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Editor: Eric C. Chaffee
Univ. of Toledo College of Law

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Thursday, July 5, 2012

Court Rejects SEC's Broad Definition of Customers: Stanford Investors Out of Luck

As I previously blogged, on July 3 the federal district court (D.C.) denied the SEC's application for an order compelling SIPC to commence a liquidation proceeding to protect customers who purchased CDs issued by an Antiguan bank marketed by the Stanford Group Company, a now-defunct broker-dealer that was a member of SIPC.  I now have read the court's opinion which concludes that the SEC failed to meet its burden of proving that SIPC "has refus[ed] ... to commit its funds or otherwise to act for the protection of customers of any member of SIPC."  (Download SECvSIPC)

While expressing sympathy to the plight of the Stanford customers who purchased the CDs, the court noted its duty to apply the statute as written by Congress.  The key issue in the dispute is whether the persons who purchased the CDs were "customers" of SGC within the meaning of the statute.  The court reviews the law and finds it well-settled that "the critical aspect of the 'customer' definition is the entrustment of cash or securities to the broker-dealer for the purpose of trading securities."  To prove entrustment, the claimant must prove that the SIPC member actually possessed the claimant's funds or securities.  Pursuant to facts stipulated by the parties, the SEC cannot show that SGC ever physically possessed the investors' funds at the time that the investors made their purchases.  The investors wrote checks or wired funds to the bank for the purpose of buying the CDs; the funds were never deposited into a SGC account.  Under a literal meaning of the statute, the investors were not customers of SGC.  The court declined the SEC's invitation to adopt a broader construction of the statute, finding that it did not square with the agency's longstanding interpretation of SIPA and was contrary to the statutory language.

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