Nearly six months after the Securities and Exchange Commission ("SEC") issued a formal request to the Securities Investor Protection Corporation ("SIPC") for coverage of losses suffered by victims of R. Allen Stanford's $7 billion Ponzi scheme, investors are still waiting to hear whether SIPC will heed the SEC's request and begin proceedings to return some or all of investor losses. The SEC made findings in a report released in mid-June that Stanford's broker-dealer, Stanford Group Company ("SGC"), had failed to meet its obligations to customers, and as a result of its membership in SIPC, was the proper subject of a customer protection liquidation and thus entitled to compensation from SIPC. Should SIPC fail to take appropriate action, warned the SEC in a thinly-veiled directive, the SEC Division of Enforcement was prepared to institute legal action against SIPC to compel such a proceeding. With no decision yet issued, pressure has continued to mount on SIPC from several fronts, and a recent letter from Congress has demanded a "satisfactory update" or decision on the matter by December 15.
The Securities Investor Protection Act of 1970 ("SIPA") mandated the creation of SIPC, which it saw as a way to allay investor fears and save the securities market in a time of crisis. While the creature of congressional legislation, SIPC is unique in that it is funded through membership fees paid by member institutions, which by statute are all persons registered as broker-dealers under Section 15(b) of the Securities Exchange Act of 1934. From 1996 until 2009, these member assessments were pegged at $150 per institution - regardless of the size of the firm's securities business. Thus, financial titans such as Goldman Sachs or JP Morgan paid $150 to sustain a fund used in the event of financial collapse. However, after the recent financial crisis, SIPC bylaws were adjusted as of April 1, 2009 to peg member assessments as the greater of $150 or ¼ of 1% of net operating revenues from the securities business. The $150 minimum requirement was later eliminated upon the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in July 2010. Firms such as Goldman and JPM, whose securities businesses generate tens of billions of dollars in annual revenues, now face SIPC membership fees in excess of tens of millions of dollars.
When a member broker-dealer fails, SIPC acts to organize the distribution of customer cash and securities to investors. To the extent that customer cash or securities are unavailable, a SIPA liquidation would provide insurance coverage of up to $500,000 of the customer's brokerage balance, including up to $250,000 in cash. Should a customer's investment exceed the compensation afforded by SIPC, a SIPA trustee would then be tasked with recovering further assets to satisfy the difference.
SIPC coverage is not all-encompassing, however, and generally does not apply to investments such as commodity of futures contracts, investment contracts, and oil/gas/mineral leases unless those investments are registered with the SEC. Most types of securities, such as stocks, bonds, certificates of deposit, and notes are generally covered by SIPC. According to its website,
no fewer than 99 percent of persons who are eligible have been made whole in the failed brokerage firm cases that it has handled to date.
Since its inception in 1970, SIPC has advanced $1.6 billion as part of wider efforts to enable the recovery of $109.3 billion in assets for nearly 750,000 investors.
SIPC has played an instrumental role in the ongoing liquidation of Bernard Madoff's failed brokerage firm. Of the $7.3 billion of claims allowed by trustee Irving Picard, SIPC has provided nearly $800 million in advances to customers of Madoff's fraud. In Picard's motion for approval of a first interim distribution to investors, he revealed that SIPC advances alone fully satisfied the claims of 868 Madoff victims.
Stanford's scheme advised clients from 113 countries to purchase more than $7 billion in certificates of deposit ("CDs") from the Stanford International Bank in Antigua. The SEC instituted civil proceedings in February 2009, and a receiver, Ralph Janvey, was appointed to marshal assets for victims. A criminal indictment soon followed in June 2009. Soon after his appointment, Janvey inquired as to whether Stanford's victims qualified for SIPC coverage. Responding to Janvey's letter in August 2009 (the "August 2009 Letter"), Stephen Harbeck, the President of SIPC, gave several reasons for the decision that "there is no basis for SIPC to initiate a proceeding under SIPA," which included:
- The SEC had not formally notified SIPC of the need to act;
- The CDs were issued by Stanford International Bank Ltd. ("SIBL"), which is not a SIPC member;
- SGC did not issue purchase confirmations for the CDs, nor were the CDs held at SGC's clearing firms;
- Investors received custody of their CDs after purchase; and
- Antiguan liquidators believed that substantive consolidation was not warranted.
Additionally, even had Stanford implied that SIPC would protect the underlying value of the CDs, Mr. Harbeck stated that this had no impact on his analysis.
Following the August 2009 Letter, a consortium of nearly fifty members of the U.S. Senate and House of Representatives sent a letter 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. Over the next two years, ten more letters (available here) followed from various members of Congress urging the SEC to expedite its review of the applicability of SIPC coverage. At one point, United State Senator David Vitters (R., La.) threatened to block two nominees to the SEC until the agency released its decision. (The SEC released its decision the next day).
On June 15, the SEC issued its decision, finding that SGC had failed to meet its obligations to customers, and "that the statutory requirements for instituting a SIPA liquidation are met here." The main point of dispute centered on the interplay between SGC - a SIPC member - and Stanford International Bank - a non-SIPC member. In the Stanford scheme, investors with accounts at SGC purchased SIBL CDs by depositing funds with SIBL. SIPC had taken the position that coverage was not appropriate because investors purchased the CDs from SIBL, not SGC. However, the SEC's analysis focused more on the substance of the transactions, rather than the form, in finding that disregarding the separate corporate form of the Stanford entities was appropriate. Thus, by purchasing CDs from SIBL, customers were effectively depositing money with SGC. The SEC also likened any result to the contrary as consistent with the goals of the fraudster, saying
Based on the totality of the facts and circumstances, the Commission has concluded that investors with brokerage accounts at SGC who purchased SIBL: CDs through SGC should be deemed to have deposited cash with SGC for purposes of SIPA coverage. Doing otherwise on the facts of this case would elevate form over substance by honoring a corporate structure designed by Stanford in order to perpetrate an egregious fraud.
SIPC pledged to review the SEC's findings "as quickly as possible" and declared that it would provide a decision by September 15. However, after September 15 came and went, SIPC Chairman Orlan Johnson issued a statement on September 16 stating that SIPC was "continuing its careful review" of the Stanford case and did not have a decision to announce.
In response to SIPC's continuing silence, a group of Congressional members sent a letter on November 22, stating that "after more than 22 weeks, the Stanford victims and the American people want and deserve answers." In offering their assistance, the Representatives also noted that the lack of a final decision or satisfactory update on SIPC's progress by December 15th - six months after the SEC decision and three months after the SIPC board meeting - would result in the recommendation to the House Financial Services Committee for the intitiation of a formal inquiry into SIPC's handling of the matter. SIPC has not issued a response to the letter.
The court-appointed receiver for the Stanford entities, Janvey, has been criticized for the failure to recover more assets for victims. Indeed, a June filing by a group of Stanford investors accused Janvey's legal team and associated experts of collecting nearly all of the $120 million recovered to date in fees. A federal judge later expressed his concerns that Janvey's search for additional resources was duplicative of ongoing efforts by the Department of Justice, and asked when a claims process might be instituted for victims. Janvey recently filed papers seeking approval for a proposed claims process, although he declined to speculate as to the amount that investors could expect in an initial distribution.
A decision by SIPC to provide coverage to Stanford victims, as urged by the SEC, would be a welcomed move. At present, the victims stand to receive pennies on the dollar for funds lost to Stanford's scheme. However, a look at the effect of SIPC intervention in the Madoff proceeding shows that over 1/3 of the approximately 2,425 allowed claims were fully satisfied as a result of SIPC advances. While such a system differs slightly from typical Ponzi proceedings where all victims are promised a pro rata share in any recovered proceeds, a SIPC-involved proceeding would aim to compensate each investor equally - at least up to the first $500,000 of losses.
A copy of the August 14, 2009 letter from SIPC to Janvey is here.
A copy of the SEC decision directing SIPC coverage is here.
A copy of the Congressional letters sent to the SEC in support of the decision on SIPC coverage is here.
A copy of the November 22, 2011 letter from Congress is here.