In a likely unprecedented move, the Securities and Exchange Commission ("SEC") filed a lawsuit against the Securities Investor Protection Corporation ("SIPC") as the culmination of a six-month effort to force SIPC to compensate victims of R. Allen Stanford's $7 billion Ponzi scheme. The suit, filed late Monday, comes after negotiations between the two agencies reached an impasse, according to the Wall Street Journal, which first broke news of the SEC's intentions early Monday morning. The move follows increased pressure by the SEC in urging SIPC to provide coverage for victims of Stanford's fraud and illustrates the fundamental disagreement between the two agencies.
The lawsuit may have caught some by surprise, for recent news reports had speculated that SIPC was preparing to make an offer to the SEC to resolve the dispute. Indeed, the Wall Street Journal quotes an unnamed source who confirms that SIPC made an offer to compensate each Stanford victim up to $250,000 - half of the $500,00 coverage that SIPC is authorized to provide per customer account - which the SEC rejected. While the outcome of the SEC's decision to resort to litigation remains uncertain, a protracted and lengthy court battle will only delay any possible payment to Stanford victims.
An earlier Ponzitracker post detailed the extensive back-and-forth between the SEC and SIPC. After the SEC instituted civil proceedings against Stanford in February 2009, the court-appointed receiver, Ralph Janvey, inquired as to whether SIPC would compensate victims of Stanford's fraud, as Stanford Group Company ("SGC") was a broker-dealer registered with SEC and SIPC. Responding to Janvey's letter, Stephen Harbeck, the President of SIPC, took the position that the certificates of deposit ("CDs") sold to SGC investors did not qualify for SIPC protection, as the CDs themselves were technically issued by Stanford International Bank ("SIB") in Antigua, which was not a SIPC member. Additionally, said Mr. Harbeck, Stanford's representations to investors that the CDs were subject to SIPC protection were irrelevant.
Over the next two years, Stanford victims appealed to their political representatives in Congress, who sent at least ten letters to then-SEC Chairwoman Mary Shapiro, requesting that the SEC take immediate action to order a liquidation proceeding of SGC and examine the possibility of extending SIPC coverage to Stanford victims. Following this, the SEC concluded in June 2011 that a liquidation under the Securities Investor Protection Act of 1970 ("SIPA") was warranted, and provided its findings to SIPC, which promised to render a decision at its September 15 meeting. However, SIPC did not issue any decision on September 15, and members of Congress continued to press SIPC for an answer, with a recent letter threatening to hold hearings on the matter should SIPC fail to deliver a decision by December 15.
The lawsuit makes a concerted effort to illustrate the nexus between the Stanford entities and the United States. This is likely in an effort to downplay SIPC's expected response that the CDs, because they were issued by an Antiguan bank that was not a SIPC member, do not qualify for SIPC coverage. The SEC points out that SGC (1) was based in Houston, Texas; (2) operated 29 offices throughout the United States that primarily marketed the sale of securities issued by SIB; (3) used the apparent legitimacy offered through U.S. regulation to generate sales of the CDs; and (4) provided account applications to potential investors touting SGC's status as a SIPC member.
In its requested relief, the SEC asked the Court to enter an Order to Show Cause essentially directing SIPC to demonstrate why it should not be compelled to initiate a SIPA liquidation of the Stanford entities. Should SIPC's response be deemed insufficient, the SEC also asked for the Court to issue an Order directing SIPC to take necessary action in commencing a SIPA liquidation.
Shortly after the suit was filed, SIPC issued a press release responding to the lawsuit. Like the SEC, SIPC sought to bolster its position by focusing on the geographic location of the entities involved. Disagreeing with the SEC's position that "SIPC must provide financial guarantees for investors who chose to purchase CDs issued by an offshore bank in Antigua," the press release highlighted the links between the fraud and Antigua. Additionally, and perhaps for the first time, SIPC raised the issue of potential financial shortfalls associated with the SEC's position, saying that an adverse decision
would vastly exceed SIPC's Fund, and would jeopardize the availability of the Fund for the legitimate purposes for which it was created."
A quick look at SIPC's 2010 financial statements adds some veracity to such a claim. According to its balance sheet as of December 31, 2010, SIPC had assets of approximately $1.38 billion and liabilities of $1.28 billion, thus resulting in roughly $100 million of net assets. Interestingly, $1.27 billion of the stated liabilities were allocated to "estimated costs to complete customer protection proceedings in progress." Nearly all of these costs are the result of the SIPA liquidation of Bernard L. Madoff Investment Securities, under which $1.09 billion has been advanced out of an estimated total cost to SIPC of $2.3 billion. The financial statements also indicate that the weight of the Madoff proceeding caused SIPC to operate at a loss in 2010 and reduced net assets from $344 million at the beginning of 2010 to $100 million at the end of the year. The recent bankruptcy of MF Global, a SIPC member, threatens to further strain resources depending on the severity of investor losses.
In the Madoff proceeding, SIPC advanced approximately $800 million to cover roughly $7.3 billion in 2,425 allowed claims. Using this rough 10% ratio of SIPC coverage to allowed claims, a Stanford SIPA liquidation with $7 billion in allowed claims would also require an outlay of $700 million in SIPA funds to victims - a cost that would outweigh the $409 million in member assessments received in 2010. SIPC does retain authority to increase its member assessments should its assets run low. SIPC will likely address the situation in its response to the lawsuit.
As the administrator of SIPA, which established SIPC, the SEC's interpretations are given deference in court.
A copy of the SEC's lawsuit is here.
A link to SIPA is here.