 entities are SIPC members.
Of special importance to the SIPC liquidation regime is the SIPC fund. All SIPC members must make
payments to the fund, which in turn pays for all SIPC expenditures. Also included in the value of the fund
is the fair market value of and interest accrued on U.S. Government securities owned by the SIPC. As of
December 2021, the value of the fund was $4.16 billion. The fund reimburses customers of a failed
brokerage firm for the value of up to $500,000 in securities, with claims for cash limited to $250,000 per
customer.
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A seven-member board of directors oversees the SIPC. Self-regulatory organizations—including stock
exchanges and the Financial Industry Regulatory Authority (FINRA)—and the Securities and Exchange
Commission (SEC) report to the SIPC about member broker-dealers who are in or nearing financial
difficulty. If SIPC determines that the member’s customers require SIPA protection, SIPC begins a
“customer protection proceeding” by applying to a U.S. district court for the appointment of a trustee
(SIPC trustee) to carry out a liquidation.
A SIPC trustee has the same powers as a bankruptcy trustee under Title 11 of the Bankruptcy Code. A
SIPC trustee’s authority also goes further. Unlike a bankruptcy trustee, a SIPC trustee may purchase
securities to satisfy customer net equity claims to particular securities. As to “street name” securities, or
securities held by a brokerage firm on behalf of a client, customers file a claim with the SIPC trustee and,
if the claim is meritorious, the trustee will satisfy the claim with either cash or, when possible, securities.
A SIPC trustee also must return “customer name securities,” or securities registered directly in the
customer’s name, to the brokerage’s customers and make distributions of customer property from the
fund.
In most cases, a failed brokerage firm will not proceed to SIPC liquidation if the SIPC can transfer the
failed firm’s assets to a different brokerage firm, but the firm will proceed to the rare next step of
liquidation if SIPC cannot arrange the account transfer. In a SIPC liquidation, the SIPC and the SIPC
trustee close down the failed brokerage firm and work to assume control of the firm’s books and records.
Next, the trustee compiles a list of all customers who had an account with the brokerage firm within the
prior year, while obtaining court approval for the forms customers will use to file claims in the
liquidation. The SIPC trustee works to recover assets belonging to the firm and its customers and report
on the reasons for the firm’s failure to the court and SIPC.
Although the bankruptcy and SIPA regimes are similar—the Bankruptcy Code also provides for the return
of customer name securities, for instance—liquidation under SIPA differs from a traditional bankruptcy in
many ways. A bankruptcy trustee will seek to convert securities to cash in satisfaction of the claims
against the debtor and then distribute the proceeds ratably, while a SIPC trustee must distribute securities
to their associated customers. Unlike the Bankruptcy Code, SIPA provides preferential treatment to one
type of creditor, customers with claims for securities and cash in their accounts by providing them with
insurance. A bankruptcy trustee seeks to sell all non-customer name securities while a SIPA trustee works
to return securities to customers where possible. Also distinct from Chapters 7 and 11 of the Bankruptcy
Code, an individual or group of individual creditors may not drag a debtor into SIPA liquidation.
The FDIC – Receiverships and Prompt Corrective Action for Banks
The FDIC plays a similar role in the winding down of failed banks that SIPC does for struggling
brokerage firms. The FDIC is an independent agency created to maintain stability in the American
banking system. The agency’s enabling statute is the Federal Deposit Insurance Act (FDI Act). The FDIC
plays two roles in the event of a failed bank, by insuring deposits up to $250,000 through the Deposit
Insurance Fund (DIF) and by serving as the failed bank’s receiver.
The need for an agency to supervise the administration of a failed bank comes from the Bankruptcy Code.
Section 109 of the Code, which sets forth who may be a debtor, carves out banks from eligibility for
bankruptcy. This means that neither a bank nor its creditors may bring a bank into bankruptcy.
Following a bank’s failure, the FDIC evaluates the bank’s finances and seeks to have a healthy bank
acquire the failed bank’s assets, in all or in part. If acquisition of the bank is impossible, the FDIC may
act according to its authority under the FDI Act, as modified by the Financial Institutions Reform,
Recovery, and Enforcement Act of 1989, to act as either a receiver or conservator for the failed bank. The
key distinction between a conservatorship and a receivership is that a conservator may continue to operate
a bank or dispose of it, while a receiver is empowered to liquidate the bank and wind down its affairs. As
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summarized by the Seventh Circuit, a “conservatorship that required liquidation would be, in effect, a
receivership.”
As to the distinctions between an FDIC proceeding and bankruptcy, perhaps the greatest procedural
difference is that FDIC receiverships are administrative while a bankruptcy takes place in court. There is
thus no ongoing judicial oversight of an FDIC conservatorship or receivership. An FDIC receiver is also
acting under statutory authority, while a bankruptcy trustee is appointed by the bankruptcy court.
As for substance, the FDIC and the Bankruptcy Code have different priority schemes. The FDIC must
resolve a failed bank according to what is least costly to the DIF. The FDIC’s rule and regulations give
preferential treatment to a failed bank’s depositors vis-á-vis other unsecured creditors. Additionally,
creditors have fewer means of participating in an FDIC resolution scheme than they do in bankruptcy.
The NCUA – A Credit Union Parallel to Banks
The NCUA is an independent agency overseen by a three-person board (the NCUA Board). Along with
the FDIC, the NCUA is one of two agencies that provide deposit insurance; in the NCUA’s case, to credit
unions. Under the Federal Credit Union Act, the NCUA’s role is to charter federal credit unions, regulate
federal credit unions and state-chartered credit unions, and administer the Share Insurance Fund, which
insures the deposits for credit union members up to $250,000.
Upon learning that a credit union is in danger of failing, the NCUA Board has the authority to place a
credit union into a conservatorship. During a conservatorship, the credit union remains open and the
Share Insurance Fund continues to insure accounts. Following the creation of a conservatorship, a credit
union may apply to a U.S. district court for an order requiring the NCUA Board to show cause why it
should not be enjoined from continuing the conservatorship.
The agency may also close an insolvent credit union for liquidation and appoint itself the liquidating
agent for the credit union. For now, the NCUA’s Asset Management and Assistance Center sets up an
asset management estate to control the former credit union’s assets, settle insurance claims by credit
union members, and attempt to recover value from the former credit union’s assets.
The text of the Federal Credit Union Act defines liquidation in mandatory terms. The NCUA board does
not have discretion when closing a failed credit union for liquidation. In a departure from the Bankruptcy
Code, where a debtor may move to dismiss an involuntary petition, a credit union has no express legal
recourse once the NCUA had closed it for liquidation. At least one district court has ruled that a credit
union should have a chance to contest the NCUA’s decision to liquidate, but only upon a showing that the
credit union was not insolvent. That court held that the credit union’s rights here sounded in the Due
Process Clause, and not the Federal Credit Union Act.
The OLA – An Untested Mechanism
Title II of the Dodd-Frank Act created the OLA. Under the OLA, the FDIC administers a regime geared
towards resolving nonbank financial firms whose standalone failure could destabilize the national
financial system. Congress created the OLA as an alternative to bankruptcy.
The OLA authorizes the Secretary of the Treasury, following the recommendation of the Federal Reserve
Board and the Board of the FDIC, to appoint the FDIC as receiver of a distressed financial company. The
FDIC occupies a similar role in this space as it does in its traditional capacity. Here, it steps in as receiver
for entities that would normally declare bankruptcy. Much of the debate around the OLA’s creation
focused on whether it was necessary given the Bankruptcy Code. The government has yet to use the OLA
more than a decade since its implementation.
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Although untested, the OLA operates at a meeting point of multiple regulatory agencies. In 2020, the
FDIC and the SEC adopted a final rule that clarified the liquidation process under the OLA for certain
brokers or dealers who would normally liquidate through an SIPC proceeding. Under the final rule, in an
orderly liquidation of a covered broker or dealer, the FDIC would continue to serve as receiver while the
SIPC would act as a trustee, looking to determine and satisfy customer claims just as it would during a
SIPA liquidation.
The OLA’s aim of mitigating systemic risk signifies an instance in which the Bankruptcy Code is
inadequate to resolve a failing company. If a company’s failing triggers the OLA, a practitioner would not
only need an understanding of the Dodd-Frank Act, but the OLA’s implementing regulations, codified at
12 C.F.R. § 380. Additionally, as the OLA empowers the FDIC to wind down a large company, it also
removes those proceedings from the court system.
The CFTC – A Hybrid Title 11
The process for liquidating a futures commission merchant (FCM) or derivatives clearing organization
(DCO) occurs partially under the Bankruptcy Code. Chapter 7, Subchapter IV, of the Bankruptcy Code
deals exclusively with the liquidation of a commodity broker. This subset of bankruptcy resides in
Chapter 7 of the Bankruptcy Code (liquidation) because the Bankruptcy Code renders commodity brokers
ineligible for Chapter 11 reorganization.
While Chapter 7, Subchapter IV, outlines the type of bankruptcy that a commodity broker may undertake,
the rules governing those bankruptcies go beyond the terms of the Bankruptcy Code. The Commodities
Exchange Act (CEA) and the CFTC’s bankruptcy rules published at 17 C.F.R. § 190 (the Part 190 Rules)
at different points supplement and supersede the provisions of Subchapter IV. For instance, Section 20 of
the CEA authorizes the CFTC to issue bankruptcy regulations “notwithstanding the Code.” The CFTC
may also elect to liquidate an FCM or DCO through an agency receivership.
The most significant departure here from a standard bankruptcy is the mixed model of governing law. To
understand an FCM or DCO’s journey through bankruptcy is to look beyond the Bankruptcy Code. Like
the OLA, a commodities-related bankruptcy implicates administrative law, which rarely bears on the
Bankruptcy Code.
Congressional Considerations
The recent spate of crypto company bankruptcies, with their unique financial structures and issues over
account ownership, poses the question of whether the Bankruptcy Code is the ideal framework for
resolving those bankruptcies. Even more broadly, there is the question of where crypto companies fit in
the financial system.
Experts continue to debate whether crypto assets constitute securities or commodities, or some
combination of both. If they are the former, then perhaps a crypto company could be liquidated under
SIPA. If they are the latter, then they may qualify for liquidation under Chapter 7, Subchapter IV, of the
Bankruptcy Code. Action by Congress could clarify how distressed crypto companies restructure
themselves, and to what extent, if any, customers receive protection during that restructuring.
The agencies overseeing banks and credit unions have a weaker connection to crypto companies. For
instance, the FDIC does not insure crypto exchanges. The FDIC has also sought to distance itself from
crypto companies that asserted on their websites that certain crypto-related products are FDIC-insured.
With that said, neither the FDIC nor the NCUA prohibit covered entities from dealing in crypto assets.
For crypto companies to fall under the authority of the FDIC, Congress would likely need to amend the
statute defining depository institutions.
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Author Information
Michael D. Contino
Legislative Attorney
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