Fate of 7,000 Stanford Ponzi Investors Hangs on Rare SEC Lawsuit
January 17, 2012
By Robert Schmidt & Joshua Gallu
For 40 years, the U.S. Securities and Exchange Commission and the congressionally chartered group that protects
against broker theft have worked in tandem to reimburse people whose accounts are pilfered.
Now the SEC and the Securities Investor Protection Corp., or SIPC, are about to face off in a bitter court fight that may determine how future fraud victims are covered, raise broker fees that support SIPC and cast doubt on the SEC's political independence.
The dispute centers on whether more than 7,000 brokerage customers who invested in the alleged $7 billion Ponzi scheme run by R. Allen Stanford are entitled to have their losses covered by SIPC.
SIPC, a nonprofit corporation funded by the brokerage industry, says the Stanford investments don't fit into the confines of the federal law that governs who's eligible for the payouts. Investors and their advocates in Congress say SIPC is deliberately taking a narrow view of the law to protect brokers from higher assessments.
The SEC's commissioners, who have oversight of SIPC, ultimately sided with the investors. In June, the agency ordered SIPC to start a process that could grant up to $500,000 per client -- the same maximum amount it offers in any case. After SIPC balked, the SEC for the first time sued the group in federal court in Washington.
Dollars and Principles
As the two prepare for a Jan. 24 court date, SIPC has come out swinging, hiring two prominent law firms and an ex-federal judge who's been on the short list for a Republican Supreme Court nomination. In legal briefs, it accuses the SEC of ceding to pressure from Congress to flout the letter of the law, and argues that the agency's position jeopardizes investor payouts in other cases, including for clients of Bernard Madoff and MF Global Holdings Ltd. (MFGLQ)
"The dollars are such and the principles are such that we have to take it seriously," said Stephen Harbeck, who has worked at SIPC for 36 years and is now its president.
Harbeck said the group would probably have to spend most if not all of the $1.5 billion in its fund and possibly have to borrow more from the Treasury if the court orders it into the Stanford case.
The case "challenges the entire nature of the relationship between the SEC and SIPC," he added. "I'm quite sure it's not for the better."
SIPC may be best known for its logo, which dues-paying brokerage firms put on their marketing materials to show customers they're protected. 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 a general insurance fund or cover investment losses. Under the Securities Investor Protection Act, it's supposed to aid investors when their securities or cash are stolen or go missing.
Stanford, who's in prison awaiting trial, allegedly used his brokerage to entice investors to buy high-interest certificates of deposits via his private Stanford International Bank Ltd. in Antigua. Instead, according to prosecutors, much of the money was used to support Stanford's businesses and lifestyle.
Harbeck has said that SIPC shouldn'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 possession of their securities, he told a court-appointed receiver in 2009. SIPC covers theft but not fraud, he said.
Letters from Lawmakers
The SEC's staff initially agreed. So did David Becker, the SEC's general counsel at the time, according to an inspector general's report. As the commissioners mulled the matter, more than 50 lawmakers signed letters asking SEC Chairman Mary Schapiro to explain why constituents weren't getting aid while SIPC was helping a court-appointed receiver recover billions of dollars for victims of Madoff's fraud.
Schapiro and other commissioners rejected the staff's analysis and ordered it redone, according to five people with knowledge of the matter. The SEC commissioners eventually decided that there was no true separation between Stanford's bank and the brokerage firm. Customers who made investments with the bank, the SEC said, were effectively depositing money with the brokerage and should get SIPC coverage.
Angela Shaw, who founded the Stanford Victims' Coalition after her family lost $4.6 million in the alleged fraud, said there was no reason for clients to think they weren't backstopped by the fund.
SIPC "helped Stanford defraud investors, period," said Shaw, who said that about 7,800 of 20,000 Stanford investors used the brokerage. "They slapped that logo on everything to create an illusion of protection."
After the SEC ordered the payout, SIPC privately offered to settle the matter with the agency for about $250,000 per customer, according to two people familiar with the legal negotiations. The SEC's five commissioners voted to reject the deal, the people said.
SEC spokesman John Nester said SIPC's accusation that the agency was responding to pressure from Congress was "inaccurate" and said "the commission's decision was based on the facts and the law."
He declined to comment on the settlement talks. "We have had a long, positive relationship with SIPC that we intend to continue," Nester said.
SIPC's Harbeck also declined to discuss the settlement offer. He said that "at the staff level" relations with the SEC still "are really good."
The larger Stanford case has been a lingering embarrassment for the SEC, which has come under criticism from investors and lawmakers for failing to uncover Ponzi schemes. The agency's inspector general's office determined that the SEC failed to conduct a meaningful investigation of Stanford Financial Group until 2005 even though its examiners suspected the firm of engaging in fraud eight years earlier.
Stanford was accused by the SEC in February 2009 of running a "massive, ongoing fraud," and was later indicted on criminal charges. He has denied all wrongdoing.
The SEC, led by its chief litigator Matthew Martens, has taken a narrow tack in the SIPC case. In court papers, the agency says it has full authority over SIPC and asks the judge to enforce its order.
SIPC's legal team at Kirkland & Ellis LLP -- which includes former U.S. appellate judge Michael McConnell, mentioned as a possible Supreme Court nominee during the George W. Bush administration -- argues that the court shouldn't just rule on the order but determine whether the Stanford investors are covered by SIPC. The group's board has also retained law firm Covington & Burling LLP.
"The SEC's position is predicated on the wrongheaded notion that it has the legal authority to compel SIPC to take whatever action the SEC says it must take," SIPC said in a Dec. 27 court filing.
SIPC's attorneys also noted that the investor fund first declined to get involved in the Stanford case in August 2009 -- a decision that wasn't challenged by the SEC for almost two years.
"The SEC expressed no disagreement with SIPC until June 2011, when a United States senator announced a hold on two nominees to become SEC commissioners while the SEC considered this issue -- and the commission abruptly flipped its position on SIPC and Stanford the next day," SIPC wrote in its filing.
The Securities Industry and Financial Markets Association, a Washington-based trade association for the brokerage industry, has also weighed in, estimating in an analysis it released last August that its firms' dues to SIPC would more than double if the protection was extended the way the SEC wants.
Brokers currently pay one-quarter of 1 percent of their net operating revenues from their securities businesses in an annual SIPC assessment.
"While we are very sympathetic for any loss incurred by victims of the Stanford Financial fraud, SIPC as created by Congress in 1970 was never enabled to provide coverage as proposed by the SEC in this case," said Andrew DeSouza, a Sifma spokesman. "An unprecedented expansion of SIPC protection to investment fraud losses is something Congress never intended."
Senator David Vitter, the Louisiana Republican who refused to allow the vote on the SEC nominees until the agency weighed in on the Stanford case, said in a statement that SIPC's court filings and public comments show "just how desperate they are to divert attention from their untenable position."
The senator, who has some 1,800 Stanford investors in his state, said that SIPC has "never before in history" ignored an order from the SEC to liquidate a failed brokerage and assess the claims of victims. SIPC is mainly worried that payments to Stanford investors would drain its protection fund, he said.
"Even more disturbing, they've highlighted directly to me concerns that their big firm dues-payers are balking at the prospect of having to replenish the fund after a Stanford payout," Vitter said.
Harbeck said that SIPC's board, which voted 6-0 to reject the SEC's order, includes only two industry representatives and has members appointed by the Treasury and the Federal Reserve.
"The viewpoints of the industry were heard, but were by no means controlling," Harbeck said. "We've looked at this as objectively as we can."
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