A federal judge has denied an attempt by the Securities and Exchange Commission ("SEC") to force an industry-funded nonprofit to institute a claims process for the victims of R. Allen Stanford's $7 billion Ponzi scheme. United States District Judge Robert Wilkins issued an order today finding that the SEC had failed to demonstrate that investors in Stanford's scheme were entitled to compensation from the Securities Investor Protection Corporation ("SIPC"). While expressing sympathy for the victims, Judge Wilkins found that the Securities Investor Protection Act of 1970 ("SIPA"), as enacted by Congress, did not encompass the purported certificates of deposit issued by non-SIPC member Stanford International Bank Ltd.
After initially deciding that Stanford victims were not entitled to SIPC protection, the SEC reversed course in June 2011 and concluded that a SIPA liquidation was required to compensate investors who had purchased certificates of deposit at the heart of Stanford's scheme. Following unsuccessful attempts by Congress to put pressure on SIPC, the SEC filed suit against SIPC in December 2011, contending that a SIPA liquidation was warranted by virtue of the Stanford Group Company's ("SGC") membership in SIPC. In response, SIPC countered that the fraudulent certificates of deposit sold to Stanford's victims originated not from SGC, but were instead issued by Stanford International Bank, an Antiguan entity that was not a SIPC member. Thus, as the Court observed:
the key issue in dispute is whether the persons who purchased the SIBL CDs are “customers” of SGC within the meaning of SIPA, because if they are, then SIPC has refused to act for their protection and the Application should be granted. On the other hand, if they are not customers, then the Application must be denied.
In its analysis, the Court noted that the "critical aspect of the customer definition" hinged on whether an investor entrusted cash with a broker-dealer who became insolvent. To reach this conclusion, a SIPC member must have actually possessed an investor's funds or securities. Applying these concepts to the facts presented, the Court found that "the SEC cannot show that SGC ever physically possessed the investors' funds at the time that the investors mad their purchases." Notably, investor checks were made out to SIBL, not SGC, and were never deposited in an account belonging to SGC. In narrowly construing the customer definition as set forth in SIPA, Judge Wilkins rejected the SEC's contention that the definition of a customer was not dependent solely on the identify of the entity receiving the initial deposit of funds. Judge Wilkins also used former policy positions of the SEC against it, referencing remarks from former SEC director Richard G. Ketchum positing that "for purposes of...[SIPA], the introducing broker-dealer's customers are presumed to be customers of the carrying broker-dealer."
The decision is a huge blow for Stanford victims, who already face bleak prospects of any immediate meaningful recovery through the ongoing receivership process headed by court-appointed receiver Ralph Janvey. A SIPA liquidation would not only cover the costs incurred by the receiver and his team (which were estimated at over $100 million), but would also provide insurance of up to $500,000 of each customer's net loss, including up to $250,000 in cash. By way of example, SIPC paid out nearly $800 million towards the losses of victims of Bernard Madoff's Ponzi scheme, whose brokerage Bernard L. Madoff Investment Securities was a SIPC member. SIPC has also covered fees and expenses totaling several hundred million dollars of the team appointed to liquidate Madoff's business and distribute assets to investors, headed by Irving Picard. While Janvey recently received approval to institute a claims process for Stanford victims, he has indicated the first distribution will likely be minimal.
The SEC has sixty days to appeal the decision. An SEC spokesman indicated that the agency is reviewing its options.