SECURITIES AND EXCHANGE COMMISSION, APPELLANT v. SECURITIES INVESTOR PROTECTION CORPORATION, APPELLEE
No. 12-5286
United States Court of Appeals FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued October 16, 2013 Decided July 18, 2014
Appeal from the United States District Court for the District of Columbia (No. 1:11-mc-00678)
Robertson Park, John Heffner, and Mark J. Andrews were on the brief for amici curiae Stanford Victims Coalition, et al. in support of petitioner.
Michael W. McConnell argued the cause for appellee. With him on the brief were Eugene F. Assaf, Edwin J. U, John C. O‘Quinn, Elizabeth M. Locke, and Josephine Wang.
Steven P. Lehotsky, Joshua S. Press, and Noah Levine were on the brief for amici curiae former SEC officials and professors of law in support of appellee.
Steuart Thomsen was on the brief for amicus curiae Financial Services Institute, Inc. in support of appellee.
Before: GARLAND, Chief Judge, SRINIVASAN, Circuit Judge, and SENTELLE, Senior Circuit Judge.
Opinion for the Court filed by Circuit Judge SRINIVASAN.
SRINIVASAN, Circuit Judge: When a brokerage firm faces insolvency, the cash and securities it holds for its customers can become ensnared in bankruptcy liquidation proceedings or otherwise be put at risk. Congress established the Securities Investor Protection Corporation (SIPC) to protect investors’ assets held on deposit by financially distressed brokerage firms. SIPC can initiate its own liquidation proceedings with the aim of securing the return of customers’ property held by the brokerage. SIPC, however, possesses authority to undertake those protective measures only with respect to member brokerage firms. Its authority does not extend to non-member institutions.
In this case, the Securities and Exchange Commission seeks a court order compelling SIPC to liquidate a member broker-dealer, Stanford Group Company (SGC). SGC played an integral role in a multibillion-dollar financial fraud carried out through a web of companies. SGC‘s financial advisors
The question in this case is whether SIPC can instead be ordered to proceed against SGC—rather than the Antiguan bank—to protect the CD investors’ property. It is common ground that SIPC can be compelled to do so only if those investors qualify as “customers” of SGC within the meaning of the governing statute. SIPC concluded that they do not, and the district court agreed. The court reasoned that the investors obtained the Antiguan bank‘s CDs by depositing funds with the bank itself, not with SGC, and they thus cannot be considered customers of the latter. We agree that the CD investors do not qualify as customers of SGC under the operative statutory definition. We therefore affirm the denial of the application to order SIPC to liquidate SGC.
I.
A.
In 1970, Congress enacted the Securities Investor Protection Act (the Act or SIPA) in response to the “failure or instability of a significant number of brokerage firms.” Sec. Investor Prot. Corp. v. Barbour, 421 U.S. 412, 415 (1975). Before the Act, customers of a brokerage firm that fell into
The Act requires the SEC and various industry self-regulatory organizations to notify SIPC upon learning that a SIPC-member firm “is in or is approaching financial difficulty.”
The Act gives the SEC “plenary authority to supervise . . . SIPC” in its implementation of the statute. Barbour, 421 U.S. at 417 (internal quotation marks omitted). For instance, the SEC “may disapprove in whole or in part any bylaw or rule adopted by the Board of Directors of . . . SIPC, or require the adoption of any rule it deems appropriate.” Id. (citing
For the district court to issue such an order, the SEC must show that SIPC has failed to “act for the protection” of the member firm‘s “customers.”
This case arises out of a massive financial fraud perpetrated by Robert Allen Stanford. As described by the SEC, Stanford conducted a “Ponzi scheme,” selling certificates of deposit to investors but then misappropriating billions of dollars in deposited funds to repay earlier investors and finance a lavish lifestyle. See generally Chadbourne & Parke LLP v. Troice, 134 S. Ct. 1058, 1064-65 (2014).
Stanford employed a complex web of companies he owned or controlled to carry out the fraudulent enterprise. Two entities are primarily at issue here: (i) Stanford International Bank, Ltd. (SIBL), a bank organized under Antiguan law, and (ii) Stanford Group Company (SGC), a Houston-based broker-dealer registered with the SEC. SIBL sold certificates of deposit, “debt assets that promised a fixed rate of return.” Chadbourne, 134 S. Ct. at 1064 (internal quotation marks omitted). SGC employees actively promoted the SIBL CDs to investors. SGC was a member of SIPC, while SIBL was not.
The parties stipulated to certain facts concerning the sales of SIBL CDs. To purchase a CD, “an investor had to open an account with SIBL. CD investors wrote checks that were deposited into SIBL accounts and/or filled out or authorized wire transfer requests asking that money be wired to SIBL for the purpose of opening their accounts at SIBL and purchasing CDs.” J.A. 952. “Most . . . investors either received the physical CD certificates or had them held by an authorized designee.” J.A. 953. SGC, for its part, did not itself hold CD certificates for investors. “To the extent that some SIBL CD investors did not receive the physical certificates, the SEC is not relying on that fact to support its claims in this proceeding.” Id. CD investors “received periodic statements from SIBL reflecting the balances in their SIBL accounts.” Id.
Stanford‘s extensive financial fraud was met with a variety of legal responses. In 2009, the SEC filed a civil enforcement action in federal district court against Stanford, SGC, SIBL, and others. The court appointed a receiver for SGC and other entities. The receiver determined that SIBL CDs worth approximately $7.2 billion were outstanding worldwide as of February 2009. The SEC ultimately prevailed, and the court imposed a civil penalty of $6 billion. See Chadbourne, 134 S. Ct. at 1064-65. Stanford himself was convicted in 2012 of conspiracy, wire fraud, mail fraud, obstruction of justice, and money laundering. He was sentenced to 110 years of imprisonment and ordered to forfeit approximately $6 billion. Id. at 1064, 1070. Antiguan authorities separately initiated proceedings to liquidate SIBL and process claims against the bank. SIBL CD investors also brought class action lawsuits against law firms, investment advisors, and other entities that allegedly assisted Stanford in perpetrating the fraud. See Chadbourne, 134 S. Ct. at 1062, 1065 (finding that four such class action suits were not barred by federal securities statutes and could proceed).
This case involves the prospect of a distinct response to the Stanford fraud: an action by SIPC to liquidate SGC. In August 2009, the court-appointed receiver in the SEC‘s civil enforcement action asked SIPC to determine whether it would liquidate SGC in order to protect the assets of investors who had purchased SIBL CDs at the suggestion of SGC employees. SIPC responded that it found no basis under the Act to initiate a liquidation of SGC. In SIPC‘s view, the CD investors were not SGC “customers” within the meaning of the Act, a precondition to liquidation of SGC. SIPC explained that the Act “protects the ‘custody’ function that brokerage firms perform for customers.” J.A. 158. Here, SIPC concluded, the circumstances fell outside the Act‘s custody function because SGC itself never held investors’ cash or securities in connection with their purchase of the CDs. Rather, “cash for the purpose of purchasing CDs . . . was sent to SIBL, which is precisely what the customer intended.” J.A. 160. As for the “physical CDs,” they presumably “were issued to, and delivered to” the investors, and SGC did not “maintain[] possession or control of the CDs.” J.A. 159-60. In short, “SGC is not, nor should it be, holding anything for . . . a customer.” J.A. 160. “The fact that the security has gone down in value, even because of a fraud in which SGC is complicit,” SIPC added, “does not change that result.” J.A. 160. Because the CD investors failed to qualify as “customers” of SGC within the meaning of the Act, SIPC concluded, the investors were ineligible for liquidation protection.
Two years later, the SEC reached the opposite conclusion. In June 2011, the Commission issued a formal analysis stating that investors who had purchased SIBL CDs at the urging of SGC employees qualified as SGC “customers” under the Act. Citing evidence that Stanford had “structured the various
The SEC then filed an application with the district court under
In a second opinion, the district court denied the SEC‘s application on the merits. See SEC v. Sec. Investor Prot. Corp., 872 F. Supp. 2d 1 (D.D.C. 2012). The court adopted SIPC‘s view that SIBL CD investors fail to qualify as SGC “customers” within the meaning of the statute because CD investors never
II.
The SEC appeals the denial of its application under
Because the district court rested its decision on uncontested facts and an interpretation of law, we review that decision de novo. See In re New Times Sec. Servs., Inc. (New Times I), 371 F.3d 68, 75 (2d Cir. 2004); Gordon v. Holder, 632 F.3d 722, 724 (D.C. Cir. 2011). We do not reach the question of the appropriate evidentiary burden, as we resolve the case based on the stipulated facts. We conclude, in agreement with the district court, that SIBL CD investors are not SGC “customers” within the meaning of the Act.
The “principal purpose of SIPA is to protect investors against financial losses arising from the insolvency of their brokers.” In re New Times Sec. Servs., Inc. (New Times II), 463 F.3d 125, 127 (2d Cir. 2006) (internal quotation marks omitted). Before SIPA, when a brokerage firm failed, customer funds and securities held on deposit with the brokerage often became depleted or enmeshed in bankruptcy proceedings. See Barbour, 421 U.S. at 415. The Act addresses that issue by protecting the custody function of brokers, i.e., by “protect[ing] customer interests in securities and cash left with broker-dealers.” Louis Loss & Joel Seligman, Securities Regulation § 8.B.5.A, at 3290 (3d ed. 2003) (citing legislative history). SIPA thus aims “to protect securities investors against losses resulting from the failure of an insolvent or otherwise failed broker-dealer to properly perform its role as the custodian of customer cash and securities.” 1 Collier on Bankruptcy ¶ 12.01, at 12-4 (16th ed. 2014).
The Act generally affords no protection against other types of losses, such as those stemming from a decline in investment value. That is so even if a broker fraudulently induced the losing investment in the first place. Consequently, “if a broker used fraudulent means to convince a customer to purchase a stock and the customer left that stock with the broker, who subsequently became insolvent, SIPC would be required by SIPA only to return the stock to the customer.” Sec. Investor Prot. Corp. v. Vigman, 803 F.2d 1513, 1517 n.1 (9th Cir. 1986). In that fashion, the statute “‘works to expose the customer to the same risks and rewards that would be enjoyed had there been no liquidation.‘” New Times II, 463 F.3d at 128 (quoting 6 Collier on Bankruptcy ¶ 741.06[6] (15th ed. rev.)). Investors who suffer losses in investment value resulting from fraud may have claims under other provisions of the securities laws. See
SIPA‘s definition of “customer” embodies the Act‘s focus on a broker‘s role as custodian of its customers’ property. SIPA defines “customer” as
any person . . . 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.
Here, insofar as the analysis focuses on the entity that in fact held custody over the property of the SIBL CD investors, the investors fail to qualify as “customers” of SGC under the statutory definition. That is because SGC never “received, acquired, or held” the investors’ cash or securities.
B.
The Commission‘s principal response is that we should disregard the legal separateness of SGC and SIBL and treat them as a combined entity. According to the Commission, the companies operated in a highly interconnected fashion in furtherance of the fraudulent Ponzi scheme, eschewing corporate formalities. As a result, the Commission contends, investors
The Commission grounds its argument for disregarding the corporate separateness of SIBL and SGC in the doctrine of “substantive consolidation,” an equitable doctrine typically applied in bankruptcy proceedings. “In general, substantive consolidation results in the combination of the assets of [two] debtors into a single pool from which the claims of creditors of both debtors are satisfied ratably.” 2 Collier on Bankruptcy ¶ 105.09[3], at 105-110–11; see In re Auto-Train Corp., 810 F.2d 270, 276 (D.C. Cir. 1987). Courts have employed a “variety” of tests when assessing whether to grant substantive consolidation. 2 Collier on Bankruptcy ¶ 105.09[2][a], at 105-96; e.g., In re Owens Corning, 419 F.3d 195, 210-11 (3d Cir. 2005). With regard to the Stanford companies, the court overseeing the receivership in connection with the SEC‘s civil enforcement action concluded that substantive consolidation was warranted.
The doctrine of substantive consolidation has been applied in SIPA liquidations. In New Times I, for instance, the bankruptcy court substantively consolidated a SIPC-member broker undergoing liquidation with a related, non-broker entity. 371 F.3d at 73. The assets of the related entity were brought into the SIPC member‘s liquidation estate, enlarging the available pool for customer recovery. Id. Investors with cash on deposit with the non-broker entity were treated as “customers” in the liquidation, even though the member broker itself never held those investors’ funds. Id. Here, the SEC
Even if we were to consolidate, however, SIBL CD investors would not be “customers” of a SIPC-member entity under the statutory definition. The Act specifically excludes from “customer” status “any person, to the extent that . . . such person has a claim for cash or securities which by contract, agreement, or understanding, or by operation of law, is part of the capital of the debtor.”
The circumstances are directly analogous to those in New Times II. In that case, SIPC had liquidated a member brokerage firm, New Times Securities Services, Inc. (New Times), whose principal had defrauded investors. See New Times II, 463 F.3d at 126-27; New Times I, 371 F.3d at 71-72. A related, non-SIPC-member entity, New Age Financial Services, Inc. (New Age), was brought into the liquidation through substantive consolidation. See New Times I, 371 F.3d at 73. The issue in New Times II was whether individuals who had been defrauded into investing in “promissory notes” issued by New Times and New Age could recover as “customers” in the liquidation. See New Times II, 463 F.3d at 126-27. The Second Circuit held that they could not. Id. at 127-30. The court explained that the Act‘s “customer” definition “distinguishes between (i) claimants (protected as customers) who are engaged through brokers in trading activities in the securities markets and (ii) those (unprotected) claimants who are relying on the ability of a business enterprise to repay a loan.” Id. at 128 (citing
The SEC does not dispute that funds loaned to an entity generally become part of the entity‘s “capital” within the meaning of
That intention also sets this case materially apart from the decisions on which the SEC relies, Primeline, 295 F.3d 1100, Old Naples, 223 F.3d 1296, and In re C.J. Wright & Co. Inc., 162 B.R. 597 (Bankr. M.D. Fla. 1993). In each of those cases, the investors had no intention to loan their funds to any affiliated entity that might be considered consolidated with the SIPC-member firm. Instead, the individuals sought to invest cash to obtain debt instruments issued by an unrelated third party. See Primeline, 295 F.3d at 1104, 1110; Old Naples, 223 F.3d at 1300-01, 1304-05; C.J. Wright, 162 B.R. at 606. The investors sought to invest “through” the consolidated entity, not “in” the consolidated entity. 1 Collier on Bankruptcy ¶ 12.12[4][a], at 12-56. The investors’ funds therefore could not be considered
Indeed, the
The SEC makes one additional argument in contending that the
C.
The SEC raises a fallback argument in the event we reject its effort to treat SGC and SIBL as one consolidated entity. According to the SEC, regardless of whether the companies are consolidated, investors who gave cash to SIBL for CDs should be deemed to have deposited cash with SGC under the approach set forth in Old Naples and Primeline. Those decisions, however, do not support concluding that the CD investors may be considered “customers” of SGC. The decisions instead reinforce our conclusion that the capital exclusion in
In Old Naples, the Eleventh Circuit considered another financial fraud involving both a SIPC-member broker and a non-SIPC-member entity. 223 F.3d at 1299-1300. Investors received instructions to send money to both entities with the understanding that the broker would then purchase bonds in the investors’ names. Id. at 1301. Instead of buying the bonds, the owner of the entities misappropriated investor funds for his personal use and for payment of the brokerage firm‘s expenses. Id. at 1300. The Eleventh Circuit held that investors who had sent money to the non-SIPC-member entity could recover in the
The Tenth Circuit‘s decision in Primeline is to the same effect. There, an employee of a SIPC-member firm operated a Ponzi scheme involving the sale to investors of “debentures in fictitious corporations.” 295 F.3d at 1104 (internal quotation marks omitted). At the employee‘s direction, investors made out checks to third-party accounts—not to the brokerage firm itself—from which the employee misappropriated investor funds. Id. Citing Old Naples, the Tenth Circuit reiterated the principle that, “[i]f a claimant intended to have the brokerage purchase securities on the claimant‘s behalf and reasonably followed the broker‘s instructions regarding payment, the claimant is a ‘customer’ under SIPA even if the brokerage or its agents misappropriate the funds.” Id. at 1107. The court affirmed the bankruptcy court‘s finding that investors had “reasonably thought” that the employee was “acting as an agent of [the broker] when he directed them to make out their checks to one of his third-party companies.” Id. (internal quotation marks omitted). As a result, the court held, those investors were entitled to recover as “customers” in the liquidation. Id. at 1109.
We need not resolve that disagreement. Even if certain SIBL CD investors reasonably believed that they had deposited cash with SGC, Old Naples and Primeline still would fail to support concluding that those investors qualify as “customers” under the Act‘s definition. The SEC‘s argument disregards a subsequent inquiry undertaken in both Old Naples and Primeline: whether the investors intended to deposit their funds
This case stands on a markedly different footing. Here, as explained, the investors who purchased SIBL CDs acted as lenders. Even assuming those investors reasonably believed SIBL and SGC were part of a unified Stanford entity, they deposited their cash with that entity as lenders: in exchange for a promise of repayment in the form of a CD. Their funds thus became part of the Stanford entity‘s “capital” for purposes of the
* * * * *
In declining to grant the SEC‘s requested relief, the district court expressed that it was “truly sympathetic to the plight of the SGC clients who purchased the SIBL CDs and now find themselves searching desperately for relief.” 872 F. Supp. 2d at 12. We fully agree. But we also agree with the district court‘s
So ordered.