Federal court sides with SIPC in dispute with SEC, rejecting SEC's bid to force SIPC to cover losses of Stanford Ponzi scheme victims

In a closely watched case brought by the Securities and Exchange Commission ("SEC") against the Securities Investor Protection Corporation ("SIPC") in the United States District Court for the District of Columbia—the first of its kind in the 42-year history of SIPC—the District Court, in a decision issued on July 3, 2012, sided with SIPC, declining to issue an order forcing SIPC to provide coverage for the victims of the multi-billion dollar Stanford Ponzi scheme.¹  All eyes are now on the SEC as it decides whether or not to appeal the District Court's decision.

Background

This case was an outgrowth of the multi-billion dollar Ponzi scheme orchestrated by Robert Allen Stanford ("Stanford"), which involved the selling of over $7 billion worth of Certificates of Deposit ("CDs") issued by the Stanford International Bank, Ltd. ("SIBL"), an Antiguan bank, and marketed by the Stanford Group Company ("SGC"), a now-defunct broker-dealer that was registered with the SEC and a SIPC member.

On February 16, 2009, the SEC filed an enforcement action in the United States District Court for the Southern District of Texas against Stanford and others, charging the defendants with a "massive Ponzi scheme" centered on the sale of SIBL CDs.²  Federal prosecutors also brought criminal charges, and on March 6, 2012, a jury in Texas federal court convicted Stanford of conspiracy, wire fraud, mail fraud, obstruction of justice and money laundering.³  On June 14, 2012, Stanford was sentenced to 110 years in prison.⁴

The Texas federal court appointed a Receiver to oversee the assets of SGC and other Stanford entities.  On December 12, 2011, after SIPC declined to file an application for a protective decree for the SGC customers—which would have initiated a liquidation proceeding allowing SGC customers who purchased SIBL CDs to file claims for recovery under the Securities Investor Protection Act ("SIPA")—the SEC filed an application with the District Court for an order directing SIPC to take action on behalf of the Stanford investors.

SIPC is a congressionally chartered, nonprofit membership corporation, funded by its member securities broker-dealers, which maintains a special reserve fund to compensate investors who lose money in insolvent or failing brokerage firms.  This is the first time in the 42 years since SIPA was enacted that the SEC has filed a lawsuit against SIPC.  The lawsuit was filed after negotiations between the two agencies broke down, and amid mounting pressure from politicians and Stanford victims.

The District Court's Decision

The key issue before the District Court was whether the investors who purchased the SIBL CDs were "customers" of SGC within the meaning of SIPA.⁵  Judge Wilkins, noting that the definition of "customer" under the statute should be construed narrowly, concluded that the investors who purchased SIBL CDs were not "customers" of SGC because there was no evidence that SGC ever "physically possessed" the investors' funds at the time that they made their purchase.⁶  As Judge Wilkins explained, because the "investors' checks were not made out to SGC and were never deposited into an account belonging to SGC . . . under a literal construction of the statute, the investors who purchased SIBL CDs are not 'customers' of SGC within the meaning of SIPA."⁷  In addition, Judge Wilkins rejected the SEC's argument, supported by evidence of the intertwining relationship between the various Stanford entities, that the definition of "customer" does not depend simply on the identity of the entity with which funds are deposited, noting that the SEC's position was at odds with its longstanding interpretation of SIPA to mean that the clients of introducing brokers (like SGC) are presumptively not "customers" within the meaning of the statute.⁸  Although Judge Wilkins noted that he was "truly sympathetic to the plight" of the Stanford investors, he determined that they were not entitled to protection under SIPA, and denied the SEC's application for a protective decree.⁹

Conclusion

Although a disappointing result for the Stanford investors, and victims of financial fraud in general, the District Court's decision in this matter of first impression provides important guidance on the interpretation and reach of SIPA.  Now the focus turns to the SEC as it decides whether to press forward with an appeal.