SIPC Response To SEC Motion To Show Cause

Case 1:11-mc-00678-RLW Document 23
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IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLUMBIA ) ) ) ) ) ) ) ) ) ) )
Securities and Exchange Commission, Applicant, v. Securities Investor Protection Corporation, Respondent.
MISC. NO. 11-MC-678-RLW [STATUS CONFERENCE SCHEDULED FOR MARCH 5, 2012]
SECURITIES INVESTOR PROTECTION CORPORATIONS BRIEF IN OPPOSITION TO SECS APPLICATION FOR ORDER UNDER 15 U.S.C. 78ggg(b)
Eugene F. Assaf, P.C. (D.C. Bar # 449778) Edwin John U (D.C. Bar #464526) John OQuinn (D.C. Bar # 485936) Elizabeth M. Locke (D.C. Bar # 976552) Michael W. McConnell (admitted pro hac vice) Susan Marie Davies (admitted pro hac vice) KIRKLAND & ELLIS LLP 655 Fifteenth Street, N.W., Suite 1200 Washington, DC 20005 Tel: (202) 879-5000 Fax: (202) 879-5200 eugene.assaf@kirkland.com edwin.u@kirkland.com john.oquinn@kirkland.com
Josephine Wang (D.C. Bar #279299) General Counsel Securities Investor Protection Corporation 805 Fifteenth Street, N.W. Washington, D.C. 20005 Tel: (202) 371-8300 jwang@sipc.org
February 16, 2012
TABLE OF CONTENTS Page INTRODUCTION ...........................................................................................................................1 BACKGROUND .............................................................................................................................4 ARGUMENT ...................................................................................................................................5 I. The SECs Application Should Be Denied. .........................................................................5 A. B. Under Section 78ggg(B), the SEC Has the Burden to Show SIPC Has Failed to Discharge Obligations to Customers of a Member. .......................6 Protected Customers Within the Meaning of SIPA Are Only Those Who Have Cash or Securities in the Custody Of a Member Brokerage Firm. .............9 1. 2. 3. 4. C. To Qualify as a Customer, SIPA Requires an Investor to Have Entrusted Cash or Securities with a Broker When It Failed...................10 SIPA Determines Customer Status Based on What a Member Was Supposed To Be Holding on Deposit at the Time It Failed. ..............11 SIPA Does Not Protect Against Investment Fraud. ...................................12 SIPA Does Not Protect The Value of Investments. ...................................12
The SEC Has Not Made the Requisite Showing That SIPC Has Failed to Discharge Its Obligations to Customers of a SIPC Member. ......................14 1. 2. 3. 4. 5. SIBL Was an Offshore BankNot a Registered Broker Dealer. ..............14 Investors Deposited Funds With the Offshore Bank and Clearly Had the Purpose of Purchasing SIBL CDs. ...............................................16 Investors Received Custody of Their SIBL CDs. ......................................18 Once a Customer Does Not Mean Always a Customer. .....................20 Ponzi Schemes Do Not Alter the Customer Analysis. ...........................20
D. E. II.
SIPAs Text Demonstrates That Corporate Formalities Matter. ...........................22 Old Naples and Primeline Are Distinguishable. ....................................................27
Limited Discovery Is Necessary and Appropriate Given the SECs Theory.....................29 A. SIPC Seeks Limited and Expedited Discovery. .....................................................29
B.
The Burden on the SEC In Producing This Material Is Minimal. .........................31
CONCLUSION ..............................................................................................................................38 CERTIFICATE OF SERVICE ......................................................................................................39
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TABLE OF AUTHORITIES Page Cases Ad Hoc Metals Coalition v. Whitman, 227 F. Supp. 2d 134 (D.D.C. 2002) .......................................................................................... 34 Anderson v. Liberty Lobby, Inc., 477 U.S. 242 (1986) ............................................................................................................ 21, 31 Arford v. Miller, 239 B.R. 698 (Bankr. S.D.N.Y. 1999) ...................................................................................... 10 Cmty. Sav. & Loan Assn v. Fed. Home Loan Bank Bd., 68 F.R.D. 378 (E.D. Wis. 1975) ................................................................................................ 35 Fund for Animals v. Williams, 391 F. Supp. 2d 191 (D.D.C. 2005) .......................................................................................... 34 Fundora v. Stanford Intl Bank Ltd., Claim No. ANUHCV 0126 of 2009 (E. Caribbean Sup. Ct., Antigua & Barbuda, Apr. 17, 2009).............................................. 25, 27 Holcomb v. Powell, 433 F.3d 889 (D.C. Cir. 2006) ............................................................................................ 21, 31 In re Adler, Coleman Clearing Corp., 216 B.R. 719 (Bankr. S.D.N.Y. 1998) ........................................................................................ 8 In re Aozora Bank Ltd., No. 11-5683, 2012 WL 28468 (S.D.N.Y. Jan. 4, 2012)...................................................... 21, 23 In re Atkeison, 446 F. Supp. 844 (M.D. Tenn. 1977) .................................................................................. 13, 16 In re Bell & Beckwith, 124 B.R. 35 (Bankr. N.D. Ohio 1990) ...................................................................................... 11 In re Brentwood Sec., Inc., 925 F.2d 325 (9th Cir. 1991) ..................................................................................... 9, 10, 12, 16 In re Brentwood Sec., Inc., 96 B.R. 1002 (B.A.P. 9th Cir. 1989) ........................................................................................... 8 In re Carolina First Sec. Grp., Inc., 173 B.R. 884 (Bankr. M.D.N.C. 1994) ..................................................................................... 26
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In re First Sec. Grp. of Cal., No. 94-56706, 1996 WL 92115 (9th Cir. Mar. 4, 1996) ........................................................... 26 In re Klein, Maus & Shire, Inc., 301 B.R. 408 (Bankr. S.D.N.Y. 2003) .................................................................................. 9, 12 In re Monitor Single Lift I, Ltd., 381 B.R. 455 (Bankr. S.D.N.Y. 2008) ...................................................................................... 27 In re MV Sec., Inc., 48 B.R. 156 (Bankr. S.D.N.Y. 1985) .......................................................................................... 9 In re New Times Sec. Servs., Inc., 463 F.3d 125 (2d Cir. 2006) .......................................................................................... 20, 21, 23 In re Old Naples Sec., Inc., 223 F.3d 1296 (8th Cir. 2000) ............................................................................................. 27, 28 In re Omni Mut., Inc., 193 B.R. 678 (S.D.N.Y. 1996) .................................................................................................... 9 In re Primeline Sec. Corp., 295 F.3d 1100 (10th Cir. 2002) ........................................................................................... 27, 28 In re Stalvey & Assocs., Inc., 750 F.2d 464 (5th Cir. 1985) ............................................................................................... 11, 20 In re: Lehman Bros. Inc., No. 08-01420 (Bankr. S.D.N.Y. Oct. 21, 2011)........................................................................ 36 JP Morgan Chase Bank v. Altos Hornos de Mexico, S.A. de C.V., 412 F.3d 418 (2d Cir. 2005) ...................................................................................................... 26 Kent Cnty., Delaware Levy Court v. EPA, 963 F.2d 391 (D.C. Cir. 1992) .................................................................................................. 34 Leocal v. Ashcroft, 543 U.S. 1 (2004) ...................................................................................................................... 13 Liberty Prop. Trust v. Republic Props. Corp., 577 F.3d 335 (D.C. Cir. 2009) .................................................................................................. 24 Natl Courier Assn v. Bd. of Governors of the Fed. Reserve Sys., 516 F.2d 1229 (D.C. Cir. 1975) ................................................................................................ 34 NRDC v. Train, 519 F.2d 287 (D.C. Cir. 1975) .................................................................................................. 34
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Occidental Petroleum Corp. v. SEC, 873 F.2d 325 (D.C. Cir. 1989) .................................................................................................. 35 Pardo v. Wilson Line of Wash., Inc., 414 F.2d 1145 (D.C. Cir. 1969) ................................................................................................ 24 Roland v. Green, No. 3:10-cv-00224 (N.D. Tex. Aug. 31, 2011) ......................................................................... 34 San Luis Obispo Mothers for Peace v. NRC, 751 F.2d 1287 (D.C. Cir. 1984) ................................................................................................ 35 SEC v. F. O. Baroff Co., Inc., 497 F.2d 280 (2d Cir. 1974) ...................................................................................................... 10 SEC v. Howard Lawrence & Co., 1 Bankr. Ct. Dec. (CRR) 577 (S.D.N.Y. 1975) ......................................................................... 12 SEC v. Kenneth Bove & Co., 378 F. Supp. 697 (S.D.N.Y. 1974) ............................................................................................ 10 SEC v. Packer, Wilbur & Co., 498 F.2d 978 (2d Cir. 1974) ...................................................................................................... 12 SEC v. S.J. Salmon & Co., 375 F. Supp. 867 (S.D.N.Y. 1974) ............................................................................................ 13 SEC v. Sec. Planners Ltd., 416 F. Supp. 762 (D. Mass. 1976) ............................................................................................ 11 Seed Co., Ltd. v. Westerman, Civ. A. No. 08-0355, 2012 WL 28521 (D.D.C. Jan. 5, 2012) .................................................. 31 SIPC v. Barbour, 421 U.S. 412 (1975) ................................................................................................ 10, 16, 20, 23 SIPC v. Vigman, 803 F.2d 1513 (9th Cir. 1986) ................................................................................................... 12 United States v. Menasche, 348 U.S. 528 (1955) .................................................................................................................. 13 Valley Fin. Inc. v. United States, 629 F.2d 162 (D.C. Cir. 1980) .................................................................................................. 24 Victrix Steamship Co., S.A. v. Salen Dry Cargo A.B., 825 F.2d 709 (2d Cir. 1987) ...................................................................................................... 27
Rules and Statutes 11 U.S.C. 510(b) ........................................................................................................................ 22 15 U.S.C. 78aaa et seq. ....................................................................................................... passim Other Authorities H. Minnerop, The Role and Regulation of Clearing Brokers, 48 The Business Lawyer, May 1993 ......................................................................................... 19 H.R. Rep. No. 91-1613, 91st Cong., 2d Sess. ............................................................................... 17 Rules Fed. R. Civ. P. 11(b) ..................................................................................................................... 36 Fed. R. Civ. P. 30(b)(6)................................................................................................................. 36
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INTRODUCTION The SECs Application should be denied as a matter of law because there is no basis for requiring SIPC to guarantee the value of investments with entities who are not members of the Securities Investor Protection Corporation (SIPC)and a contrary ruling would rewrite what it means to be an eligible customer of a member as those terms are defined under the Securities Investor Protection Act (SIPA), 15 U.S.C. 78aa, et seq. As a factual matter, the
SECs Application also should be denied for the straightforward reason that it has failed to provide competent, admissible evidence establishing that there are any eligible customers of a member under the facts of the Stanford case. Despite the SECs manifest effort to avoid testing the facts on this score, it is the SEC, not SIPC, that bears the burden of proving its entitlement to relief under 15 U.S.C. 78ggg(b), especially when the facts thus far indicate that SIPA does not even permitmuch less requirethe initiation of a liquidation for purchasers of the offshore bank Certificates of Deposit (CDs) at issue here. None of the points that the SEC advances in favor of its position is right on the law, and all of them at least require targeted discovery to develop a record from which to conduct meaningful judicial review. Under these circumstances, the SECs liquidate first, ask questions later approach should be rejected. As an initial matter, the SECs Application proceeds from an incorrect premise by ignoring its burden of proof and instead demanding that SIPC prove the negative by showing why a liquidation should not be started. The problem for the SEC, however, is that the statute vests SIPC with the authority to make the determination whether to seek a liquidation under the facts of each case, and SIPC has explained since 2009 why the statute does not apply under the facts of the Stanford fraud. As Part I.A of this brief explains, it is the SEC that comes to this Court demanding the reversal of that outcome by applying for an order under section 78ggg(b),
and thus the SEC must demonstrate that it is entitled to such relief. (Feb. 9, 2012 Mem. Op. (Dkt. 21) at 11.) Moreover, the SECs Application must be denied on the existing record because the SEC has not come forward with evidence establishing that there are any eligible customers of a member for whom SIPC is even authorizedmuch less requiredto seek a liquidation. As Parts I.B and I.C explain, both section 78ggg(b) (the provision requiring the SEC to come to this Court) and section 78eee(a)(3)(A) (the provision guiding SIPCs determination whether to seek a liquidation) turn on the existence of eligible customers of a SIPC member brokerage firmto support a finding that SIPC has failed to discharge its obligations under the statute. What that means here is that the SEC must show that Stanford Group Company (SGC)a SIPC-member brokerage firmwas holding a persons cash or securities as part of a custodial function, when SGC went into receivership in 2009. The record thus far shows the opposite. It is no answer for the SEC to claim that its theory is different by pointing to immaterial facts and then claiming that those facts are undisputed. As Parts I.D and I.E explain, the problem for the SEC is that its theory overlooks the focus on eligible customers of a member that SIPC must find to exist in deciding if a liquidation can be sought. For example, while the SEC places great emphasis on the fact that Allen Stanfords business operated in an interconnected manner, there is no basis for using an alter-ego theory to make an unrelated third partySIPCliable for the obligations of non-members (such as related banks or foreign investment advisors) in addition to the obligations of member brokerage firms. The SEC itself has emphasized that it had no authority to regulate Stanford International Bank, Ltd. (SIBL) in Antigua because it was a distinct legal entity from SGC in the U.S., and that distinction confirms the inconsistency in the SECs demand for SIPA coverage here.
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All of this underscores that the parties disputes raise intensely factual issues. Even if the SECs Application is to be given further consideration, targeted discovery is the least that due process requires to test whether there are, in fact, any eligible customers of a member, where their CDs were delivered, whether SGC and SIBL were separate or the same, and what facts supported the SEC Staffs initial determination that there was no SIPA coverage in the Stanford case. The SECs Application does not resolve any of these factual questions. As discussed in Part II, nor may the SEC rely upon selective evidence presented in its June 15, 2011 Analysis and its December 12, 2011 Application, while depriving the parties and the Court of anything else that bears on whether SIPA applies. That is not say that the Court has to adjudicate the claims of thousands of individual investors: the key point here is that the SEC has steadfastly refused to present admissible evidence that there are any covered customers within the specialized definition that SIPA places on that term. While the SECs Application should be denied as a matter of law for the reasons stated above, SIPC alternatively requests targetedand expediteddiscovery limited to approximately 5-10 requests for admissions, 5-10 document requests, 5-10 interrogatories, and focused depositions of the handful of would-be customers and examiners the SEC presumably can proffer in support of its case. The federal court order appointing the SEC Receiver requires him to [p]romptly provide the [SEC] and other governmental agencies with all information and documentation they may seek in connection with its regulatory or investigatory activities underscoring that the SEC readily has the ability to provide this information quickly. Critically, these are issues for now, not later. The SECs own Inspector General has noted that liquidations cost literally tens of million of dollars, and the SEC itself conceded during the January 24, 2012 hearing that liquidations are very hard to unwind. (Jan. 24, 2012 Hrg
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Tr. (Ex. 1) 8:17-18.) It is neither necessary nor appropriate to send this case to a different court, especially when section 78ggg(b) requires this Court, and none other, to determine whether SIPC has failed to discharge its obligationsand yet there is no competent, admissible evidence showing there are any eligible customers of a member requiring the initiation of a liquidation in the Stanford case. BACKGROUND Beginning as early as 1997, the SEC had every reason to know that Allen Stanford and his companies were engaged in a Ponzi scheme by selling offshore CDs issued by SIBL in Antigua. (Mar. 31, 2010 Report of Investigation, SEC, Office of Inspector General,
Investigation of the SECs Response to Concerns Regarding Robert Allen Stanfords Alleged Ponzi Scheme (Mar. 31, 2010 OIG Report) (Ex. 2) at 16-17, 149.) Fourteen years later, on February 16, 2009, the SEC filed an enforcement action against Stanford and others, charging the defendants with a massive, ongoing fraud. (See SEC v. Stanford, No. 09-0298, Compl. 1 (N.D. Tex. Feb. 16, 2009).) At the SECs request, the court appointed a receiver, Ralph S. Janvey (the SEC Receiver), to oversee the liquidation of Stanfords assets. By that time, the CDs had lost all or nearly all of their value. (See Aug. 12, 2009 Letter from R. Janvey to SIPC at 1-2, available at http://www.stanfordfinancialreceivership.com/documents/SIPC_ltr_with_
exhibits.PDF.) On August 12, 2009, the SEC Receiver asked SIPC for its position as to whether SIPA applied to the Stanford case. (Id.) SIPC responded in writing two days later with a copy to the SEC staff, explaining that there is no basis for SIPC to initiate a proceeding under SIPA, because the statute does not cover investments with an offshore bank that is not a SIPC-member firm. (Aug. 14, 2009 Letter from S. Harbeck to R. Janvey (Ex. 3) at 3.) The SEC did not dispute SIPCs analysis at the time. To the contrary, the SECs own General Counsel at the time agreed 4
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with the analysis. (Sept. 16, 2011 Report of Investigation, SEC, Office of Inspector General, Investigation of Conflict of Interest Arising from Former General Counsels Participation in Madoff-Related Matters (excerpts attached as Ex. 4) at 10, 111-12 & n.95.) Over two years after commencing the Stanford case, but only one day after a U.S. Senator threatened to block confirmation of two SEC Commissioners, the SEC asserted for the first time that investors who had purchased these Antiguan bank CDs were entitled to protection under the statute.1 Consistent with the analysis previously provided to the SEC Receiver in August 2009, the SIPC Board of Directors reaffirmed after careful review in October 2011 that SIPA did not authorize the initiation of a liquidation under the facts of the Stanford case. On December 12, 2011, the SEC filed an Application in this Court, demanding an Order requiring SIPC to initiate a liquidation. (See Dec. 12, 2011 SEC Application (Dkt. 1) at 1.) Pursuant to the Courts February 9, 2012 Order (see Dkt. 22), SIPC respectfully submits this response to the SECs Application. ARGUMENT I. THE SECS APPLICATION SHOULD BE DENIED. As this Court observed in its February 9 decision, section 78ggg(b) requires the SEC to prove that SIPC has refused to commit its funds or otherwise to act for the protection of customers of any SIPC member, such that it can be ordered to discharge its obligations under the statute. (Feb. 9, 2012 Mem. Op. (Dkt. No. 21) at 11-13.) The SEC cannot make that showingas it must do under section 78ggg(b)for the simple reason that it has not and cannot put forward competent, admissible evidence that there are any eligible customers of a SIPC
1
(See Exhibit 2 to Dec. 12, 2011 M. Martens Decl. (Dkt. 1-1) (June 15, 2011 Analysis) at 1; June 14, 2011 Senator D. Vitter Press Release, available at http://www.vitter.senate.gov/public/index.cfm?Fuse Action=PressRoom.PressReleases&ContentRecord_id=8f2e65df-802a-23ad-458d-e0eb0391d4ef&Region _id=&Issue_id= (Vitter to Block SEC Nominees Until Stanford Victims Get Answers).)
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member within the specialized meaning that SIPA places on those terms. Accordingly, this Court should deny the SECs Application. A. Under Section 78ggg(B), the SEC Has the Burden to Show SIPC Has Failed to Discharge Obligations to Customers of a Member.
As a threshold matter, the plain text of section 78ggg(b) requires the SEC to show that there are eligible customers of a member of SIPC under the facts of a given case, and that SIPC has refused to discharge its obligations to them. Section 78ggg(b states in its entirety: In the event of the refusal of SIPC to commit its funds or otherwise to act for the protection of customers of any member of SIPC, the Commission may apply to the district court of the United States in which the principal office of SIPC is located for an order requiring SIPC to discharge its obligations under this chapter and for such other relief as the court may deem appropriate to carry out the purposes of this chapter. 15 U.S.C. 78ggg(b). There can be no doubt that in light of this text, and as the party that initiated this action and seeks affirmative relief under section 78ggg(b), the SEC bears the burden of proving that it is entitled to what it demands in this case. Indeed, by its very terms, the SECs Application seeks to compel SIPC to initiate a liquidation even though SIPC itself (including its presidentially-nominated, Senate-confirmed board) has concluded that the statute does not even allow a liquidation under the facts of the Stanford case.2 As the Court correctly noted in its Memorandum Opinion, nothing in SIPA creates an obligation for SIPC to start a liquidation proceeding simply because the SEC has made a determination that one should be brought. (See Feb. 9, 2012 Mem. Op. (Dkt. 21) at 11 (This determination must be made by the Court, not unilaterally by the SEC.).) Rather, as the Court noted, [t]he use, plain meaning and context of apply in Section 78ggg(b), in contrast to the use of require elsewhere in SIPA,
SIPCs Board of Directors is comprised of five Senate-confirmed presidential appointees and one representative each from Treasury and the Federal Reserve. See 15 U.S.C. 78ccc(c).
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strongly suggests that Congress intended that the SEC must demonstrate that it is entitled to relief. (Id. (emphasis added).) It is therefore not enough to say that SIPC has refused to commit funds in the abstract without regard to whether there are customers of a member at issue: First, the phrase for the protection of customers of any member of SIPC in section 78ggg(b) necessarily modifies both a refusal to commit funds and a refusal to actor else the statutes use of the word otherwise would have no meaning in drawing a parallel between the two. Second, the statute itself discusses the commitment of funds in section 78fff-3, and likewise refers to Advances for Customers Claims without requiring SIPC to pay monies just on the SECs say-so. Third, if any refusal to commit funds whatsoever entitled the SEC to relief (an argument that not even the SEC makes in its Application), then section 78ggg(b) would have no limiting effect differentiating it from other provisions of SIPAlike sections 78ccc(e)(3) and 78ggg(c)(1)that allow the SEC to require certain SIPC action such as adopting a bylaw or submitting periodic reports. As the Court observed in its February 9, 2012 ruling, the distinction makes a difference. Finally, to initiate a liquidation proceeding under section 78eee(a)(3)(A), SIPA requires the existence of eligible customers of a SIPC member, 15 U.S.C. 78eee(a)(3)(A) (SIPC may, upon notice to a member of SIPC, file an application for a protective decree if SIPC determines that(A) the member has failed or is in danger of failing to meet its obligations to customers. (emphasis added)), because the very purpose[] of such a liquidation is to deliver customer name securities and customer property and to satisfy net equity claims of customers, id. 78fff (emphasis added). SIPA does not authorizemuch less obligateSIPC to pay anyone regardless of whether the statute covers them. In addition, the statute vests SIPC, not the SEC, with the power to make the determination whether a liquidation proceeding should begin. Section 78eee makes this clear: SIPC may, upon notice to a member of SIPC, file an application for a protective decree with any court of competent jurisdiction , if SIPC determines that (A) the member has failed or is in danger of failing to meet its obligations to customers . Id. 78eee(a)(3)(A) (emphasis added). If the SEC wishes to overturn SIPCs determination, it must prove that each of the elements of its 78ggg(b) claim for relief are met. And to do that,
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the SEC logically must show how SIPC has failed to discharge its obligations under SIPA by refus[ing] . . . to commit its funds or otherwise to act for the protection of customers of any member of SIPC. Id. 78ggg(b). Indeed, it would be particularly inappropriate to require SIPC to prove the negative as to why a liquidation should not be initiated when the SEC has control over its record and wheneven without the benefit of discovery or other formal processthe facts that SIPC has uncovered show that investors in SIBL CDs do not qualify for SIPA protection.3 The SEC, as a regulator, has access to the facts. It must produce the relevant facts. SIPC has no regulatory authority and thus does not have access to the SECs fact-finding hereabsent discovery. See 15 U.S.C. 78eee(a)(1) (requiring the SEC and any self-regulatory organization to immediately notify SIPC of facts relevant for SIPC to determine whether to bring a liquidation). All of this underscores why it is not enough, for example, for the SEC to say there are colorable customer claims that may or may not exist (Dec. 12, 2011 SEC Application (Dkt. 1) at 1), or that there is a customer need to determine whether this is so (Dec. 12, 2011 SEC Mem. in Supp. of Application (Dkt. 1) at 11). Rather, these are threshold questions that section
This is precisely why in the ordinary course the investors themselves bear the burden of proving that they are covered customers under SIPA. See, e.g., In re Adler, Coleman Clearing Corp., 216 B.R. 719, 723 (Bankr. S.D.N.Y. 1998) (emphasizing that claimants must prove that they are customers and that the equity in their accounts is customer property under SIPA); In re Brentwood Sec., Inc., 96 B.R. 1002, 1006 (B.A.P. 9th Cir. 1989) (noting the investors burden of proving that he was a customer . . . with respect to each claim made and therefore entitled to SIPA protection). The party seeking relief must necessarily already haveand be able to come forward withthe evidentiary basis for its affirmative request for relief. It should be noted that, although the question whether an investor is a customer under SIPA and is thus eligible for protection may be adjudicated in the liquidation, that adjudication occurs only after SIPC has determined that there are customers in need of, and eligible for, SIPA protection and therefore, grounds exist to start a liquidation proceeding. Inevitably, once the proceeding is begun, many ineligible claimants will file claims seeking customer status. In that context, the question of customer status will be litigated in the liquidation proceeding. However, that is a very different situation from the one presented herenamely, whether customers exist, in the first instance, whom SIPC can protect under SIPA. The latter question is one that Congress has required this Court to decide under section 78ggg(b).
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78ggg(b) requires this Court to answer, especially when the statute does not authorize a liquidation where the SEC has failed to identify any eligible customers in the Stanford case. B. Protected Customers Within the Meaning of SIPA Are Only Those Who Have Cash or Securities in the Custody Of a Member Brokerage Firm.
As an initial matter, SIPA does not define customers to include anyone who ever invested through a member brokerage firm, and instead limits that term to those who entrusted cash or securities with the brokerage at the time it failed. Put another way, because the statute protects only a brokerages lockbox function (for example, if a broker is supposed to holding a persons stock certificates but then runs away), only persons who are supposed to have something in the lockbox qualify as customers under the statute. In particular, the statute states that a customer: 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. 15 U.S.C. 78lll(2)(A) (emphasis added). A customer also includes any person who has deposited cash with the debtor for the purpose of purchasing securities. Id. 78lll(2)(B). The customer definition was carefully crafted, precisely delineating the categories of investors it protects, In re Brentwood Sec., Inc., 925 F.2d 325, 327 (9th Cir. 1991), and it must consequently be construed narrowly, In re Omni Mut., Inc., 193 B.R. 678, 680 (S.D.N.Y. 1996); see also In re Klein, Maus & Shire, Inc., 301 B.R. 408, 418 (Bankr. S.D.N.Y. 2003) (The courts have consistently taken a restrictive view of the definition of a customer under SIPA and, accordingly, the burden is not easily met.); In re MV Sec., Inc., 48 B.R. 156, 160 (Bankr. S.D.N.Y. 1985).
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1.
To Qualify as a Customer, SIPA Requires an Investor to Have Entrusted Cash or Securities with a Broker When It Failed.
Courts have repeatedly emphasized that the relevant inquiry is whether a SIPC-member brokerage was entrusted to hold in its custody cash or securities on deposit when it failed. See SIPC v. Barbour, 421 U.S. 412, 412 (1975). [T]he term customer in the Act is to be read as embracing only one who has entrusted securities to a broker for some purpose connected with participation in the securities markets. SEC v. Kenneth Bove & Co., 378 F. Supp. 697, 700 (S.D.N.Y. 1974) (quoting SEC v. F. O. Baroff Co., Inc., 497 F.2d 280, 283 (2d Cir. 1974)); see also Arford v. Miller, 239 B.R. 698, 701 (Bankr. S.D.N.Y. 1999). In SEC v. Kenneth Bove & Co., for example, the court held that several claimants were not SIPA customers because they had delivered their securities to a second firm at their SIPC-member brokers request. 378 F. Supp. at 699. Although the claimants argued that they had been instructed by their broker to deposit securities with the second firm, and that therefore there was constructive delivery to the Debtor, the court found this irrelevant: Whether or not any such instructions were given, it is clear that compliance with such instructions would not result in receipt, acquisition or holding of the securities by the Debtor in the evident sense required by the Actthat is, an actual possession. Id. at 700; see also id. (Whatever may be the merit of a constructive delivery argument in other litigated contexts, it does not meet the sine qua non of the protection of the Act, namely, the possible loss of securities actually entrusted to a debtor forced into liquidation.). Similarly, in Brentwood Securities, the court held that claimants were not customers because, although they gave checks to their broker with the intent to purchase securities, those checks were made out to the issuer. In re Brentwood Sec., 925 F.2d at 327-28.
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2.
SIPA Determines Customer Status Based on What a Member Was Supposed To Be Holding on Deposit at the Time It Failed.
This determination, moreover, must be made at the time the member firm is placed into receivership or becomes insolvent: it does not include everyone who ever gave cash or securities to a broker-dealer at some point in the past. In In re Stalvey & Associates, Inc., for example, the Fifth Circuit expressly rejected the notion of once a customer, always a customerconcluding that an investor who previously placed securities on deposit with a broker ceased to be a customer under SIPA once he pledged those securities as collateral for a bank loan, because doing so meant that the broker was no longer supposed to be holding those securities for the investors safekeeping. 750 F.2d 464, 470-72 (5th Cir. 1985). An investors customer status in the course of some dealings with a broker will not confer that status upon other dealings, no matter how intimately related, unless those other dealings also fall within the ambit of the statute. Id. at 471; see also SEC v. Sec. Planners Ltd., 416 F. Supp. 762, 765 (D. Mass. 1976) (The definition of customer indicates a Congressional purpose to provide relief similar to a preference only to the clients of the brokerage firm who have entrusted property to the brokerage firm as of the filing date. (quotation marks omitted; emphasis added)); see also In re Bell & Beckwith, 124 B.R. 35, 36 (Bankr. N.D. Ohio 1990). This makes sense: because SIPA protects only the cash or securities that a brokerage is holding for a person when it fails, it does not entitle someone who buys and receives stock from a broker in 2006 to recoup the original purchase price just because the stock becomes worthless in 2009 or the broker later fails after delivering stock to that person. independent reasons. This is so for two separate and
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3.
SIPA Does Not Protect Against Investment Fraud.
First, SIPA does not protect against investment loss, fraud, or misrepresentationeven on the part of broker-dealers. See, e.g., In re Brentwood Sec., 925 F.2d at 330 (SIPA protects investors when a broker holding their assets becomes insolvent. It does not comprehensively protect investors from the risk that some deals will go bad or that some securities issuers will behave dishonestly.); SEC v. Packer, Wilbur & Co., 498 F.2d 978, 983 (2d Cir. 1974) (SIPA was not designed to provide full protection to all victims of a brokerage collapse.). As courts interpreting SIPA have consistently made clear, claims for damages resulting from a brokers misrepresentations, fraud or breach of contract are not protected. In re Klein, Maus & Shire, 301 B.R. at 421; see also SEC v. Howard Lawrence & Co., 1 Bankr. Ct. Dec. (CRR) 577, 579 (S.D.N.Y. 1975) (SIPA does not protect customer claims based on fraud or breach of contract.). Damages sustained from a brokers fraud or misrepresentation accordingly give rise to claims only as a general creditor, not as a SIPA customer. See, e.g., SIPC v. Vigman, 803 F.2d 1513, 1517 n.1 (9th Cir. 1986) ([I]f a broker used fraudulent means to convince a customer to purchase a stock and the customer left that stock with the broker , SIPC would be required by SIPA only to return the stock to the customer. The customer would retain any securities fraud claim against the broker for inducing the purchase. (citations omitted)). This is the case no matter how innocent or duped the investor. 4. SIPA Does Not Protect The Value of Investments.
Second, SIPA does not guarantee the value of investments even if they fail; the statute ensures only the return of customer property held by an insolvent or troubled broker-dealer. The purpose[] of a liquidation proceeding is to distribute customer property (i.e., the securities or cash that is supposed to be in the brokers custody) and to satisfy net equity claims of customers, which are measured on the date of the members liquidation or financial failure. 12
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See 15 U.S.C. 78fff(a)(1)(B); 78lll(4); 78lll(7); 78lll(11). Thus, when customers owned securities entrusted to a SIPC member, at most, these customers are entitled to the return of the securities they purchased or the value of those securities at the time of liquidationnot the hypothetical value of those investments had the investments prospered or even the value of the investors principal deposit.4 See In re Atkeison, 446 F. Supp. 844, 848 (M.D. Tenn. 1977) (If [the certificates] are securities, then she has already received the benefit of her bargain, albeit a bad one, for she has the securities themselves.). This is precisely why SIPA does not require a liquidation when there is no net equity and no customer relief is possible. Section 78eee(a)(3)(A) expressly prohibits SIPC from filing an application for a protective decree when the only customers of which are persons whose claims could not be satisfied [because the investor has zero net equity]. 15 U.S.C. 78eee(a)(3)(A); see also 78fff-3(a)(1). If the SEC were allowed to prevail without first showing that there are any eligible customersi.e., customers who have positive net equitythe resulting order would require SIPC to initiate a liquidation that the statute expressly prohibits. Reading section 78ggg(b) in this manner would thus render the prohibition in section 78eee(a)(3)(A) meaningless. See Leocal v. Ashcroft, 543 U.S. 1, 12 (2004) ([W]e must give effect to every word of a statute wherever possible.); United States v. Menasche, 348 U.S. 528, 538-39 (1955) (It is our duty to give effect, if possible, to every clause and word of a statute, rather than to emasculate an entire section. (internal quotation marks omitted)).
The return of an investors original purchase price is legally defined as a rescission. Even where fraud is demonstrated, SIPA does not provide for rescission. See SEC v. S.J. Salmon & Co., 375 F. Supp. 867 (S.D.N.Y. 1974).
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C.
The SEC Has Not Made the Requisite Showing That SIPC Has Failed to Discharge Its Obligations to Customers of a SIPC Member.
Against this backdrop, the relevant question for the Court to decide is whether SIPC has failed to discharge obligations to customers of a member under the facts of the Stanford case. This is an inherently factual inquiry, and the SEC cannot avoid it by claiming that its theory is somehow different and then framing immaterial issues such as whether Stanford operated a Ponzi scheme, whether some of the proceeds from the CDs SIBL sold went from SIBL back to SGC, and whether Stanford entities operated in an interconnected manner in some general way. Whether or not those issues are disputed, none of them is material to whether SIPC has failed to act for the protection of customers under section 78ggg(b) and whether there are any eligible customers of a member here. The SEC is required to demonstrate that it is entitled to the relief it seeks (Feb. 9, 2012 Mem. Op. (Dkt. No. 21) at 11 (emphasis added))and is not entitled to relief as of right. 1. SIBL Was an Offshore BankNot a Registered Broker Dealer.
As an initial matter, the SEC has never alleged that SIBLthe offshore bank that issued these CDsis a SIPC member, given that (1) it is not a broker-dealer, 15 U.S.C. 78ccc(a)(2)(A); and (2) its principal business was conducted outside the United States, id. 78ccc(a)(2)(i)(A). As the SEC has admitted, SIBL is a private international bank, chartered and domiciled in St. Johns, Antigua, (Dec. 12, 2011 SEC Application (Dkt. 1) 5), which is currently subject to the jurisdiction of an Antiguan liquidation, (see Jan. 6, 2012 Letter from Antiguan Liquidators to Congress (Ex. 5) at 3). Moreover, SIBL has never claimed to be a SIPC memberits Disclosure Statements to CD investors stated just the opposite:
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(Nov. 15, 2007 SIBL CD Disclosure Statement (Ex. 6) at 4; see also Exhibit 128 to Mar. 31, 2010 OIG Report at 4 (The Disclosure Statement acknowledge[s] that the investment is not insured .), available at http://www.sec.gov/foia/docs/oig-526-exhibits-95-144.pdf.) The SEC Receiver himself has confirmed that SIBL is not a SIPC member. (See Aug. 12, 2009 Letter from R. Janvey to SIPC (SIBL is not a member of SIPC.), available at
http://www.stanfordfinancialreceivership.com/documents/SIPC_ltr_with_exhibits.PDF.) All of this is precisely why the SEC does not purport to argue that SIPC should bring a liquidation proceeding against SIBLand for good reason. SIPA does not authorize the liquidation of a non-member, offshore bank. See 15 U.S.C. 78eee(a)(3)(A) (granting SIPC discretion to
commence a liquidation only in the event a member has failed or is in danger of failing to meet its obligations to customers (emphasis added)). The CDs are obligations of SIBL. They are expressly not the obligation of the SIPC-member firm or SIPC.5 This, alone, is fatal to the SECs case. Indeed, the SEC has recognized that it lacks regulatory authority over SIBL as an offshore bank. (See Mar. 31, 2010 OIG Report (Ex. 2) at 69, 74, 105, 109; see also Exhibit 78 to Mar. 31, 2010 OIG Report (Ex. 7) at 2 (As we understand it, SIB is a bank domiciled in the
(See Nov. 15, 2007 SIBL CD Disclosure Statement (Ex. 6) at 17 (We, [SIBL], not SGC, will be solely responsible to you for all amounts due in respect of the CD Deposit. In the event of nonpayment of funds due and owing under the CD Deposit for any reason, you will have no claim or right against SGC or any other dealer of sales representative. (emphasis added)).)
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country of Antigua and, therefore, is subject to the banking laws and regulations of that country, not those of the United States.).) For example, the SEC noted in a 2004 investigation of SGC that [s]ince SIB is located in Antigua, it was unable to require SIB to provide or to otherwise gather the necessary documents to inspect its financial products. (Exhibit 98 to Mar. 31, 2010 OIG Report at 3, available at http://www.sec.gov/foia/docs/oig-526-exhibits-95-144.pdf.) This underscores the incompatibility of foreign entities and the SIPA scheme: the SEC cannot regulate such entities and therefore immediately notify SIPC when such entities are in danger, as the SEC is required to do by statute. 15 U.S.C. 78eee(a)(1). And because such entities will be under foreign control upon collapsethe U.S. Receivers attempt to assert control of the SIBL liquidation was rebuffed by the Antiguan Liquidators and the Antiguan courts (see Jan. 6, 2012 Letter from Antiguan Liquidators to Congress)SIPC will be unable to reimburse its expenses from the member firms estate, which, again, is inconsistent with the statutory scheme. See 15 U.S.C. 78fff(e) (All costs and expenses of administration of the estate of the debtor and of the liquidation proceeding shall be borne by the general estate of the debtor to the extent it is sufficient therefor.). 2. Investors Deposited Funds With the Offshore Bank and Clearly Had the Purpose of Purchasing SIBL CDs.
Because the SEC cannot demonstrate that SIBL is a SIPC member, it instead insists that SIPC must institute a liquidation against Stanford Group Company in the U.S. This approach fails because the SEC offers no evidence to demonstrate that SGC was entrusted with custody of customer cash or securities to hold on deposit at the time it went into receivership (once the SEC filed its enforcement action against Stanford in February 2009). See, e.g., Barbour, 421 U.S. at 412; In re Brentwood Sec., Inc., 925 F.2d at 330; In re Atkeison, 446 F. Supp. at 847 (SIPA is designed to protect customers who have either cash or securities or both in the
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custody of broker-dealer firms. (quoting H.R. Rep. No. 91-1613, 91st Cong., 2d Sess.) (emphasis added)). The SEC itself has admitted that investors actually deposited funds with SIBLnot SGCfor the purpose of buying offshore SIBL CDs. The SECs own June 15, 2011 Analysis the analysis that allegedly supports the SECs pursuit of this caseadmits that [t]he evidence currently available shows that investors with accounts at SGC who purchased SIBL CDs deposited funds with SIBL and clearly had the purpose of purchasing SIBL CDs. (Exhibit 2 to Dec. 12, 2011 M. Martens Decl. (Dkt. 1-1) at 7 (emphasis added); see also id. at 5 (Customer funds intended for the purchase of SIB[L] CDs were deposited into SIB[L] accounts. (quoting Declaration of Karyl Van Tassel (filed July 27, 2009) 9) (emphasis added))).) In this respect, at least, the SECs Analysis is consistent with the facts as SIPC understands them. For example, the materials provided to SIBL CD purchasers made clear that their payments were to be made to SIBLnot SGCand that investors would have to open a separate bank account with SIBL in order to purchase these CDs. (See Nov. 15, 2007 SIBL CD Disclosure Statement (explaining that payments were to be sent to SIBL in Antigua and that SIBL would have to open a separate account in the investors name); Dec. 2004 SIBL Subscription Agreement (Ex. 8).) And investors, in fact, acknowledged that their funds were being sent to SIBL in Antigua. (See Feb. 19, 2008 Wiring Instructions (Ex. 9) (Please accept this letter as my authorization and request to transfer entire balance from my account number to my account at Stanford International Bank. (emphasis added)); May 29, 2007 Wiring Instructions (Ex. 10) (same); July 20, 2007 Wiring Instructions (Ex. 11) (same); Nov. 8, 2005 Check to SIBL (Ex. 12) (copy of investors check sent to SIBL); Aug. 7, 2008 Check to SIBL
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(Ex. 13) (same); Apr. 20, 2009 Confirmation (Ex. 14) (confirmation of SIBL CD investment issued by SIBL and sent from SIBL in Antigua to U.S. investor).)6 These facts should come as no surprise to the SEC: it observed long ago in a letter to SGC that SGC does not actually receive investor money invested in the CDs and that investor funds are directly invested with SIB[L]. (Exhibit 69 to Mar. 31, 2010 OIG Report (Ex. 15) at 3.) 3. Investors Received Custody of Their SIBL CDs.
The SEC knows that upon sending their funds to SIBL, investors or their designees received their actual CDs in return. (See Aug. 12, 2009 Letter from SEC Receiver at 3 (It appears that, in general neither SGC, Pershing nor J.P. Morgan maintained custody or possession of any physical certificates that evidenced CDs. Instead, these certificates appear to have been physically held by the owner of the CD.), available at http://www.stanford
financialreceivership.com/documents/SIPC_ltr_with_exhibits.PDF.) Indeed, even the SEC and its Receiver admit that they cannot claim that SGC had custodydirectly or indirectlyof SIBL CDs. (See Dec. 19, 2002 Mem. from H. Wright to Office of Compliance Inspections and Examinations (Dec. 19, 2002 SEC Report) (excerpts attached as Ex. 16) at 14-15 (stating that [t]he staff also considered questioning whether SGC had indirect custody of its clients funds or securities through their investments in SIB CDs. However, based upon existing no action guidance, it did not appear that the Examination Staff could claim SGC had such custody. (emphasis added)).) For example, while Stanford Trust Company (which was also not a SIPC member) may have held CDs for those who had IRAs, the U.S. Receiver himself has emphasizedeven after the failure of SGCthat those CDs are freely available for delivery to
6
For this reason, the SECs inclusion of investor checks made out to Stanford as exhibits to the SECs Analysis proves nothing. (See Exhibit 2, Attachment 7 to Dec. 12, 2011 M. Martens Decl. (Dkt. 1-1).) The key point here is that investors had to acknowledgein order to place their CD ordersthat the money would end up with an offshore bank, pursuant to disclosures stating there would be no SIPA protection.
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other IRA custodians as investors see fit: this is not a situation in which the CDs have disappeared. (See June 5, 2009 Stanford Financial Group Receivership, Procedures for Transfer of Certain Stanford Trust Company Customer Accounts (Receiver Q&A) (Ex. 17) at 26 (noting that if investors transfer [their] STC account to a successor trustee or other financial institution, they will receive a copy of the document evidencing the transfer of [their] SIB[L] CD and its related claim).) Other investors have acknowledged that they received their SIBL CDs. (See, e.g., May 23, 2010 Letter from SIBL CD investor to SEC (Ex. 18) (attaching copy of SIBL CD in investors possession).)7 The SEC simply has not demonstrated that any investors cash or securities were on deposit with SGC as part of a custodial lockbox function at the time it went into receivership. Indeed, it should be noted that SGC had no custodial lockbox function. The firm was both a registered investment advisor (i.e., not a SIPC member because investment advisors are not SIPC members) and a securities broker. In its capacity as a brokerage, it was only an introducing broker-dealer, meaning that it introduced clients to other carrying brokerage or clearing firms that actually held customers cash and securities. See H. Minnerop, The Role and Regulation of Clearing Brokers, 48 The Business Lawyer, May 1993, at 841-43. In this case, SGC introduced business to Pershing, the carrying or clearing firm. As an introducing broker, SGC was not authorized, nor was its function, to hold customer cash or securities. Upon information and belief, Pershing, the clearing firm, held no Antiguan Bank CDs for any SIBL CD purchaser.
The SEC includes an affidavit from an alleged SGC client, Sally Matthews, who states that she ordered but never received a SIBL CD. (Exhibit 2, Attachment 5 to Dec. 12, 2011 M. Martens Decl. (Dkt. 1-1) 1-9.) This affidavit proves nothing for the simple reason that Matthews admits to wiring money not to SGC, but to the appropriate Stanford accountthat is, SIBLto purchase the CDs. (Id. 3.) That SIBL may have then failed to deliver a CD is immaterial, as SIBLs actions would not implicate SGCs custodial function. But even if this Court were to disagree, due process requires that SIPC be afforded some ability to test what the affiant says through discovery. See infra Part II.
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4.
Once a Customer Does Not Mean Always a Customer.
It is no answer for the SEC to say that cash at some point may have passed through the hands of the SGC en route to SIBL. (See Jan. 24, 2012 Hrg Tr. (Ex. 1) at 14 ([T]he statute provides that one is a customer if one has submitted cash to a broker for purposes of purchasing securities; and we believe, as set forth in the Commissions analysis, that that is the situation presented here.).) Because the statute is limited to protecting cash or securities that remained entrusted with a brokerage under its custodial function, cash previously sent does not confer customer status if the cash has already been used to purchase securities that have already been delivered: there is nothing left on deposit for SIPC to protect. Barbour, 421 U.S. at 413 (observing that SIPC was established by Congress as a nonprofit membership corporation for the purpose, inter alia, of providing financial relief to the customers of failing broker-dealers with whom they had left cash or securities on deposit (emphasis added)); In re Stalvey & Assocs., Inc., 750 F.2d at 471 (rejecting the notion of once a customer, always a customer); In re New Times Securities Services, Inc., 463 F.3d 125, 130 (2d Cir. 2006) (holding that accountholders became lenders by swapping cash and securities in their brokerage accounts for notes issued by the debtor, and thus were not customers). 5. Ponzi Schemes Do Not Alter the Customer Analysis.
Nor can the SEC circumvent this principle by arguing that money indirectly made its way back to a SIPC-member firm or that Allen Stanford operated a Ponzi scheme. (See, e.g., Exhibit 1 to Dec. 12, 2011 M. Martens Decl. (Dkt. 1-1) at 4 (Sept. 2, 2008 Letter providing notification of affiliate referral fees from SIBL to SGC).) In In re Aozora Bank Ltd., for example, investors in feeder funds that in turn invested in Madoff Securities (a SIPC member) asserted that they qualified as SIPC customers, arguing that the feeder funds and Madoff Securities were highly interconnected such that funds placed with the former should be deemed equivalent to funds 20
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placed with the latter. No. 11-5683, 2012 WL 28468, *at 1 (S.D.N.Y. Jan. 4, 2012) (appeal pending). The court rejected this theory, emphasizing that the existence of an agency or conspiratorial relationship between the Feeder Funds and [Madoff Securities] did not create any property interest for the appellants in the assets the Feeder Funds placed with [Madoff Securities]. Id. at *10. The claimants had entrusted money with the feeder funds that were not SIPC members, and the fact that the funds used those monies to invest with Madoff Securities was insufficient: SIPA simply does not protect against all cases of alleged dishonesty and fraud. Id. (quoting In re New Times Sec. Servs., Inc., 463 F.3d at 130); see also In re Aozora Bank Ltd., 2012 WL 28468, at *5. And in any event, the SEC knew for at least fourteen years that Stanford was likely operating a Ponzi scheme. (See Mar. 31, 2010 OIG Report at 149 (The OIG investigation found that the SECs Fort Worth office was aware since 1997 that Robert Allen Stanford was likely operating a Ponzi scheme.).) If the existence of a Ponzi scheme were a dispositive fact, then the SEC would have had a statutory duty to immediately notify SIPC of the Stanford fraud years ago. See 15 U.S.C. 78eee(a)(1).8 That the SEC is highlighting these immaterial facts, of course, does not demonstrate that it is entitled to relief under section 78ggg(b). See Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986) ([T]he substantive lawhere section 78ggg(b)will identify which facts are material.); see also Holcomb v. Powell, 433 F.3d 889, 895 (D.C. Cir. 2006).
To the extent that the SEC points to the Madoff liquidation as support for its claim that the existence of a Ponzi schemes is somehow material to the Courts analysis, it is a red herring. The question at issue in the Madoff liquidation was how to calculate the amount of a customers net equity claim. A customers net equity is limited to the value of the securities or cash on deposit at the time of liquidation, 15 U.S.C. 78lll(11) which, in a Ponzi situation, is something substantially less than the anticipated value of a customers investment. There was never a threshold dispute, however, as to whether individuals who invested through Bernard Madoff Securities, LLC, which was a SIPC-member firm, were customers under SIPA. Indeed, in Madoff, SIPC acted promptly to fulfill its obligation to commence a liquidation to protect customers. The customer assets were specifically held at the SIPC-member firm, and for that reason, SIPC immediately commenced a customer protection proceeding.
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D.
SIPAs Text Demonstrates That Corporate Formalities Matter.
SIPA itself recognizes the principle that corporate forms matter, by limiting customer status to those whose cash or securities are in the custody of a broker-dealer and excluding transactions even with entities that concededly are related. For example, the definition of customer expressly excludes any person whose claim arises out of transactions with a foreign subsidiary of a member of SIPC, 15 U.S.C. 78lll(2)(C)(i). It also excludes claims that, by operation of law [are] subordinated to the claims of any or all creditors of the debtor, id. 78lll(2)(C)(ii)where the Bankruptcy Code provides that claim[s] arising from rescission of a purchase or sale of a security of an affiliate of the debtor shall be subordinated to all claims or interests that are senior to or equal the claim or interest represented by such security. 11 U.S.C. 510(b) (emphasis added). (See also Exhibit 69 to Mar. 31, 2010 OIG Report (Ex. 15) at 3 (recognizing that CDs were issued by an affiliated bank domiciled in St. Johns, Antigua).) The key point here is that corporate forms matter, especially when not even the SEC disputes that SIBL issued these offshore bank CDs and was a separate entity organized in Antigua under Antiguan law and regulated by Antiguan authorities.9 As the SECs own June 15, 2011 Analysis admits, [t]he evidence currently shows that investors with accounts at SGC who purchased SIBL CDs deposited funds with SIBL for the purpose of purchasing securities. (Exhibit 2 to Dec. 12, 2011 M. Martens Decl. (Dkt. 1-1) at 7; see also id. at 5.) Indeed, drawing a clear line based on custody of cash or securities is wholly consistent with Congresss very purposes in creating SIPC. Because the SEC has not presented competent,
The SEC itself has relied on this distinction. In explaining why it did not investigate the Stanford fraud years earlier, the SEC emphasized that SGC was distinct from SIBL, and that its authority to audit SGC as a registered broker-dealer did not give it authority to audit SIBL as an offshore Antiguan bank. (See Mar. 31, 2010 OIG Report (Ex. 2) at 69, 86-87.) There is no basis for the SEC to take a contrary position here: just as the SECs resources are limited by law to overseeing firms within the scope of its regulatory purview, there is no legal basis for requiring SIPC to cover investments with non-SIPC-member firms.
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admissible evidence to show that there are any customers whose cash or securities were supposed to be in the custody of SGCrather than SIBLat the time of SGCs receivership, any liquidation would not accomplish the completion of open transactions or the speedy return of customer property under SIPA. Barbour, 421 U.S. at 416; see also In re Aozora Bank Ltd., 2012 WL 28468, at *10 (denying customer protection based on an alleged conspiratorial relationship between feeder funds and member broker because SIPA simply does not protect against all cases of alleged dishonesty and fraud (quoting In re New Times Sec. Servs., Inc., 463 F.3d at 130)). Because the SEC knows that it has no factual basis upon which to pursue a claim that SGC maintained custody of investors cash or SIBL CDs at the time of its receivership, the SEC predicates its claim for relief under section 78ggg(b) on the theory that investments with SIBL and investments with SGC should be deemed one and the same. (See Exhibit 2 to Dec. 12, 2011 M. Martens Decl. (Dkt. 1-1) at 7 ([U]nder certain circumstances, an investor may be deemed to have deposited cash with a broker-dealer for the purposes of purchasing securities and thus be a customer under Section 16(2) of SIPAeven if the investor initially deposited those funds with an entity other than the broker-dealer. (emphasis added)).) According to the SECs theory, SIBL and SGC (and other Stanford entities) were so interconnected that the separate existence of [every Stanford entity] should be disregarded. (Id. at 8; see also Jan. 24, 2012 Hrg Tr. (Ex. 1) at 14 ([W]e believe that cash can be deemed submitted with a broker if its submitted to an interrelated party, as occurred here.).) In other words, the SEC purports to assert a veil-piercing theory to permit investors who purchased CDs from an offshore bank and do not have cash or securities on deposit with a SIPC member to seek recovery from SIPC.
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As set forth above, however, SIPAs unambiguous text does not permit recovery under a veil-piercing theory. SIPAs text excludes as customers investors who conducted transactions with a foreign subsidiary of the debtor. See 15 U.S.C. 78lll(2)(C). And Congress intent to limit SIPAs protection to customers of a member should be followednot disregarded. (See Exhibit 2 to Dec. 12, 2011 M. Martens Decl. (Dkt. 1-1) at 8.)10 Even if SIPAs text did not expressly preclude the SECs veil piercing theory, whether SIBL and SGC were alter egos is an intensely factual question that cannot be answered with generalizations such as saying that they operated in an interconnected manner. See Liberty Prop. Trust v. Republic Props. Corp., 577 F.3d 335, 340 n.2 (D.C. Cir. 2009) (reversing grant of motion to dismiss because [i]t was inappropriate, on a motion to dismiss, for the district court to disregard the corporate form without a factual determination that each corporation was simply the alter ego of its owners (quoting Valley Fin. Inc. v. United States, 629 F.2d 162, 172 (D.C. Cir. 1980)); see also Valley Fin., 629 F.2d at 172 (explaining that alter ego analysis is a fact issue and is based largely on a reading of the particular factual circumstances). Courts will disregard corporate forms only in the rarest circumstances. See, e.g., Pardo v. Wilson Line of Wash., Inc., 414 F.2d 1145, 1149-50 (D.C. Cir. 1969) (Piercing a corporate veil is a task which a court undertakes reluctantly.). And piercing the corporate veil is particularly inappropriate here because the investors were explicitly told that the SIPC-member firm was not responsible for principal and interest on the CDs. (See Nov. 15, 2007 SIBL CD Disclosure Statement (Ex. 6) at 17 (We, [SIBL], not SGC, will be solely responsible to you for all amounts due in respect of the CD Deposit. In the event
10
Accordingly, it is irrelevant as a legal matter that SGC may have issued consolidated investor statements that included SIBL CD account balances. (See Exhibit 1 to Dec. 12, 2011 M. Martens Decl. (Dkt. 1-1) at 5-22.) Even setting SIPAs plain text aside, as a factual matter these statements make clear that they were being provided for informational purposes only and do not replace actual account information obtained from the issuing financial institutioni.e., SIBL. (Id. at 22.)
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of nonpayment of funds due and owing under the CD Deposit for any reason, you will have no claim or right against SGC or any other dealer of sales representative. (emphasis added)).) Indeed, it would be particularly inappropriate to disregard corporate forms where, as here, the facts reveal a foreign company with its own employees, auditors, and physical presence registered under foreign law and regulated by foreign authorities, and now in liquidation under foreign control. The SECs bare allegation that SGC and SIBL should be treated as one and the same is belied by evidence that SGC and SIBL were, in fact, separate entities: SIBL had its own Board of Directors and its own management (see Nov. 15, 2007 SIBL Disclosure Statement at 14-15; see also June 10, 1998 Letter from Jack Ballard to SEC (Ex. 19) at 1 (noting relationship between SGC and SIBL was governed by contract)); SIBL maintained a physical presence in Antigua (see SEC v. Stanford, No. 09-0298, Second Am. Compl. 25 (N.D. Tex. June 19, 2009) (SIB . . . is a private, offshore bank located in Antigua.); SEC v. Stanford, No. 09-0298, Appendix in Support of the Receivers Notice of United Kingdom Judgment 97 (N.D. Tex. July 6, 2009) (Its physical headquarters were in Antigua [and] almost all of its employees were located in Antigua.)), while SGC was headquartered in Houston, Texas (see SEC v. Stanford, Second Am. Compl. 14); SIBL was licensed under Antigua law (see Nov. 15, 2007 SIBL Disclosure Statement at 2); SIBL did notbecause it was not required toprovide its investors with U.S. tax Form 1099, and SGC likewise did not include SIBL CD income on its Form 1099 for its investors (see June 15, 2009 Decl. of IRS Agent D. Reeves (Ex. 20) at 6); SIBL compiled its own financial statements, which were independently audited by an Antiguan auditor (see Nov. 15, 2007 SIBL Disclosure Statement (Ex. 6) at 12); SIBL issued its own annual reports (see SEC v. Stanford, Second Am. Compl. 35 (referencing SIBLs 2006 and 2007 Annual Reports)); and SIBL is subject to an Antiguan receivershipafter the U.S. SEC Receiver tried but failed to assert control over SIBL in addition to SGC (see Jan. 6, 2012 Letter from Antiguan Liquidators to Congress (Ex. 5); Fundora v. Stanford Intl Bank Ltd., Claim No. ANUHCV 0126 of 2009, at *10-*11 (E. Caribbean Sup. Ct., Antigua & Barbuda, Apr. 17, 2009) (Ex. 21) (The U.S. receiver . . . has no legal entitlement to standing in Antigua and Barbuda.)).
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In fact, courts that have examined the relationship between SIBL and SGC have concluded that the corporate distinction between SGC and SIBL should be respected, not disregarded. The U.K. High Court of Justice heldafter an examination of the evidencethat SIB[L] was not merely a letterbox company. Its physical headquarters were in Antigua; almost all of its employees were located in Antigua; its contracts both with investors and financial advisers were governed by the laws of Antigua; and its marketing material gave prominence to its presence in Antigua. (SEC v. Stanford, No. 09-0298, Appendix In Support of the Receivers Notice of United Kingdom Judgment 97 (N.D. Tex. July 6, 2009).) And while equitable considerations may favor disregarding those forms when a parent ought to be liable for the debts of a subsidiary, the SECs Application offers no law, no facts, and no argument to support using an alter-ego theory to create obligations on an unrelated third party such as SIPC. This is not a situation in which a parent is held responsible for the acts of a subsidiary, for example, but instead about whether SIPCas a third partycan suddenly become responsible for both member and non-member firms. See In re First Sec. Grp. of Cal., No. 94-56706, 1996 WL 92115, at *2 (9th Cir. Mar. 4, 1996) (holding that the district court erroneously applied the alter ego doctrine to shift liability to an innocent third party); see also In re Carolina First Sec. Grp., Inc., 173 B.R. 884, 889 n.7 (Bankr. M.D.N.C. 1994) (noting that a claimant would not necessarily be a customer under SIPA even if it assumed two entities were alter egos and one of those two entities was a broker-dealer because [r]elief under the SIPA is predicated on a specific transaction, not the prior relationship between the parties involved).11
11
In any event, a U.S. court order piercing the veil against SIBL would likely be unenforceable in Antiguan liquidation proceedings. Such an order would violate the principles of comity normally afforded to foreign bankruptcy proceedings. See JP Morgan Chase Bank v. Altos Hornos de Mexico, S.A. de C.V., 412 F.3d 418, 424 (2d Cir. 2005) (We have repeatedly held that U.S. courts should ordinarily decline to adjudicate creditor claims that are the subject of a foreign bankruptcy proceeding.... In such cases, deference to the foreign court is appropriate so long as the foreign proceedings are procedurally fair and ... do not contravene the laws or public policy of the United States.); Victrix Steamship Co., S.A. v. Salen Dry Cargo A.B., 825 F.2d 709, 713 (2d Cir.
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E.
Old Naples and Primeline Are Distinguishable.
The two cases upon which the SEC primarily relies to support its veil-piercing theory, In re Old Naples Securities, Inc., 223 F.3d 1296 (8th Cir. 2000), and In re Primeline Securities Corp., 295 F.3d 1100 (10th Cir. 2002)which are not binding on this Courtare distinguishable on both the law and the facts. (See Exhibit 2 to Dec. 12, 2011 M. Martens Decl. (Dkt. 1-1) at 7-12.) Neither of these cases supports the wholesale expansion of SIPC protection to investments made with a non-SIPC-member entity where: (1) the investments were made with a foreign subsidiary or affiliate of a SIPC member; (2) the investors had reason to know that, even though they were introduced to an investment product by a SIPC member, they were depositing money for and purchasing from a different entity; and (3) the investors actually received the very securities they agreed to purchase.12 First, neither Old Naples nor Primeline involved a scenario where, as here, investors were purchasing securities from a foreign subsidiary or affiliate of the debtor. Indeed, Old Naples expressly recognized that SIPA would not provide protection where, as here, claims [are] based on transactions with foreign subsidiaries of any SIPC member brokerage or claims [are] for cash or securities that form a part of the brokerages capital. Old Naples, 223 F.3d at
1987); In re Monitor Single Lift I, Ltd., 381 B.R. 455, 465 (Bankr. S.D.N.Y. 2008) (Where there is a pending foreign insolvency proceeding, concerns of comity must be taken into account and deference must be given to the foreign proceedings.). And as a practical matter, it is not obvious that the Antiguan Receiver or an Antiguan Court would surrender SIBL assets held in Antigua. See Fundora v. Stanford Intl Bank Ltd., Claim No. ANUHCV 0126 of 2009, at *10-*11 (E. Caribbean Sup. Ct., Antigua & Barbuda, Apr. 17, 2009) (Ex. 21) (The U.S. receiver . . . has no legal entitlement to standing in Antigua and Barbuda.).
12
Not only are these cases distinguishable, they were also wrongly decided. Both disregard SIPAs plain text limiting customer status to someone who has a claim on account of securities received, acquired, or held by the debtor, 15 U.S.C. 78lll(2)(A), or who has deposited cash with the debtor for the purpose of purchasing securities, id. 78lll(2)(B)(i). Instead, these cases erroneously hold that it does not matter whether a claimant deposited cash or securities with the debtor at all. Old Naples, 223 F.3d at 1302 (Whether a claimant deposited cash with the debtor, however, does not depend simply on to whom the claimant handed her cash or made her check payable, or even where the funds were initially deposited.); Primeline, 295 F.3d at 1107 (Whether a claimant deposited funds with the debtor does not depend simply on to whom claimants made their checks payable.). With all due respect, this analysis stretches SIPAs text beyond recognition. It is for Congressnot the courtsto determine whether SIPAs protections should extend to non-SIPC-member firms.
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1306 (citing 15 U.S.C. 78lll(2)(A) & (B)). Second, both cases involved factual scenarios in which investor[s] intended to have the brokerage purchase securities on [their] behalf and believed that [they] [were] sending money to the brokerage. Old Naples, 223 F.3d at 1303; Primeline, 295 F.3d at 1107 (noting that claimant[s] intended to have the brokerage purchase securities on the claimant[s] behalf). Both decisions recognized that, as here, claimants who invest directly in a third-party company are not protected by SIPA, even if their broker suggested the investment. Primeline, 295 F.3d at 1107 (citing Old Naples, 223 F.3d at 1302). Finally, none of the investors in either of the two cases actually received the securities they agreed to purchase, whereas here the SEC cannot deny that SIBL CDs were delivered to investors or their designees and were not left in the custody of SGC. Primeline, 295 F.3d at 1107; Old Naples, 223 F.3d at 1305 (noting the ample evidence that the claimants believe [the broker-dealer] would buy the bonds in their names and for their individual accounts). In any event, both Old Naples and Primeline recognized that these inquiries require a specific factual showing under SIPA, which the SEC has yet to make. See Old Naples, 223 F.3d at 1301 (concluding that SIPC coverage first required bankruptcy court to find, inter alia, that neither [investor] had any reason to know that they were not dealing directly with the debtor brokerage when they wired funds to [a non-debtor entity] and that the transactions had the characteristics, at least from the claimants perspective, of a typical fiduciary relationship between a broker and client). Importantly, SIPC believes the facts will show (and the SEC will not be able to dispute) that: SIBLs offering documentation warned investors that there was no SIPC coverage for these CDs. In order to purchase these CDs, investors had to open bank accounts with SIBLthe offshore bank in Antigua.
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SGCthe SIPC member brokerage firmdid not and does not have custody of the CDs, because they were delivered to investors or their designees. The CDs were sold to accredited investors (and thus were exempt from SEC registration requirements) with returns that would not be reported to the IRS.
At bottom, even if SIPA were to permit the SEC to assert a veil-piercing claim in this case under these facts, it must first demonstrate the factual basis for each aspect of that claim such that there truly are customers in need of protection as that term is defined under the Act. (See Feb. 9, 2012 Mem. Op. (Dkt. 21) at 11 (Congress intended that the SEC must ask this Court for relief and demonstrate that it is entitled to such relief.).) A contrary ruling would require SIPC to seek a liquidation even if there are no customers of a member under the facts of the Stanford case, and thus exceed the scope of what the statute permits. II. LIMITED DISCOVERY IS NECESSARY AND APPROPRIATE GIVEN THE SECS THEORY. In its February 9, 2012 Memorandum Opinion, the Court directed the parties to submit briefing on the procedures and discovery that are necessary and appropriate in this case. SIPC respectfully submits thatif the Court concludes that the SEC Application does not fail as a legal matterlimited and expedited discovery is required because there are disputed factual issues. A. SIPC Seeks Limited and Expedited Discovery.
Because the SEC has yet to demonstrate through competent, admissible evidence the predicate facts that are required to trigger the availability of relief under section 78ggg(b), SIPC submits that discovery is both necessary and appropriateso that the right result can be reached, and so that there is a real record from which to conduct meaningful judicial review. Customers. Because an SEC proceeding under section 78ggg(b) and the initiation of a liquidation under section 78eee(a)(3)(A) both require customers, SIPC seeks targeted discovery to test the SECs assertion that there are eligible customers in this case. This would include evidence about when the SECs 29
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proffered customers purchased their SIBL CDs; how they purchased them (i.e., who sold the CD to them and where they sent their money); what disclosures or other documents they received in the course of purchasing the CDs; and what statements they received after purchasing the CDs. Certificates of Deposit. Because customer status exists only if a SIPC member firm was supposed to be holding an investors cash or securities when the brokerage failed, SIPC seeks targeted discovery showing where the CDs purchased by the SECs proffered customers were sent, where they are located now, and what evidence the SEC has to show that the CDs were on deposit with SGC when it went into receivership in 2009. Corporate Structure. Because SIPA does not confer customer status based on transactions with different subsidiaries or affiliates, see supra Part I.D, and because the SEC itself claims that SGC and SIBL should be deemed one and the same, SIPC seeks targeted discovery to test the SECs contention that SIBL and SGCs corporate forms should be disregarded, including: observance of corporate formalities; shared management, officers, and employees; shared locations of physical offices; and common or separate book-keeping. The Underlying Evidentiary RecordIncluding Any Evidence the SEC Has Uncovered That Undermines the Case for SIPA Protection. Finally, SIPC seeks the complete record considered by, or available to, the SEC and its Staff in evaluating whether SIPA applies to the Stanford caseincluding exculpatory facts that rebut the existence of protection, not simply the supporting facts that the SEC selectively cites in its June 15, 2011 Analysis.13
This is not to say that SIPC seeks discovery about each and every alleged customer in order to test thousands of different alleged claims. Far from it. SIPC does not seek discovery with respect to each and every person who invested in a SIBL CD, nor does SIPC seek discovery regarding every person the SEC contends to be entitled to SIPA protection. (See Jan. 24, 2012 Hrg Tr. (Ex. 1) at 76:7-19.) The key point here is that SEC has failed to show that there are any customers under the facts of the Stanford case; it has failed to show that SIBL and SGC operated as a single enterprise such that the Court should ignore their corporate forms; and it has failed to produce any potentially exculpatory documents it may have omitted from its
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On February 13, 2012, SIPCs counsel met with the SECs counsel in an initial effort to craft a discovery plan pursuant to the Courts February 9, 2012 Order. As these conversations continue, SIPC will refine the scope of these requests, particularly if the parties are able to come to an agreement about the nature and extent of discovery appropriate for this case.
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June 15, 2011 Analysis. For example, if the SEC claims that it has identified a dozen or so representative customers sufficient to justify a liquidation, SIPCs requested customerdiscovery and CD discovery would focus on those proffered investors. The SEC may not avoid discovery hereand seek what amounts to summary judgmentby simply pointing to immaterial facts and claiming that they are undisputed (i.e., that Stanford was operating a Ponzi scheme, that SGC and SIBL operated in a highly interconnected fashion, and that some funds used to purchase SIBL CDs may have made their way back to SGC). See Holcomb v. Powell, 433 F.3d at 895 ([F]actual disputes that are irrelevant or unnecessary do not affect the summary judgment determination.) (citation omitted). Summary judgment is appropriate, of course, only where there are no material facts in dispute. Liberty Lobby, Inc., 477 U.S. at 248. Moreover, when a non-moving party does not have access to material facts, a court likewise should not grant a motion for summary judgment, but instead permit time for the party to conduct discovery. See, e.g., Seed Co., Ltd. v.
Westerman, Civ. A. No. 08-0355, 2012 WL 28521, at *4 (D.D.C. Jan. 5, 2012). B. The Burden on the SEC In Producing This Material Is Minimal.
Lest there be any doubt, the material facts are unquestionably in the SECs control. Before 2011, the SEC did not think SIPA supported a liquidation, because otherwise the SEC would have breached its statutory duty to immediately notify SIPC upon becoming aware that SIPC protection is warranted in any given situation. See 15 U.S.C. 78eee(a)(1). To the contrary, the SECs own General Counsel agreed with SIPC that there was no protection under the facts of the Stanford case, and the facts behind the Staffs earlier conclusions are plainly relevant to whether SIPA does or does not authorize a liquidation as the SEC contends. (See SECs Jan. 3, 2012 Reply Br. (Dkt. 16) at 6 n.5 (claiming that SEC had ongoing investigation that included SGCs activities and continued through early 2011 to receive relevant information 31
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from victims of the Stanford fraud).) Taking the SEC at its word, if it took years of investigation for the SEC to become aware of facts supporting its conclusion that SIPA does apply, see id., then surely the SEC is in possession of the facts. Moreover, it is clear that the SEC has sought and gained access to the evidence gathered by its Receiver in the Northern District of Texas. Despite the SECs contention during the January 24, 2012 hearing that obtaining the facts would require burdensome third-party discovery from the Receiver (see Jan. 24, 2012 Hrg Tr. (Ex. 1) at 76:23-24 (SECs Counsel: And lets be clear, it is third party discovery.)), the federal court order appointing the Receiver requires him to [p]romptly provide the [SEC] and other governmental agencies with all information and documentation they may seek in connection with its regulatory or investigatory activities. (See SEC v. Stanford, No. 09-0298, Am. Order Appointing Receiver 5(k) (N.D. Tex. Mar. 12, 2009) (Ex. 22).) The SEC has also been able to use compulsory court process to investigate any and all aspects of the Stanford situation. (See id. 15(c) (The [SEC] and Receiver may obtain, by presentation of this Order, documents, books, records, accounts, deposits, or other information within the custody or control of any person or entity sufficient to identify accounts, properties, liabilities, causes of action, or employees of the Receivership Estate.).) Further, the SEC Receiver has reported on numerous occasions that it has coordinated directly with the SEC in developing evidence to support the Stanford enforcement action. (See SEC v. Stanford, No. 09-0298, Receivers Consolidated Reply to Objs. To Mot. for Approval of Interim Fee Application and Procedures for Future Compensation at 20-21 (N.D. Tex. June 19, 2009) (noting that the SEC was in almost daily contact with the Receiver and was frequently present in the Stanford offices where the work was being performed and that the SEC itself was the source of the requests for much of the work done); see also SEC v. Stanford, No. 09-
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0298, Receivers Mot. for Approval of Interim Fee Application and Procedures for Future Compensation of Fees and Expenses and Brief in Support at 8 (N.D. Tex. May 15, 2009) ([T]he Receiver has expended substantial time and effort to comply with requests for information and assistance from various federal law enforcement and other government agencies, including the SEC.); SEC v. Stanford, Civ. No. 09-0298, Receivers Mot. for Approval of Second Interim Fee Application at 6, 18, 28 (N.D. Tex. Aug. 4, 2009) (detailing that SEC has made numerous requests for information and documents); SEC v. Stanford, Civ. No. 09-0298, Receivers Mot. for Approval of Third Interim Fee Application at 28 (N.D. Tex. Oct. 2, 2009) (same).) The SEC also has access to other government files as well. (See Jan. 6, 2012 Letter from Antiguan Liquidators to Congress (Ex. 5) (explaining that [w]e have provided documents to the DoJ to assist them in the prosecution of Mr. Stanford and will continue to assist them where we can).) Finally, the SEC has received voluminous material from victims groups such as the Stanford Victims Coalition (SVC). (See May 19, 2010 Letter from SEC to SVC Counsel (Ex. 23) (We appreciate receiving the information you have provided to date, which we have reviewed. In addition, we have reviewed documents sent to us by other SGC customers and certain other SGC records.); id. (requesting additional information to be sure that our analysis is fully informed, including account statements (from SIBL, and/or SGC), cancelled checks for the purchase of the CDs, account opening documents, and CD purchase documents, as well as any correspondence between the [investor] and SGC or SIBL relating to the CDs, and any other materials [that] might assist us in reviewing the facts of the case).) While the SEC has claimed that its June 15, 2011 Analysis constitutes a formal determination that there are SIPA customers (Jan. 3, 2012 SEC Reply Br. (Dkt. 16) at 17 n.19), the key point here is that neither SIPC nor the Court should be limited to the selective citation of
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facts used to support that analysis, without also reviewing other facts that the SEC considered or had available to it, but left out of its papers. Such materials were plainly before the SEC. The SEC Receiver has emphasized in court-ordered reports that he has provided voluminous information to the government, including the SEC. In addition, the SEC has not included in the record material documents from its own investigations of SGC. See Roland v. Green, No. 3:10-cv-00224, slip op. at 19 (N.D. Tex. Aug. 31, 2011) (noting that the SEC reviewed a sample of 52 SGC client files). This conflicts with the hornbook requirement that an agency may not skew the record in its favor by excluding pertinent but unfavorable information. Fund for Animals v. Williams, 391 F. Supp. 2d 191, 197 (D.D.C. 2005). Nor may the agency exclude information on the grounds that it did not rely on the excluded information in its final decision. Id. (quoting Ad Hoc Metals Coalition v. Whitman, 227 F. Supp. 2d 134, 139 (D.D.C. 2002)). At a bare minimum, SIPC is entitled to all information that might have influenced the agencys decision, not merely those on which the agency relied in its final decision. See Natl Courier Assn v. Bd. of Governors of the Fed. Reserve Sys., 516 F.2d 1229, 1241 (D.C. Cir. 1975). Even in the context of reviewing an agencys decision, the D.C. Circuit itself has concluded that a party adverse to the agency is entitled to at least some discovery to test the contours of the agencys purported record. See NRDC v. Train, 519 F.2d 287, 292 (D.C. Cir. 1975) ([T]he plaintiffs are entitled to an opportunity to determine, by limited discovery, whether any other documents which are properly part of the administrative record have been withheld.). SIPC is therefore entitled to substantive discovery when the record before the SEC is shown to be incomplete. See Kent Cnty., Delaware Levy Court v. EPA, 963 F.2d 391, 395-96 (D.C. Cir. 1992) (supplementation of administrative record proper where agency excluded from
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the record evidence adverse to its position (quoting San Luis Obispo Mothers for Peace v. NRC, 751 F.2d 1287, 1327 (D.C. Cir. 1984))). This Court accordingly should compel the SEC to produce all information it considered or had available to itincluding exculpatory informationbearing on whether SIPA applies to the Stanford case. See Occidental Petroleum Corp. v. SEC, 873 F.2d 325, 338-39, 342 (D.C. Cir. 1989).14 Given that the SEC itself
recognized in 2002 that it did not appear that the Examination Staff could claim SGC had such custody of SIBL CDs (Dec. 19, 2002 SEC Report (Ex. 16) at 14-15), and that its own General Counsel agreed with SIPC before 2011 that the statute did not apply to Stanfords investors, the SEC is plainly in possession of such evidence. Indeed, those admissions are directly relevant to whether there are any eligible customers of a member. The fact that the SEC tellingly omitted these points from its June 15, 2011 Analysis is all the more reason why discovery should be had. At bottom, balancing the burdens of discovery on the SEC and the attendant harms SIPC would face it if were forced to commence a liquidation when there are no eligible customers of a SIPC member clearly weighs in SIPCs favor. The discovery SIPC seeks is neither onerous for the SEC nor time-consuming: especially if the SEC follows an open-file policy, as one would expect if this case were as clear-cut as its Application tries to suggest. SIPC submits that such discovery may include as few as five interrogatories, five requests for production, and five requests for admission served on the SEC and its Receiver, as well as depositions of the handful of alleged customers whom the SEC proffers in support of why a liquidation should be
14
Courts have noted, moreover, that full and complete discovery is particularly appropriate where, as here, an agency has changed its position without explanation. See, e.g., Cmty. Sav. & Loan Assn v. Fed. Home Loan Bank Bd., 68 F.R.D. 378, 382 (E.D. Wis. 1975) (In a case like the present, where the agency has completely changed its position on an application within a relatively short period of time, public confidence in the soundness of the decision-making process will be promoted by allowing plaintiffs to see the information they request.).
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commenced. Discovery into the corporate structure of SGC versus SIBL likewise could proceed in an expedited manner, for example through an SEC examiner or other witness akin to a corporate representative under Rule 30(b)(6), who could identify what facts the SEC does or does not have in its possession. Assuming that the SEC did, in fact, gather facts to make its referral determination (and to comply with Rule 11(b)), the burden of turning those facts over to SIPC is minimaland it pales in comparison to the prejudice that SIPC will suffer if it is improperly forced to initiate a liquidation proceeding. There is no doubt about just how expensivein terms of party resources, judicial resources, and sheer dollarsthe administrative costs of a liquidation proceeding will be. The Lehman Brothers liquidation, for instance, has incurred $642 million solely in administrative fees, and it has been going on for more than three years even though SIPC promptly started the process the day after the Lehman bankruptcy proceeding began. (See In re Lehman Bros. Inc., No. 08-01420, Trustees Sixth Interim Report for the Period Apr. 23, 2011 Through October 21, 2011 197 (Bankr. S.D.N.Y. Oct. 21, 2011).) Administrative costs for the Madoff liquidation exceeded $3.2 million over the first fifteen days after a trustee was appointed, and they exceeded $8 million in the first two-and-a-half months after the trustee was appointed in the Lehman liquidation. (See 2008 SIPC Annual Report at 26-27, available at http://www.sipc.org/pdf/ SIPC%20Annual%20Report%202008%20FINAL.pdf.) From December 2008 to September
2010a mere 21 monthsadministrative costs were $102 million. (See Mar. 30, 2011 SEC Report of Office of Inspector General Oversight of SIPC at 22, available at http://www.secoig.gov/Reports/AuditsInspections/2011/495.pdf.) This $102 million is a mere fraction of what will eventually be spent, and it will not be recouped from the estate. (Id.) Indeed, these administrative fees may well jeopardize the very solvency of the SIPC Fund itself. (Id. at 23
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(Because the outcome of the Lehman liquidation is uncertain and SIPC is advancing its own funds to pay the administrative expenses for the Madoff liquidation, the possibility exists that SIPC could deplete its $2.5 billion fund.).) All of this underscores that starting a liquidation is a precipitous step, confirming why these are questions to be addressed here rather than deferring them to another court in a proceeding which the SEC itself admits would be very hard to unwind. (See Jan. 24, 2012 Hrg Tr. at 8:17-18.) Once a liquidation is started, anyone can file an informal claim which SIPC must then litigate before the trustee and then in the courts, even if the process ultimately establishes that a person does not qualify as an eligible customer of a member as the statute defines them. 15 U.S.C. 78fff-2(a). And in every liquidation, where there is no general estate, SIPC is obligated to pay for professional fees (including for a trustee, counsel and claims review and forensic accounting consultants), mailings, publications, preparation and filing of taxes for the debtor, computer and data system rentals, equipment leases and rent and utilities for office space. (See, e.g., May 31, 2009 Madoff Form 17 (Ex. 24) (itemizing SIPCs administrative costs).) For the liquidation of North American Clearing, Inc., where there were only 1700 claims filed compared with potentially 21,500 disputed Stanford claims, (see Dec. 12, 2011 SEC Mem. in Supp. of Application (Dkt. No. 1) at 7 n.6), administrative fees exceeded $2.8 million after only five months, and $8.7 million after 18 months, (see 2008 SIPC Annual Report at 26-27, available at http://www.sipc.org/pdf/SIPC%20Annual%20Report%202008%20FINAL.pdf;
2009 SIPC Annual Report at 28-29, available at http://www.sipc.org/pdf/2009%20 Annual%20Report.pdf). To permit the SEC to force SIPC to initiate a liquidationand to incur the massive costs associated with such a liquidationwithout providing even targeted, expedited discovery as described above would deprive judicial review of any serious meaning.
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CONCLUSION For the foregoing reasons, the Court should deny the SECs Application. Dated: February 16, 2012 Respectfully submitted, /s/ Eugene F. Assaf Eugene F. Assaf, P.C. (D.C. Bar # 449778) Edwin John U (D.C. Bar #464526) John OQuinn (D.C. Bar # 485936) Elizabeth M. Locke (D.C. Bar # 976552) Michael W. McConnell (admitted pro hac vice) Susan Marie Davies (admitted pro hac vice) KIRKLAND & ELLIS LLP 655 Fifteenth Street, N.W., Suite 1200 Washington, DC 20005 Tel: (202) 879-5000 Fax: (202) 879-5200 eugene.assaf@kirkland.com edwin.u@kirkland.com john.oquinn@kirkland.com Josephine Wang (D.C. Bar #279299) General Counsel Securities Investor Protection Corporation 805 Fifteenth Street, N.W. Washington, D.C. 20005 Tel: (202) 371-8300 Fax: (202) 371-6728 jwang@sipc.org Attorneys for Securities Investor Protection Corporation
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CERTIFICATE OF SERVICE I hereby certify that on the 16th day of February, 2012, I served the Securities Investor Protection Corporations Opposition to the SECs Application For Order Under 15 U.S.C. Section 78ggg(b) via ECF to the following:
Matthew T. Martens (martensm@sec.gov) David S. Mendel (mendeld@sec.gov) Securities and Exchange Commission 100 F Street NE Washington, DC 20549 202-551-4481
/s/ Eugene F. Assaf Eugene F. Assaf, P.C. Edwin John U John OQuinn Elizabeth M. Locke KIRKLAND & ELLIS LLP 655 Fifteenth Street, N.W. Washington, D.C. 20005 Telephone: (202) 879-5000 Facsimile: (202) 879-5200 eugene.assaf@kirkland.com edwin.u@kirkland.com john.oquinn@kirkland.com Counsel for Defendant Securities Investor Protection Corporation

SIPC Response To SEC Motion To Show Cause

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IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLUMBIA ) ) ) ) ) ) ) ) ) ) )

MISC. NO. 11-MC-678-RLW [STATUS CONFERENCE SCHEDULED FOR MARCH 5, 2012]

February 16, 2012

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The Burden on the SEC In Producing This Material Is Minimal. .........................31

CONCLUSION ..............................................................................................................................38 CERTIFICATE OF SERVICE ......................................................................................................39

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SIPA Does Not Protect Against Investment Fraud.

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Once a Customer Does Not Mean Always a Customer.

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