Congress: SIPC Needs to Decide Whether it Will Provide Coverage to Victims of Stanford Ponzi Scheme

Nearly six months after the Securities and Exchange Commission ("SEC") issued a formal request to the Securities Investor Protection Corporation ("SIPC") for coverage of losses suffered by victims of R. Allen Stanford's $7 billion Ponzi scheme, investors are still waiting to hear whether SIPC will heed the SEC's request and begin proceedings to return some or all of investor losses.  The SEC made findings in a report released in mid-June that Stanford's broker-dealer, Stanford Group Company ("SGC"), had failed to meet its obligations to customers, and as a result of its membership in SIPC, was the proper subject of a customer protection liquidation and thus entitled to compensation from SIPC.  Should SIPC fail to take appropriate action, warned the SEC in a thinly-veiled directive, the SEC Division of Enforcement was prepared to institute legal action against SIPC to compel such a proceeding.  With no decision yet issued, pressure has continued to mount on SIPC from several fronts, and a recent letter from Congress has demanded a "satisfactory update" or decision on the matter by December 15.

The Securities Investor Protection Act of 1970 ("SIPA") mandated the creation of SIPC, which it saw as a way to allay investor fears and save the securities market in a time of crisis.  While the creature of congressional legislation, SIPC is unique in that it is funded through membership fees paid by member institutions, which by statute are all persons registered as broker-dealers under Section 15(b) of the Securities Exchange Act of 1934.  From 1996 until 2009, these member assessments were pegged at $150 per institution - regardless of the size of the firm's securities business.  Thus, financial titans such as Goldman Sachs or JP Morgan paid $150 to sustain a fund used in the event of financial collapse.  However, after the recent financial crisis, SIPC bylaws were adjusted as of April 1, 2009 to peg member assessments as the greater of $150 or ¼ of 1% of net operating revenues from the securities business.  The $150 minimum requirement was later eliminated upon the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in July 2010.  Firms such as Goldman and JPM, whose securities businesses generate tens of billions of dollars in annual revenues, now face SIPC membership fees in excess of tens of millions of dollars.

When a member broker-dealer fails, SIPC acts to organize the distribution of customer cash and securities to investors.  To the extent that customer cash or securities are unavailable, a SIPA liquidation would provide insurance coverage of up to $500,000 of the customer's brokerage balance, including up to $250,000 in cash. Should a customer's investment exceed the compensation afforded by SIPC, a SIPA trustee would then be tasked with recovering further assets to satisfy the difference.

SIPC coverage is not all-encompassing, however, and generally does not apply to investments such as commodity of futures contracts, investment contracts, and oil/gas/mineral leases unless those investments are registered with the SEC.  Most types of securities, such as stocks, bonds, certificates of deposit, and notes are generally covered by SIPC.  According to its website, 

no fewer than 99 percent of persons who are eligible have been made whole in the failed brokerage firm cases that it has handled to date.

Since its inception in 1970, SIPC has advanced $1.6 billion as part of wider efforts to enable the recovery of $109.3 billion in assets for nearly 750,000 investors.  

SIPC has played an instrumental role in the ongoing liquidation of Bernard Madoff's failed brokerage firm.  Of the $7.3 billion of claims allowed by trustee Irving Picard, SIPC has provided nearly $800 million in advances to customers of Madoff's fraud.  In Picard's motion for approval of a first interim distribution to investors, he revealed that SIPC advances alone fully satisfied the claims of 868 Madoff victims.  

Stanford's scheme advised clients from 113 countries to purchase more than $7 billion in certificates of deposit ("CDs") from the Stanford International Bank in Antigua.  The SEC instituted civil proceedings in February 2009, and a receiver, Ralph Janvey, was appointed to marshal assets for victims.  A criminal indictment soon followed in June 2009.  Soon after his appointment, Janvey inquired as to whether Stanford's victims qualified for SIPC coverage.  Responding to Janvey's letter in August 2009 (the "August 2009 Letter"), Stephen Harbeck, the President of SIPC, gave several reasons for the decision that "there is no basis for SIPC to initiate a proceeding under SIPA," which included:

• The SEC had not formally notified SIPC of the need to act;
• The CDs were issued by Stanford International Bank Ltd. ("SIBL"), which is not a SIPC member;
• SGC did not issue purchase confirmations for the CDs, nor were the CDs held at SGC's clearing firms;
• Investors received custody of their CDs after purchase; and
• Antiguan liquidators believed that substantive consolidation was not warranted.

Additionally, even had Stanford implied that SIPC would protect the underlying value of the CDs, Mr. Harbeck stated that this had no impact on his analysis.  

Following the August 2009 Letter, a consortium of nearly fifty members of the U.S. Senate and House of Representatives sent a letter to then-SEC Chairwoman Mary Shapiro, requesting that the SEC take immediate action to order a liquidation proceeding of SGC and examine the possibility of extending SIPC coverage to Stanford victims.  Over the next two years, ten more letters (available here) followed from various members of Congress urging the SEC to expedite its review of the applicability of SIPC coverage.  At one point, United State Senator David Vitters (R., La.) threatened to block two nominees to the SEC until the agency released its decision.  (The SEC released its decision the next day).  

On June 15, the SEC issued its decision, finding that SGC had failed to meet its obligations to customers, and "that the statutory requirements for instituting a SIPA liquidation are met here." The main point of dispute centered on the interplay between SGC - a SIPC member - and Stanford International Bank - a non-SIPC member.  In the Stanford scheme, investors with accounts at SGC purchased SIBL CDs by depositing funds with SIBL.  SIPC had taken the position that coverage was not appropriate because investors purchased the CDs from SIBL, not SGC.  However, the SEC's analysis focused more on the substance of the transactions, rather than the form, in finding that disregarding the separate corporate form of the Stanford entities was appropriate.  Thus, by purchasing CDs from SIBL, customers were effectively depositing money with SGC.  The SEC also likened any result to the contrary as consistent with the goals of the fraudster, saying

Based on the totality of the facts and circumstances, the Commission has concluded that investors with brokerage accounts at SGC who purchased SIBL: CDs through SGC should be deemed to have deposited cash with SGC for purposes of SIPA coverage.  Doing otherwise on the facts of this case would elevate form over substance by honoring a corporate structure designed by Stanford in order to perpetrate an egregious fraud.

SIPC pledged to review the SEC's findings "as quickly as possible" and declared that it would provide a decision by September 15.  However, after September 15 came and went, SIPC Chairman Orlan Johnson issued a statement on September 16 stating that SIPC was "continuing its careful review" of the Stanford case and did not have a decision to announce.  

In response to SIPC's continuing silence, a group of Congressional members sent a letter on November 22, stating that "after more than 22 weeks, the Stanford victims and the American people want and deserve answers." In offering their assistance, the Representatives also noted that the lack of a final decision or satisfactory update on SIPC's progress by December 15th - six months after the SEC decision and three months after the SIPC board meeting - would result in the recommendation to the House Financial Services Committee for the intitiation of a formal inquiry into SIPC's handling of the matter.  SIPC has not issued a response to the letter.

The court-appointed receiver for the Stanford entities, Janvey, has been criticized for the failure to recover more assets for victims.  Indeed, a June filing by a group of Stanford investors accused Janvey's legal team and associated experts of collecting nearly all of the $120 million recovered to date in fees.  A federal judge later expressed his concerns that Janvey's search for additional resources was duplicative of ongoing efforts by the Department of Justice, and asked when a claims process might be instituted for victims.  Janvey recently filed papers seeking approval for a proposed claims process, although he declined to speculate as to the amount that investors could expect in an initial distribution. 

A decision by SIPC to provide coverage to Stanford victims, as urged by the SEC, would be a welcomed move. At present, the victims stand to receive pennies on the dollar for funds lost to Stanford's scheme.  However, a look at the effect of SIPC intervention in the Madoff proceeding shows that over 1/3 of the approximately 2,425 allowed claims were fully satisfied as a result of SIPC advances.  While such a system differs slightly from typical Ponzi proceedings where all victims are promised a pro rata share in any recovered proceeds, a SIPC-involved proceeding would aim to compensate each investor equally - at least up to the first $500,000 of losses.

A copy of the August 14, 2009 letter from SIPC to Janvey is here.

A copy of the SEC decision directing SIPC coverage is here.

A copy of the Congressional letters sent to the SEC in support of the decision on SIPC coverage is here.

A copy of the November 22, 2011 letter from Congress is here.

Judge: Cayman Islands Lawsuit Against Madoff Trustee is Void

A Bankruptcy Court Judge issued a strongly-worded order holding that a lawsuit recently filed in the Cayman Islands against the Madoff trustee was void and could not proceed any further.  Irving Picard, the court-appointed trustee for Bernard L. Madoff Investment Securities ("BLMIS"), sued Maxam Absolute Return Fund, Ltd ("Maxam"), seeking the return of nearly $100 million in fraudulent transfers made in the six years preceding the bankruptcy filing of BLMIS.  After answering that complaint, Maxam then filed an action in the Cayman Islands (the "Cayman Action") seeking a declaration that Maxam was not liable for the transfers.  According to Judge Lifland, that action is forbidden by the Bankruptcy Code and other federal laws, and constitutes a "clear attack on this Court’s exclusive jurisdiction and a blatant attempt to hijack the key issues to another court for determination."

While such an action would normally be allowed, the act of filing for bankruptcy triggered provisions in the Bankruptcy Code that forbid actions by third parties to recover or obtain assets in the bankruptcy estate. Specifically, section 362 of the Bankruptcy Code contains what is known as an "automatic stay" provision that forbids:

the commencement or continuation . . . of a judicial, administrative, or other action or proceeding against the debtor,” or “any act to obtain possession of . . . or to exercise control over property of the estate.

Additionally, BLMIS's membership in the Securities Investor Protection Corporation ("SIPC") resulted in the bankruptcy being subject to the provision of the Securities Investor Protection Act, which contains similar prohibitions.  In the Cayman Action, Maxam sought 

a declaration that Maxam Limited is not liable to the Trustee for either the $25 million Maxam Limited received from Maxam Fund within the period of 90 days prior to the Filing Date or any amounts in excess of the $25 million that Maxam Limited received from Maxam Fund within the period of two years prior to December 11, 2008.

However, according to Judge Lifland, the Bankruptcy Code and SIPA prevent such an action from continuing. Noting that Picard would be forced to essentially relitigate the merits of the clawback lawsuit, Judge Lifland opined that unneeded time, expenses and resources would be expended.  Additionally, the suit interferes with the Bankruptcy Court's exclusive jurisdiction over the property of Madoff's brokerage firm.  Finally, Judge Lifland also noted that the suit violated the Barton Doctrine, which is a judge-created rule that before a court-appointed receiver or trustee can be sued, the petitioning party must first seek leave of the court.  

Under Section 105 of the Bankruptcy Code, a Bankruptcy Court is granted equitable powers to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Code].” Noting the ramifications should each foreign individual or entity sued by Picard be permitted to seek relief in their own country, Judge Lifland utilized these powers by issuing an injunction preventing Maxam from continuing the Cayman Action.   

A copy of the Order is here.

Madoff Trustee Set to Make Initial $312 Million Distribution to Victims on Wednesday

Victims of Bernard Madoff's massive Ponzi scheme are set to receive their first distribution of funds recovered in the wake of the fraud on Wednesday, five days after the initial distribution date was delayed.  Irving Picard, the court-appointed trustee, had originally intended to make the distribution by September 30th to investors holding claims as of September 15th.  However, the distribution was delayed after a federal judge dismissed most of Picard's claims against several owners of the New York Mets last week.  Along with the dismissal of nearly all of Picard's claims, United States District Judge Jed S. Rakoff also made several rulings that could potentially threaten the magnitude of any future recoveries in the approximately 1,000 cases filed by Picard thus far. Ponzitracker covered Judge Rakoff's ruling in greater detail here.  In a statement late last week, Picard announced that out of an abundance of caution, his legal team was delaying the scheduled distribution to evaluate the impact of the rulings.

The majority of lawsuits filed by Picard have sought to "claw back" false profits from investors who withdrew more funds than they invested with Madoff.  Based partly in equity, this procedure seeks to pool all recovered funds and make pro rata distributions to all investors, rather than allowing some investors, usually those that were able to invest in the scheme earlier on, to keep their profits while ignoring others who had invested later and had not received as many purported interest payments to offset their principal investment losses.  Because of the duration of Madoff's scheme, which Picard argues spanned several decades, thousands of investors had accounts with Madoff.  Some who were fortunate to invest in the early days of the scheme have since recouped their original investment by many times.  Picard's largest single recovery to date comes from the estate of one of these early investors, Jeffrey Picower, who agreed to return over $7 billion of false profits received during his relationship with Madoff.  

In the ruling last week, Judge Rakoff dismissed nearly all of Picard's claims asserted against several principals of the New York Mets.  Picard had taken the rare step of not only asking for any false profits, but also for the return of the original principal investment, arguing that the mens' close relationship with Madoff and investing knowledge should have alerted them to the fraud.  Judge Rakoff's ruling severely limited Picard's reach, holding that a "Safe harbor" provision in the U.S. Bankruptcy Code forbade Picard from seeking any false profits received over two years from the date Madoff's brokerage filed for bankruptcy.  This safe harbor provision restricts a bankruptcy trustee's power to recover payments that are otherwise avoidable under the Bankruptcy Code, and represents the interplay between bankruptcy and securities law.  While Picard had argued that the "safe harbor" provision did not apply, Judge Rakoff held otherwise.  

In his statement issued today, Picard stated that additional settlements had allowed him to increase the amount of the initial distribution from $272 million to $312 million.  This distribution would account for roughly 4.6% of allowed investor losses.  Picard also stated that the total funds recovered for victims thus far had increased to $8.694 billion - approximately 50% of the $17.3 billion amount Picard had estimated was lost by Madoff's victims.  Of the nearly $2.4 billion available for distribution, most remains tied up by pending litigation.  

Investors with allowed claims have also received over $700 million in total cash advances from the Securities Investor Protection Corporation ("SIPC"), a federally-mandated non-profit that protects investors if a broker-dealer fails.  Nearly all broker-dealers registered with the Securities and Exchange Commission are members of SIPC.  Under SIPC guidelines, investors holding securities or cash in accounts of failed broker-dealers are entitled to receive up to $500,000 in cash advances to cover their losses.

A copy of the Statement issued today by the Trustee is here.

JP Morgan Files Brief in Support of Effort to Dismiss Madoff Trustee's Case

JP Morgan filed a strongly-worded reply in support of its effort to win dismissal of Madoff trustee Irving Picard's suit seeking billions from the bank.  In a September 16th filing, JPMorgan ("JPM") argued not only that Picard was "mistaken" in bringing the claims, but that his rationale was contrary to established legal precedent and was "clearly wrong".  Picard is currently seeking nearly $20 billion in damages from JPM, claiming that their longstanding banking relationship with Madoff both lent an air of legitimacy to the scheme and further allowed Madoff to continue defrauding victims despite numerous red flags.  While he initially sought $5.4 billion, Picard later tripled the amount sought in an amended complaint, asserting numerous common law claims.  

JPM is quick to point out that Picard's approach in seeking damages from various financial entities associated with Madoff based on common law theories has not been well received, most recently in Judge Jed Rakoff's dismissal of similar claims asserted against HSBC.  The crux of Judge Rakoff's reasoning, and unsurprisingly strongly asserted by JPM, rested in the premise that a bankruptcy trustee, who stands in the shoes of the debtor, cannot simultaneously bring claims on behalf of creditors.  As JPM states, 

Since the Supreme Court’s decision in Caplin v. Marine Midland, 406 U.S. 416 (1972), it has been settled law that a trustee for a bankrupt corporation does not have power to assert claims belonging to the debtor’s creditors. 

In his Response to JPM's Motion to Dismiss, Picard had stated that his authority to pursue claims against JPM stemmed from Section 544(a) of the Bankruptcy Code, which endows a trustee with the rights of a “creditor that extends credit to the debtor at the time of the commencement of the case.” 11 U.S.C. § 544(a).  However, such a grant of rights does not equate to a carte blanche to pursue claims that, according to JPM, rest solely with third-party creditors.  As JPM so eloquently states, Picard does not represent the interests of third-party creditors, but rather, "stands in the shoes of a thief."  

JPM also reverts to its original claim that Picard had failed to sufficiently plead his claims above the required legal standard, pointing to the "massive gap between the Trustee’s blustering accusations and the facts that he has actually alleged to support them. Despite taking extensive pre-trial discovery, the Trustee has still completely failed to allege facts showing that any individual at JPMorgan had actual knowledge of Madoff’s fraud."  In doing so, JPM highlights the increasingly heightened standard in which financial institutions can be held liable for fraud committed by customers.  Courts have increasingly adopted an "actual knowledge" standard, rather than what an institution should have known based on the presence of red flags.

Finally, JPM contests Picard's claim that a trustee appointed under the Securities Investor Protection Act ("SIPA") has even greater powers than a trustee proceeding under the United States Bankruptcy Code.  In doing so, JPM argues that nothing provides Picard with authority for such an interpretation, and cites Judge Rakoff's rationale in the recent HSBC decision that "the Trustee’s powers are cabined by Title 11, and SIPA conveys no authority to a SIPA trustee to bring the common law claims here in issue.”  

With this filing, absent the request by Picard to file a sur-reply, briefing of the issue is now complete.  A hearing may also be scheduled before United States District Judge Colleen McMahon, who is overseeing the case.  

JPMorgan's Reply in Support of its Motion to Dismiss is here.

The Amended Complaint filed against JPMorgan is here.

SIPC Files Motion Opposing Wilpon Efforts to Dismiss Case

The Securities Investor Protection Corporation ("SIPC") filed documents opposing an effort by Sterling Equities, consisting of owners of the New York Mets baseball team, to dismiss trustee Irving Picard's suit seeking $1 billion transferred by Bernard Madoff. During a hearing on July 1 in New York federal court, United States District Judge Jed S. Rakoff questioned the viability of Picard's approach, which seeks not only to recover the $300 million in false profits above Sterling's initial investment, but also the $700 million of initial principal on the notion that the Mets' owners knew or should have known of the fraud through their extensive dealings and relationship with Madoff.  SIPC is in agreement with Picard that a reading of bankruptcy law permits the trustee's approach.

The vast majority of actions filed by Picard have sought only fictitious profits above and beyond an investor's initial principal.  This course of action is pursuant to Section 548(c) of the Bankruptcy Code, which states that a transferee who receives funds that would otherwise be subject to avoidance under the Code is entitled to retain those fund when the transferee gives value and the transfer is taken in good faith.  Picard has not pursued such a position in nearly all of his lawsuits, instead seeking the return of profits from so called "net winners" of Madoff's scheme for pro rata distribution to defrauded investors aptly termed "net losers."

Picard alleges that Sterling Equities and its principals should have been alerted to the nature of Madoff's scheme through numerous red flags and warning signs.  Additionally, their involvement in litigation seeking the return of principal and fictitious profits from an investment in the Bayou Superfund, which was later revealed to be a massive Ponzi scheme, should have also alerted Sterling to Madoff's fraud.  Instead, as Picard and SIPC allege, the profitable nature of the relationship with Madoff caused the Sterling defendants to ignore these warnings.  As SIPC states,  

The long-term nature of the relationship and its scope enabled the Defendants to gain insight into Madoff and his operations. In the face of such knowledge, the actions of the Defendants, as alleged in the Complaint, are proof of the Defendants’ lack of good faith, and their inability, therefore, to establish good faith as a defense to the Trustee’s fraudulent conveyance claims against them. 

A copy of SIPC's Motion Opposing the Sterling Defendant's Motion to Dismiss is here.