D.C. Circuit Court of Appeals Considers Whether Stanford Fraud Victims are “Customers” under the Securities Investor Protection Act

Despite the famous R. Allen Stanford Ponzi scheme being unraveled in early 2009, the past two weeks have been important for the victims of the fraud who are still trying to recover their financial losses.  On October 7, the Supreme Court heard arguments on whether the Securities Litigation Uniform Standards Act precludes investors from bringing state law claims against third-party entities who allegedly participated in Stanford’s fraudulent scheme.  For further discussion on that topic, click here. 

Yesterday, the SEC argued in front of the D.C. Circuit Court of Appeals seeking to overturn a District Court’s ruling that barred the agency from ordering the Securities Investor Protection Corp. (“SIPC”) to compensate victims of the Stanford Ponzi scheme.  SIPC is a congressionally chartered corporation that oversees liquidation of failed brokerages and may also pay investors’ claims for missing money or securities through an industry-financed fund.    

Since the CD’s at the heart of the Ponzi scheme were marketed to investors by Houston-based Stanford Group Company (“SGC”) – a broker dealer registered with the SEC and SIPC – in 2009, the court appointed receiver of Stanford’s companies asked SIPC to evaluate whether the customers of SGC were entitled to SIPC’s protection.  SIPC declined to file an application for protective decree because it concluded that SGC did not perform a custody function for the customers who purchased CD’s from the Antigua-based Stanford International Bank (“SIB”) which was not a member of SIPC.  However, in 2011, the SEC issued a formal analysis disagreeing with SIPC’s position and filed an application in District Court ordering SIPC to meet its obligations. 

This is the first time the SEC has requested a court to force SIPC to extend its coverage.  During the proceedings in the District Court, the key issue was whether persons who purchased CD’s from SIB were considered customers of SGC within the meaning of the Securities Investor Protection Act.  SIPA defines “customer” as follows:

(A) IN GENERAL

The term ‘customer’ of a debtor means any person (including any person with whom the debtor deals as principal or agent) who has a claim on account of securities received, acquired, or held by the debtor in the ordinary course of its business as a broker or dealer from or for the securities accounts of such person for safekeeping, with a view to sale, to cover consummated sales, pursuant to purchases, as collateral, security, or for purposes of effecting transfer.

(B) INCLUDED PERSONS

The term `customer' includes—

(i) any person who has deposited cash with the debtor for the purpose of purchasing securities;…

SIPCs argued that although many of the victims purchased the foreign CD’s through SGC, the victims ultimately entrusted their money with SIB which was not a member of SIPC.  Furthermore, investors received disclosures explicitly telling them the Antiguan bank was not SIPC-protected or regulated by the U.S. 

The SEC, however, argued that the location of the Stanford bank is irrelevant because Stanford’s entire business organization was operating one massive fraud, and that no actual certificates of deposit truly existed.

The District Court found that since SGC never physically possessed the investors’ funds at the time of the purchases, the investors were not customers of SGC under the literal construction of the statute.  Click here to review the court’s opinion.   

During oral arguments in front of the D.C. Circuit, much of the hearing was consumed by discussion and debate over the legal definition of “customer” and whether the SEC can force SIPC to construe that term to include victims of a collapse that involves both member and non-member companies.  Just like the highest court last week, the Circuit judges gave no clear indication of how they will rule. 

A few former SEC commissioners filed a friend of the court brief urging the Circuit to uphold the lower court’s ruling because an “unwarranted expansion” of the term “customer” has the potential to substantially increase SIPC’s exposure and could threaten its ability to function as Congress intended.

In sum, the rulings of the Supreme Court and the D.C. Circuit Court of Appeals will both have a substantial impact on the victims’ chances to recover their losses.