December 12, 2011
By Loren Steffy
By Loren Steffy
The Securities and Exchange Commission, in an unprecedented
move, sued a national brokerage insurance fund to force it to
cover potential investor losses from R. Allen Stanford's
alleged $7.2 billion Ponzi scheme.
The lawsuit, filed in federal court in Washington, would require the Securities Investor Protection Corp., or SIPC, to begin a liquidation proceeding for Stanford's U.S. brokerage, which was based in Houston. The liquidation would let customers file claims under federal investor protection laws.
The court action comes after months of negotiations between the SEC and SIPC failed to produce an agreement. SIPC, which is funded by the brokerage industry, has resisted covering losses in the 2009 collapse of Stanford Financial Group, saying the investments were certificates of deposit with an offshore bank rather than securities.
"It's time to get even tougher in our fight for the victims," said Sen. David Vitter, R-La., who led the fight in Congress on behalf of Stanford investors. "I've been urging SIPC Chairman Johnson to act quickly for months, but the victims still haven't received an up-or-down answer. This move by the SEC is encouraging and should significantly help the process."
Last week, Vitter pressed SEC Chairman Mary Schapiro to sue.
The SEC, which has oversight authority for SIPC, argued that the CDs constituted securities and were sold to investors through Stanford's SIPC-insured brokerage.
In June, the commission ordered SIPC to cover investor losses, much as it has for those who lost money in Bernard Madoff's Ponzi scheme, but SIPC's board didn't respond to the order.
"Because SIPC has declined to take steps to initiate the proceeding for the protection of Stanford customers, the commission filed suit today asking a court to compel it to do so," the SEC said in a statement.
Why it's fighting back
SIPC officials said they intend to fight the suit.
"After careful and exacting analysis, we believe the SEC's theory in this case conflicts with the Securities Investor Protection Act, the law that created SIPC and has guided it for the last 40 years," fund chairman Orlan Johnson said in a prepared statement.
Stanford's membership in SIPC reassured investors like Carl Rabenaldt, who works for a Houston engineering firm. He invested his retirement in the CDs in part because he thought his money was covered by SIPC. "Then, when there's a claim against it, they're finding reasons not to pay it," he said.
R. Allen Stanford is accused of defrauding thousands of investors by selling them certificates of deposit from his bank in Antigua, assuring them that the investments were safe.
He then allegedly used the money for other purposes, including funding a lavish lifestyle for himself and investing it in highly speculative private businesses.
Settlement offered?
SIPC last week offered to cover a portion of the Stanford investors' losses, but the SEC found the offer unacceptable, according to a person familiar with the discussions.
At a closed-door meeting Wednesday, the commission decided to proceed with the suit, the person said, adding that SIPC may still make another settlement offer.
SIPC, created in 1970, is designed to insure investors if a brokerage fails and cash or securities are missing from customer accounts. It isn't designed to cover losses from declines in investments' value.
SIPC officials had argued that the Stanford case is different than Madoff's. Stanford investors sent money to buy CDs directly to Stanford's Antiguan bank and therefore they weren't "customers" of the brokerage under the definition of the law, they said. In addition, they argued that Stanford's CDs, while worthless, did exist, and therefore insurance coverage isn't warranted.
The SEC contends the money investors thought was being used to buy the CDs was diverted for other purposes and the CDs were never actually purchased. Because the CDs were sold through the SIPC-insured brokerage, the insurance pool should cover the losses, it argued.
The coverage would apply to about 7,800 of Stanford's 20,000 investors worldwide.
The lawsuit, filed in federal court in Washington, would require the Securities Investor Protection Corp., or SIPC, to begin a liquidation proceeding for Stanford's U.S. brokerage, which was based in Houston. The liquidation would let customers file claims under federal investor protection laws.
The court action comes after months of negotiations between the SEC and SIPC failed to produce an agreement. SIPC, which is funded by the brokerage industry, has resisted covering losses in the 2009 collapse of Stanford Financial Group, saying the investments were certificates of deposit with an offshore bank rather than securities.
"It's time to get even tougher in our fight for the victims," said Sen. David Vitter, R-La., who led the fight in Congress on behalf of Stanford investors. "I've been urging SIPC Chairman Johnson to act quickly for months, but the victims still haven't received an up-or-down answer. This move by the SEC is encouraging and should significantly help the process."
Last week, Vitter pressed SEC Chairman Mary Schapiro to sue.
The SEC, which has oversight authority for SIPC, argued that the CDs constituted securities and were sold to investors through Stanford's SIPC-insured brokerage.
In June, the commission ordered SIPC to cover investor losses, much as it has for those who lost money in Bernard Madoff's Ponzi scheme, but SIPC's board didn't respond to the order.
"Because SIPC has declined to take steps to initiate the proceeding for the protection of Stanford customers, the commission filed suit today asking a court to compel it to do so," the SEC said in a statement.
Why it's fighting back
SIPC officials said they intend to fight the suit.
"After careful and exacting analysis, we believe the SEC's theory in this case conflicts with the Securities Investor Protection Act, the law that created SIPC and has guided it for the last 40 years," fund chairman Orlan Johnson said in a prepared statement.
Stanford's membership in SIPC reassured investors like Carl Rabenaldt, who works for a Houston engineering firm. He invested his retirement in the CDs in part because he thought his money was covered by SIPC. "Then, when there's a claim against it, they're finding reasons not to pay it," he said.
R. Allen Stanford is accused of defrauding thousands of investors by selling them certificates of deposit from his bank in Antigua, assuring them that the investments were safe.
He then allegedly used the money for other purposes, including funding a lavish lifestyle for himself and investing it in highly speculative private businesses.
Settlement offered?
SIPC last week offered to cover a portion of the Stanford investors' losses, but the SEC found the offer unacceptable, according to a person familiar with the discussions.
At a closed-door meeting Wednesday, the commission decided to proceed with the suit, the person said, adding that SIPC may still make another settlement offer.
SIPC, created in 1970, is designed to insure investors if a brokerage fails and cash or securities are missing from customer accounts. It isn't designed to cover losses from declines in investments' value.
SIPC officials had argued that the Stanford case is different than Madoff's. Stanford investors sent money to buy CDs directly to Stanford's Antiguan bank and therefore they weren't "customers" of the brokerage under the definition of the law, they said. In addition, they argued that Stanford's CDs, while worthless, did exist, and therefore insurance coverage isn't warranted.
The SEC contends the money investors thought was being used to buy the CDs was diverted for other purposes and the CDs were never actually purchased. Because the CDs were sold through the SIPC-insured brokerage, the insurance pool should cover the losses, it argued.
The coverage would apply to about 7,800 of Stanford's 20,000 investors worldwide.
ANALYSIS OF SECURITIES INVESTOR PROTECTION ACT COVERAGE FOR STANFORD GROUP COMPANY
The SEC has authorized its Division of Enforcement to bring an action in district court against SIPC to compel the
institution of a proceeding to liquidate SGC under SIPA.
The Commission has determined that the statutory requirements for instituting a SIPA liquidation are met here. SGC is insolvent and the subject of a receivership. And for the reasons discussed below, the Commission has concluded that SGC has failed to meet its obligations to customers. Based on the totality of the facts and circumstances of this case, the Commission has determined (in an exercise of its discretion) that SIPC should initiate a proceeding under SIPA to liquidate SGC.
In concluding that investors who purchased the SIBL CDs through SGC qualify for protected "customer" status, the Commission finds two lines of cases applying SIPA particularly relevant. First, courts have held that, under certain circumstances, an investor may be deemed to have deposited cash with a brokerdealer for the purpose of purchasing securities-and thus be a "customer" under Section 16(2) of SIPA - even if the investor initially deposited those funds with an entity other than the broker-dealer. Second, courts have held that when securities purportedly acquired for customers by a broker-dealer are actually fraudulent vehicles for carrying out a Ponzi scheme, customers' "net equity" claims under SIPA can be measured by the net amount of cash customers invested and not by the purported but unreal value of the fraudulent securities (including fictitious "profits").
In In re Old Naples, the Eleventh Circuit addressed whether claimants who had deposited cash with an affiliate of a broker-dealer in order to purchase securities could nonetheless qualify as customers of the failed broker-dealer. The court held that the investors should be deemed to have deposited cash with the broker-dealer based on evidence supporting the bankruptcy court's findings that (1) the investors "had no reason to know that they were not dealing with" the broker-dealer; and (2) the funds investors deposited with the affiliate "were used by, or at least for," the broker-dealer, who "diverted some of the investors' money from [the affiliate] for personal use, and... used much of the money to pay [the broker-dealer's] expenses."
The totality of facts and circumstances in this case supports a similar conclusion about the status of the investors with accounts at SGC who purchased SIBL CDs, i.e., that by depositing money with SIBL, investors were effectively depositing money with SGC. Based on the findings of the Receiver and his expert investigators, the separate existence of SIBL, SGC, STC, and their ultimate, sole owner, Stanford should be disregarded.
In so doing, the court focused on the substance of the transactions rather than their form.
Credible evidence shows that Stanford structured the various entities in his financial empire, including SGC and SIBL, for the principal, if not sole, purpose of carrying out a single fraudulent Ponzi scheme. These many entities (controlled and directly or indirectly owned by Stanford) were operated in a highly interconnected fashion, with a core objective of selling fraudulent SIBL CDs.
Additionally, as in Old Naples, there are facts that could have led SGC account holders who purchased SIBL CDs through SGC to believe they were depositing cash with SGC for the purpose of purchasing the CDs. Defrauded CD investors have submitted affidavits stating that they were told by their SGC financial advisors that SGC and SIBL were both members of the "Stanford Financial Group," and that Stanford financial advisers frequently referred simply to "Stanford" without clearly distinguishing between SGC and SIBL. Affidavit of Sally Matthews
Both SGC and SIBL had the word "Stanford" in their names and used the same logo, and SGC provided at least some customers with "advisory statements" bearing that logo that listed their SIBL CD positions.
There is also credible evidence that, as in Old Naples, the funds deposited with SIBL were diverted for Stanford's personal use and used to pay the expenses of SGC.
In an August 14, 2009 letter to the Receiver, SIPC President Stephen P. Harbeck stated that "if SGC and SIBL are consolidated ... the CDs are, in effect, debts of SGC, and are part of the capital of SGC. Such a relationship negates 'customer' status under 15 U.S.C. § 78lll(2)(B) [as amended, § 78lll(2)(C)(ii)]." The Commission disagrees for the reasons the courts in C.J. Wright, Old Naples, and Primeline rejected similar arguments advanced by the SIPA Trustee as grounds for denying customer status. In C.J. Wright, the court found that claimants "believed they were depositing funds for the purchase of securities and were not told and were not aware that their investment was to become part of debtor's capital."
The Commission has determined that the statutory requirements for instituting a SIPA liquidation are met here. SGC is insolvent and the subject of a receivership. And for the reasons discussed below, the Commission has concluded that SGC has failed to meet its obligations to customers. Based on the totality of the facts and circumstances of this case, the Commission has determined (in an exercise of its discretion) that SIPC should initiate a proceeding under SIPA to liquidate SGC.
In concluding that investors who purchased the SIBL CDs through SGC qualify for protected "customer" status, the Commission finds two lines of cases applying SIPA particularly relevant. First, courts have held that, under certain circumstances, an investor may be deemed to have deposited cash with a brokerdealer for the purpose of purchasing securities-and thus be a "customer" under Section 16(2) of SIPA - even if the investor initially deposited those funds with an entity other than the broker-dealer. Second, courts have held that when securities purportedly acquired for customers by a broker-dealer are actually fraudulent vehicles for carrying out a Ponzi scheme, customers' "net equity" claims under SIPA can be measured by the net amount of cash customers invested and not by the purported but unreal value of the fraudulent securities (including fictitious "profits").
In In re Old Naples, the Eleventh Circuit addressed whether claimants who had deposited cash with an affiliate of a broker-dealer in order to purchase securities could nonetheless qualify as customers of the failed broker-dealer. The court held that the investors should be deemed to have deposited cash with the broker-dealer based on evidence supporting the bankruptcy court's findings that (1) the investors "had no reason to know that they were not dealing with" the broker-dealer; and (2) the funds investors deposited with the affiliate "were used by, or at least for," the broker-dealer, who "diverted some of the investors' money from [the affiliate] for personal use, and... used much of the money to pay [the broker-dealer's] expenses."
The totality of facts and circumstances in this case supports a similar conclusion about the status of the investors with accounts at SGC who purchased SIBL CDs, i.e., that by depositing money with SIBL, investors were effectively depositing money with SGC. Based on the findings of the Receiver and his expert investigators, the separate existence of SIBL, SGC, STC, and their ultimate, sole owner, Stanford should be disregarded.
In so doing, the court focused on the substance of the transactions rather than their form.
Credible evidence shows that Stanford structured the various entities in his financial empire, including SGC and SIBL, for the principal, if not sole, purpose of carrying out a single fraudulent Ponzi scheme. These many entities (controlled and directly or indirectly owned by Stanford) were operated in a highly interconnected fashion, with a core objective of selling fraudulent SIBL CDs.
Additionally, as in Old Naples, there are facts that could have led SGC account holders who purchased SIBL CDs through SGC to believe they were depositing cash with SGC for the purpose of purchasing the CDs. Defrauded CD investors have submitted affidavits stating that they were told by their SGC financial advisors that SGC and SIBL were both members of the "Stanford Financial Group," and that Stanford financial advisers frequently referred simply to "Stanford" without clearly distinguishing between SGC and SIBL. Affidavit of Sally Matthews
Both SGC and SIBL had the word "Stanford" in their names and used the same logo, and SGC provided at least some customers with "advisory statements" bearing that logo that listed their SIBL CD positions.
There is also credible evidence that, as in Old Naples, the funds deposited with SIBL were diverted for Stanford's personal use and used to pay the expenses of SGC.
In an August 14, 2009 letter to the Receiver, SIPC President Stephen P. Harbeck stated that "if SGC and SIBL are consolidated ... the CDs are, in effect, debts of SGC, and are part of the capital of SGC. Such a relationship negates 'customer' status under 15 U.S.C. § 78lll(2)(B) [as amended, § 78lll(2)(C)(ii)]." The Commission disagrees for the reasons the courts in C.J. Wright, Old Naples, and Primeline rejected similar arguments advanced by the SIPA Trustee as grounds for denying customer status. In C.J. Wright, the court found that claimants "believed they were depositing funds for the purchase of securities and were not told and were not aware that their investment was to become part of debtor's capital."
Related article: SEC Concludes
Stanford Investors Are Entitled to Protections of SIPA
SECURITIES AND EXCHANGE COMMISSION'S
MEMORANDUM OF POINTS AND AUTHORITIES IN SUPPORT OF APPLICATION.
Visit the Stanford International Victims Group - SIVG official forum http://sivg.org/forum/
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