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From Securities Regulation Daily, July 18, 2014

Stanford Ponzi scheme victims out of luck despite SEC’s efforts

By Anne Sherry, J.D.

Purchasers of CDs issued by Allen Stanford’s Antiguan bank have been disenfranchised by a D.C. Circuit ruling that the Securities Investor Protection Corporation (SIPC) cannot be compelled to liquidate the Stanford broker-dealer through which the CD investments were made. The SEC had sued to compel liquidation, but the court determined that the CD investors were not the broker-dealer’s “customers” under the Securities Investor Protection Act (Act) (SEC v. SIPC, July 18, 2014, Srinivasan, S.).

SEC-SIPC dispute. Five years ago, the SEC urged SIPC to liquidate the broker-dealer, Stanford Group Company (SGC), but the corporation determined that the investors in the Antiguan CDs were not “customers” of SGC — a necessary predicate for liquidation. Two years after that, the SEC issued a formal analysis arguing that the separate existence of SGC and Stanford International Bank, Ltd. (SIBL) should be disregarded and that investors who purchased CDs through their brokerage accounts at SGC should be deemed to have deposited cash with SGC for purposes of coverage under the Act. SIPC again declined to initiate a liquidation proceeding, and the SEC sought an order from the district court compelling liquidation.

District court denial. The district court denied the SEC’s application on the merits, holding that because the CD investors never directly deposited funds or securities with SGC itself, they were not SGC “customers.” The court distinguished cases where brokers had misappropriated funds without completing the promised purchase; here, the CDs were purchased and did exist for the SGC clients.

Custody function. The appeals court, on de novo review, stressed that the Act protects the custody function of brokers and affords no protection against losses that do not result from a broker’s failure to perform its role as custodian — even in cases where the broker fraudulently induced the losing investment. The Act’s definition of “customer” as someone “who has a claim on account of securities received, acquired, or held by the debtor,” including a “person who deposited cash with the debtor for the purpose of purchasing securities,” embodies the concept that an investor has recourse to SIPC only if he had entrusted cash or securities to the broker-dealer. In this case, SGC never “received, acquired, or held” the CD investors’ cash or securities.

Debtor-creditor relationship. The SEC reiterated its argument that SGC and SIBL should be treated as a combined entity via the bankruptcy-law doctrine of substantive consolidation because the companies were interconnected in furtherance of the Ponzi scheme. Even treating the entities as one, the D.C. Circuit held, the investors still would not qualify as “customers” of a SIPC-member firm. The Act excludes from the definition of “customer” anyone with a claim for cash or securities that is part of the capital of the debtor. As investors in, rather than through, SIBL, the CD buyers loaned funds that became part of SIBL’s capital, creating a debtor-creditor relationship rather than a fiduciary one.

SIPC statement. SIPC President Stephen Harbeck said of the decision, “We appreciate the considerable time and attention the Appeals Court gave to this case and to its decision that SIPC acted in this matter consistent with the Securities Investor Protection Act. I want to underscore that SIPC has the deepest sympathy for the victims of the Stanford Antigua bank fraud, which caused them significant harm. SIPC’s focus remains where it always has been: protecting customers against the loss of missing cash or securities in the custody of failing or insolvent SIPC member brokerage firms. We will continue to work within the mandate of the Securities Investor Protection Act to protect customers in the manner that always has been intended.”

The case is No. 12-5286.

Attorneys: John Wallace Avery for the SEC. Josephine Wang for the SIPC.

Companies: Securities Investor Protection Corp.

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