SEC’s Stanford Ponzi Ruling Provokes Clash With Investor Fund

When regulators froze R. Allen Stanford’s assets two years ago and accused him of running a $7 billion Ponzi scheme, some 20,000 investors were left wondering if they’d ever get their money back.

Now the Securities and Exchange Commission and a federally chartered investor protection group are clashing over whether Stanford’s clients should be as eligible for payments as the victims of Bernard Madoff. The dispute highlights how the rules can get murky when politics collides with securities law.

The group -- the Securities Investor Protection Corp., known as SIPC -- has maintained that the law doesn’t provide for payouts to investors in the circumstances of the Stanford case. The SEC’s staff initially agreed. SEC Chairman Mary Schapiro and two other commissioners rejected the analysis and ordered it redone, according to five people with knowledge of the matter.

On June 15, the SEC told SIPC to start a process that could give as much as $500,000 to each qualified Stanford investor. The agency further surprised SIPC by threatening to sue if it didn’t carry out the plan.

The SEC’s action “is highly unusual,” and a lawsuit would be unprecedented, said Stephen Harbeck, SIPC’s president, who has worked at the group for 36 years.

Harbeck has said publicly that he doesn’t think the Stanford investors are eligible for repayments. SIPC is supposed to aid investors when their securities are stolen or go missing at a brokerage. Stanford’s customers still have possession of their securities, he said, and fraud by itself isn’t covered.

‘Difficult to Explain’

For people who have lost a lot of money, “it is very difficult to explain the difference between theft and fraud,” Harbeck said.

The question will remain unsettled until at least mid- September, when the SIPC board is set to meet to decide whether to follow the SEC’s opinion.

For the SEC, the decision came after more than two years of political pressure on Schapiro. More than 50 lawmakers signed letters asking her to explain why Stanford investors among their constituents weren’t getting aid from SIPC, which is helping a court-appointed receiver return billions of dollars to Madoff victims.

Schapiro was grilled on the matter almost every time she appeared in Congress. The House panel overseeing the agency’s budget warned her to speed up the deliberations. Senator David Vitter of Louisiana, who has some 1,800 Stanford investors in his state, blocked the nominations of two SEC commissioners.

A day after Vitter’s move, the SEC announced its decision. “This is big, big news,” said Vitter, a Republican, who released his hold on the nominees that day. He called the SEC’s action “a huge step and a sigh of relief for many.”

Ignoring Warnings

The dispute involves two entities suffering from their own reputational challenges.

The SEC has been fighting to regain credibility after being assailed by lawmakers and investors for bungling investigations into Ponzi schemes. Inspector General H. David Kotz determined the agency didn’t act on warnings about Madoff’s activities or conduct a meaningful probe of Stanford Financial Group until 2005, even though examiners suspected Stanford of engaging in fraud eight years earlier.

SIPC, a nonprofit industry-funded group with a widely misunderstood mission, has been targeted by politicians and victims who say it protects brokers by deliberately taking a narrow view of the law so it can parsimoniously dole out its funds.

“We just wanted to be treated the same way that the Madoff victims are,” said Angela Shaw, who founded the Stanford Victims Coalition after her family lost $4.6 million in the alleged fraud. “To aspire to be like the Madoff victims, that’s a bad place to be in.”

‘Ongoing Fraud’

Harbeck said SIPC wouldn’t hesitate to use “every last penny we have” for investors who are eligible for its protections.

Authorities say investors were ensnared in Stanford’s scheme over nearly two decades. A Texas native once ranked as the world’s 605th richest person by Forbes Magazine, Stanford saw his assets frozen in February 2009 when the SEC accused him of running a “massive, ongoing fraud.” Later that year, he was indicted on federal criminal charges.

Prosecutors said Stanford’s activities centered on enticing investors to buy certificates of deposits via Stanford International Bank, a private subsidiary located in Antigua.

Awaiting Trial

The interest on the CDs was substantially higher than those that could be purchased in the U.S. and they were marketed as conservative, liquid investments, authorities said. Instead, the system turned out to be bogus, with much of the money going to Stanford via undocumented “loans” that supported his businesses and lifestyle, according to prosecutors.

Stanford is now in prison awaiting a trial scheduled for next year; he has denied all wrongdoing.

Congress established SIPC in 1970. Brokerages are required by law to be members and pay assessments. In return, they get the right to put the group’s logo on their marketing materials.

While investors may regard the label as equivalent to the guarantee that the Federal Deposit Insurance Corp. gives to bank accounts, SIPC doesn’t run an insurance fund. Nor is it a government agency, even though five of its seven board members are appointed by the president and confirmed by the Senate. The two others are filled by the Treasury Department and the Federal Reserve.

SIPC’s fund now holds about $1.3 billion, according to Harbeck. The question of who gets access to that money -- and SIPC’s help with a firm’s liquidation -- is determined by the facts of each case.

Losses Uncovered

Under the 1970 Securities Investor Protection Act, if a broker absconds with, say, 100 shares of stock, SIPC will replace it for the client. SIPC also will cover missing cash, up to $250,000 within a $500,000 cap per customer.

SIPC doesn’t cover investment losses, however, even when they come from securities fraud. That’s an issue at play in the Stanford matter.

Harbeck informally advised a court-appointed receiver in August 2009 that SIPC wouldn’t get involved because investors received actual CDs after the brokerage passed their money to a bank. What happened after that isn’t under SIPC’s purview because the Stanford account holders “have their securities,” Harbeck wrote to the receiver.

The SEC rejected that reasoning in its June 15 analysis, arguing that there was no true separation between the bank and the brokerage firm. Customers who made their investments with the bank, the SEC said, were effectively depositing money with the brokerage and thus should be eligible for SIPC coverage.

Split Decision

One of the five SEC commissioners, Republican Kathleen Casey, voted against the decision, the people briefed on the matter said. Casey declined to comment through an aide.

The SEC’s determination, some securities lawyers said, could set a new precedent for expanding SIPC coverage for investors who buy fraudulent securities that were issued by a bank affiliated with the brokerage.

“That standard would apply to some very large brokerage firms that are subsidiaries of even larger banks,” said John Coffee, a law professor at Columbia University in New York. The liability, which would be borne by the brokerage industry, “could be astronomic in some conceivable cases,” he said.

Others saw the decision as overdue. Harvey Pitt, a former SEC chairman who runs Kalorama Partners, a Washington-based consulting firm, said he agreed with the SEC’s order because the investor protection fund has long been too resistant to claims.

$7.6 Billion

“I never understood how SIPC could refuse to make good on those who lost money because of Stanford’s misconduct,” Pitt said in an interview.

SEC spokesman Kevin Callahan declined to comment on the internal deliberations. “After extensive discussions, the SEC determined this was the right decision and the right analysis,” he said.

In the Madoff case, SIPC has worked with a court-appointed trustee to recover $7.6 billion as of early May, about 44 percent of the $17.3 billion in lost principal that Madoff customers have claimed.

Even there, the group’s decisions have been in dispute. SIPC determined that account holders should be repaid based on what they invested minus any funds they took out. A number of Madoff clients are challenging that in court, arguing they should be granted coverage based on their final account statement, a figure that SIPC says includes fake profits.

Lobbying

The gap between SIPC’s treatment of the Madoff and Stanford cases has spurred much of the lobbying and congressional advocacy on behalf of Stanford’s investors.

Shaw, the founder of the victims’ coalition, says that in the end, the decision to provide SIPC payouts was made on the legal merits.

New evidence emerged early this year showing that the investors’ money, though ostensibly used to buy the CDs, never left Stanford’s U.S. firm, Shaw said. That would mean funds were missing from the brokerage and thus eligible for the payout, she said.

Shortly after the SEC’s decision, Shaw met for the first time with SIPC’s general counsel and left the meeting feeling “optimistic” that the fund will comply with the ruling, she said.

“It’s been a hard two years,” said Shaw, who works part time in the public affairs department of the Federal Reserve Bank of Dallas and is the mother of a 7-year-old special needs child.

The long days in Washington lobbying Congress and the SEC have been worth it, she said. Shaw estimates that about 80 percent of Stanford brokerage account holders could be made whole by the SIPC money because they invested less than $500,000. While that would still leave thousands of people who invested via other Stanford affiliates unprotected, some 7,800 clients may file claims, she said.

“I have a renewed sense of belief in the system,” said Shaw. “You want to believe that the government is there for you, and in the end it was.”

For Related News and Information:

To contact the reporters on this story: Robert Schmidt in Washington at rschmidt5@bloomberg.net; Joshua Gallu in Washington at jgallu@bloomberg.net

To contact the editor responsible for this story: Lawrence Roberts at lroberts13@bloomberg.net.

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