The Securities Investor Protection Corp., an industry fund that covers losses from brokerage firm failures, must compensate victims of Allen Stanford’s $7 billion Ponzi scheme because they were customers of a U.S.-based brokerage, a government lawyer told an appeals court.
“We’re not claiming that anyone is covered who did not have a brokerage account” with Houston-based Stanford Group Co., U.S. Securities and Exchange Commission attorney John Avery told a panel of the U.S. Court of Appeals today in Washington. “That’s how they got sucked into this scheme.”
The SEC is seeking to overturn a lower court ruling that blocked the agency from ordering SIPC to cover the Stanford victims, who invested in phony certificates of deposit. U.S. District Judge Robert Wilkins in July 2012 ruled the SEC had failed to show the 7,000 investors in the scheme met the definition of “customer” under the Securities Investor Protection Act, which set up the nonprofit fund run by the brokerage industry.
The Stanford case is the first time the SEC has gone to court to force SIPC to extend coverage.
Michael McConnell, an attorney for SIPC, urged the judges to uphold the ruling.
In Stanford’s swindle, his brokerage clients were directed to buy the CDs at his Antigua-based Stanford International Bank LLC, which was not a SIPC member, McConnell said.
“There was no deposit of money with SGC in this case” and thus no basis for extending coverage to its clients, McConnell told circuit judges Merrick Garland and Sri Srinivasan. A third judge, David Sentelle, was absent and will listen to a recording of arguments.
Much of the hour-and-20-minute hearing was consumed by debate over the legal definition of “customer” and whether the SEC has authority to force SIPC to amend its rules to broaden the meaning to include victims when a collapse involves both member and non-member companies.
Garland said that in some cases, “the courts have thought it reasonable to consolidate the covered with the non-covered.”
Stanford was convicted of multiple counts of wire fraud, mail fraud and other charges in March 2012 and was sentenced to 110 years in prison.
SIPC, a congressionally chartered corporation, oversees liquidation of failed brokerages and through an industry-financed fund may also pay claims of as much as $500,000 a client for missing money and securities.
SIPC agreed to pay victims of Bernard Madoff’s Ponzi scheme, in which $17 billion of principal disappeared according to the U.S., as well as investors who lost money in the collapse of Lehman Brothers in September 2008 and the MF Global Holdings Inc. commodities brokerage in October 2011.
The SEC argued that the denial of coverage didn’t consider the relationship between Stanford’s bank and brokerage.
“It’s very difficult to draw and distinction, a meaningful distinction, between any of these Stanford entities,” Avery said in court.
Money spent on the CDs from the Antiguan bank came back to Stanford-controlled entities in the U.S., he said.
“This was a Ponzi scheme based in the United States,” he said.
The SIPC fund contains about $1.9 billion and exposure from Stanford victims is “potentially in the billions,” Dan McGinn, a spokesman for SIPC, said in an interview last week.
Former SEC commissioners Joseph Grundfest and Paul Atkins filed a friend of the court brief urging rejection of the SEC request because it represents an “unwarranted expansion” of the term “customer” that would “substantially increase the exposure of the SIPC fund.”
“The SEC’s proposed expansion of SIPC protection, absent even the most rudimentary consideration of any financial consequences, would radically transform the SIPA and threaten SIPC’s ability to function as Congress intended,” they wrote.
John Coffee Jr., a professor of securities law at Columbia University, said deciding how far to extend SIPC coverage is a fundamental question that should be addressed by Congress “rather than through judicial lawmaking.”
“Legislation is the better way to go rather than to try to extend SIPC coverage retroactively,” Coffee, who has no involvement with the case, said in a telephone interview.
The case is Securities and Exchange Commission v. Securities Investor Protection Corp., 12-5286, U.S. Court of Appeals, District of Columbia (Washington).