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Securities and Exchange Commission v. Securities Investor Protection Corporation

July 3, 2012

SECURITIES AND EXCHANGE COMMISSION, APPLICANT,
v.
SECURITIES INVESTOR PROTECTION CORPORATION, RESPONDENT.



The opinion of the court was delivered by: Robert L. Wilkins United States District Judge

MEMORANDUM OPINION AND ORDER

In SIPC v. Barbour, 421 U.S. 412 (1975), the Supreme Court held that persons claiming to be customers of a broker dealer do not have an implied right of action under the Securities Investor Protection Act ("SIPA") to compel the Securities Investor Protection Corporation ("SIPC") to exercise its statutory authority for their benefit. Instead, the Court held that Congress granted the Securities and Exchange Commission ("SEC") the role "of 'plenary authority' to supervise the SIPC[,]" which includes the statutory authority to "seek in district court to compel the SIPC 'to commit its funds or otherwise to act for the protection' of such customers." Id. at 417-18 (quoting S. Rep. No. 91-1218, p.1 (1970) and 15 U.S.C. § 78ggg(b)). As described in this Court's prior opinion,*fn1 this proceeding is the first instance since SIPA was enacted 42 years ago in which the SEC has sought to use its "plenary authority" to compel the SIPC to file an application for a protective decree. Thus, as matters of first impression, this Court must determine the standard of proof required of the SEC, what process is due the parties, and whether the SEC has met its burden of proof.

I.BACKGROUND

As set forth in the Court's prior opinion, of which familiarity is presumed, this case is an outgrowth of the 2009 collapse of a group of companies owned or controlled by Robert Allen Stanford. Stanford allegedly sold over $7 billion worth of certificates of deposit ("CDs") that were issued by the Stanford International Bank, Ltd. ("SIBL"), an Antiguan bank. The CDs were marketed by the Stanford Group Company ("SGC"), a now-defunct broker-dealer that was registered with the SEC and that was a member of SIPC.

The SEC contends that Stanford actually misappropriated billions of dollars and operated a fraudulent "Ponzi scheme" -- in which obligations of the CDs were paid using the proceeds from the sale of new CDs rather than from earnings, liquid assets or reserves. Following an investigation, the SEC brought a civil enforcement action against Stanford and his entities in the Texas federal court. Federal prosecutors have also brought criminal charges, and on March 6, 2012 a jury in the Texas federal court convicted Stanford of conspiracy, wire fraud, mail fraud, obstruction of justice and money laundering. U.S. v. Robert Allen Stanford, 09-cr-00342 (S.D. Tx.), Dkt. No. 808. On June 14, 2012, Stanford was sentenced to 1,320 months (110 years) in prison. Id., Dkt. No. 878.

The Texas federal court has appointed a Receiver to oversee the assets of SGC and other Stanford entities. The Receiver reports that as of February 2009, SGC had approximately 32,000 active accounts for which it acted as the introducing broker.

In early 2009, the Receiver asked SIPC to review whether the SGC customers who were allegedly defrauded were entitled to protection from SIPC. SIPC has declined to file an application for a protective decree for the SGC customers in the Texas federal court -- the court which would have jurisdiction over the liquidation proceeding. SIPC has concluded that the SGC customers are not covered by the statute because, among other grounds, SGC did not perform a custody function for the customers who purchased the SIBL CDs. On June 15, 2011, the SEC delivered a formal analysis to SIPC ("SEC Analysis") arguing that SGC "has failed to meet its obligations to customers," that the SGC customers were in need of the protections of the SIPA, and that SIPC should seek to commence a liquidation proceeding. SIPC has advised the SEC that it has considered the SEC Analysis, that it disagrees with the SEC, and that it will not seek to commence a liquidation proceeding. Hence, the SEC seeks an order from this Court compelling SIPC to commence such a liquidation proceeding.

II.THE LEGAL STANDARDS

A.Burden of Proof

The parties have differing viewpoints with respect to the critical issue of the standard of proof required of the SEC and what process is due the parties. The SEC contends that probable cause supported by hearsay is sufficient to carry its burden, while SIPC argues that the applicable standard is preponderance of evidence supported by admissible evidence. To answer these questions, this Court will observe the recent admonition of our Circuit Court to "heed Professor Frankfurter's timeless advice: '(1) Read the statute; (2) read the statute; (3) read the statute!'" Kellmer v. Raines, 674 F.3d 848, 850 (D.C. Cir. 2012) (quoting Henry J. Friendly, Mr. Justice Frankfurter and the Reading of Statutes, in Benchmarks 196, 202 (1967)).

Heeding this sage advice, the Court turns to the words of the statute. The SIPA provision at issue reads as follows:

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) (emphasis added). Thus, the SIPA statute clearly specifies that the SEC must proceed by "apply[ing] to the district court . . . for an order requiring SIPC" to comply with the statute.

Although not cited by the parties, the SIPA statute provides some general, but significant, guidance about how its provisions should be interpreted. The statute specifies that except as expressly provided otherwise, SIPA should be construed as if it were an "amendment to" and "included as a section of" the Securities Exchange Act of 1934. 15 U.S.C. § 78bbb.*fn2 (The Securities Exchange Act of 1934 is also commonly referred to as the "1934 Act." Id.)

This interpretative guidance is noteworthy, because the 1934 Act contains a specific provision that authorizes the SEC to file an "application" for an "order" that "command[s]" a person or entity "to comply" with the 1934 Act. 15 U.S.C. § 78u(e)(1).*fn3 This provision is found in Section 21(e) of the 1934 Act [codified at 15 U.S.C. § 78u(e)]. See text at http://www.sec.gov/about/laws/sea34.pdf. Such an application, "commanding" a person "to comply" with the 1934 Act, bears a remarkably close resemblance to an application by the SEC, pursuant to SIPA, "requiring" SIPC "to discharge its obligations" under SIPA. The similarity between the two provisions is quite significant since SIPA is meant to be construed as if it were part of the 1934 Act.

Several courts have had occasion to determine the burden of proof attendant to an SEC application to enforce compliance pursuant to Section 21(e) of the 1934 Act. Our Circuit has held that the preponderance of the evidence standard is the appropriate burden of proof when the Commission seeks a permanent injunction pursuant to the 1934 Act. Securities and Exchange Commission v. Savoy Industries, Inc., 587 F.2d 1149, 1168-69 (D.C. Cir. 1978). While the court in Savoy did not specifically state that the SEC application for injunction was brought pursuant to Section 21(e) of the 1934 Act, this basis for the application was made clear in a subsequent opinion. Securities and Exchange Commission v. Savoy Industries, Inc., 665 F.2d 1310, 1317 n.54 (D.C. Cir. 1981) ("Section 21(d) of the Securities Exchange Act, 15 U.S.C. § 78u(d) (1976), authorizes SEC to sue in the federal district courts for injunctions against violations of the federal securities laws. By § 21(e), 15 U.S.C. § 78u(e) (1976), these courts are empowered to issue injunctions commanding compliance with the laws and regulations promulgated thereunder."). Accordingly, in this Circuit, the SEC must prove a violation of the 1934 Act by a preponderance of the evidence to obtain a permanent injunction. Id.; see also S.E.C. v. International Loan Network, Inc.. 770 F.Supp. 678, 688 n.10 (D.D.C. 1991) (applying preponderance standard to SEC request for injunction, citing Savoy and Section 21(e) of the 1934 Act); S.E.C. v. Moran, 922 F.Supp. 867, 887-90 (S.D.N.Y. 1996) (Judge Newman of the Second Circuit, sitting by designation, follows Savoy and holds that the preponderance of evidence standard applies to civil enforcement actions brought by the Commission pursuant to Section 21(e) of the 1934 Act); S.E.C. v. Tome, 638 F.Supp. 596, 620 n.45 (S.D.N.Y. 1986) (noting that in injunctive action brought by SEC pursuant to Section 21(e) of the 1934 Act, "preponderance of the evidence standard is the proper burden of proof . . . .").

While a strong argument could be made that the current application by the Commission, brought pursuant to 15 U.S.C. § 78ggg(b), seeking an order compelling SIPC to comply with the requirements of the SIPA statute, is really the same as an application brought by the Commission pursuant to 15 U.S.C. § 78u(e)(1) to enforce the 1934 Act, the Court need not reach that issue today. It shall suffice for present purposes to hold that Savoy and the related authority pursuant to the 1934 Act compel the conclusion that the preponderance standard is the appropriate burden for the Commission to bear to obtain the relief sought in the present Application pursuant to 15 U.S.C. § 78ggg(b). This result seems particularly sound not only because Congress has directed that SIPA be construed as if it were a part of the 1934 Act, but also because of the preference for the preponderance standard in civil litigation generally. See Herman & MacLean v. Huddleston, 459 U.S. 375, 387-91 (1983) (holding that the preponderance of evidence standard is generally appropriate in a civil action brought by a private plaintiff to adjudicate violations of the 1934 Act). *fn4 In addition, the Court is mindful that SIPC, a corporate body, is entitled to due process in the present proceeding, even if the SEC is considered to be its plenary supervisor under the SIPA statutory scheme. It is quite clear that the initiation of a SIPA liquidation would potentially involve tens of thousands of claimants and entail millions of dollars in administrative costs, even if all of the claims were ultimately denied. Such a cost would place a great burden upon SIPC that is not eliminated by the SEC offer to "loan" funds to SIPC, since SIPC ultimately would have to repay any such loan to the SEC, resulting in costs that would be ultimately borne by SIPC members rather than the SEC.

Accordingly, the SEC has the burden of proving, by a preponderance of the evidence, that SIPC has "refus[ed] . . . to commit its funds or otherwise to act for the protection of customers of ...


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