The U.S. Securities and Exchange Commission cannot force the Securities Investor Protection Corp. to compensate victims of convicted tycoon Robert Allen Stanford's $7 billion Ponzi scheme, a Washington federal judge said Tuesday in a first-of-its-kind decision.
U.S. District Judge Robert L. Wilkins threw out the SEC's Dec. 12 application to compel SIPC to pay the fraud victims' claims through a liquidation proceeding. The corporation, funded by the brokerage industry to cover investors who lose money in failing firms, successfully argued that the Securities Investment Protection Act only allowed it to compensate customers of SIPC members.
Stanford's U.S.-based Stanford Group Co. was a member of SIPC, but the Antigua-based Stanford International Bank was not, the judge said. Stanford International Bank was an offshore bank, not a registered broker-dealer, which is what the SIPC oversees, according to the judge.
"Pursuant to the stipulated facts, the SEC cannot show that [Stanford Group] ever physically possessed the investors' funds at the time that the investors made their purchases," the judge said.
"In sum, the interpretation sought by the SEC is extraordinarily broad and would unreasonably contort the statutory language," the judge added.
The decision was a major blow to victims of the Ponzi scheme, who together lost upwards of $7 billion in certificates of deposit administered by Stanford International Bank.
It also carried broader legal significance, marking the first time since the enactment of SIPA 42 years ago that a federal court had ruled on how much power the SEC has to command a SIPC liquidation. The U.S. Supreme Court has ruled that brokerage customers cannot force such proceedings, but that the SEC has the "plenary authority" to do so.
Because of its precedential nature, a key issue in the Stanford dispute was the standard of proof required of the SEC. The agency argued for a more lenient standard than SIPC, describing its burden as merely probable cause supported by hearsay.
Judge Wilkins ultimately chose a higher standard requested by SIPC: a preponderance of the evidence. That is the burden required of the SEC to win a permanent injunction — a similar kind of command — under the Securities Exchange Act of 1934, the judge noted.
Judge Wilkins said he was "truly sympathetic to the plight" of Ponzi scheme victims who were awarded a measure of justice but not made financially whole by Stanford's 110-year sentence June 14 in Texas federal court.
"But," the judge said, "this court has a duty to apply the SIPA statute as written by Congress, and, as other courts have done, this court also has a duty to construe narrowly the 'customer' definition of the statute."
The ruling was cheered by SIPC, which had faced the prospect of a liquidation involving thousands of claimants and millions of dollars in administrative costs alone.
"As SIPC said from the beginning, the SEC had taken the unprecedented position that SIPC must provide financial guarantees for investors who chose to purchase [certificates of deposit] issued by an offshore bank in Antigua," the corporation said in a statement. "If accepted, that position would have rewritten SIPC's 40-year mandate under the law."
SEC spokesman John Nester said the agency was reviewing the decision, but declined to comment further.
The ruling marked another legal setback for the SEC over the massive Stanford fraud. On Monday, victims of the scheme sued the federal government in Louisiana federal court, claiming an SEC office in Texas essentially facilitated the scheme by ignoring evidence of wrongdoing.
The SIPC is represented by Edwin John U, Eugene F. Assaf Jr., John C. O'Quinn, Michael W. McConnell and Susan Davies of Kirkland & Ellis LLP.
The case is Securities and Exchange Commission v. Securities Investor Protection Corp., case number 1:11-mc-00678, in the U.S. District Court for the District of Columbia.
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