The use of the net investment method to measure the claims of investors who purchased certificates of deposit in the alleged Stanford Ponzi scheme, as urged in an SEC Analysis, would be unsupported by law or policy, in the view of a securities industry group. In a letter to the SIPC, the Securities Industry and Financial Markets Association (SIFMA) noted that, unlike the situation in the cases relied upon by the SEC , including the liquidation of Bernard L. Madoff Investment Securities LLC, the purchasers of Stanford certificates actually purchased the very security they sought to acquire.
While the Securities Investor Protection Act does not prescribe a single means of calculating net equity that applies in the myriad circumstances that may arise in a SIPA liquidation, a Second Circuit panel recently ruled that the Madoff Trustee’s selection of the Net Investment Method was more consistent with the statutory definition of net equity than any other method advocated by the parties, including the Last Statement Method. Both SIPC and the SEC submitted briefs supporting the Trustee’s use of the Net Investment Method.
On June 15, 2011, the SEC issued an analysis of Securities Investor Protection Act coverage for the Stanford Group Company invoking the net investment method. In the view of SIFMA, valuing the claims of purchasers of the Stanford certificates of deposit on a net investment basis would result in an unprecedented expansion of SIPA protection to ordinary investment losses. The SEC Analysis is fundamentally inconsistent with SIPA‘s narrow mandate, said SIFMA, and, if followed, would result in an unprecedented expansion of SIPA protection with a concomitant increase in assessments levied against SIPC members.
SIPA is a narrowly crafted statute designed to accomplish a narrow goal, said SIFMA, its sole purpose is to protect customers against the loss of their cash and securities which are in the custody of a broker-dealer that becomes insolvent. SIPA gives preferential status to the net equity claims of customers in a liquidation of a broker-dealer by requiring the customer property held by the debtor to be used, pro rata, to satisfy customers‘ net equity claims and providing for advances from SIPC of up to $500,000 on each customer‘s net equity claim. SIFMA emphasized that SIPA does not, and never has been intended to, comprehensively protect investors from the risk that some deals will go bad or that some securities issuers will behave dishonestly.
The Stanford customer net equity claims are limited to the value of the CDs they purchased. These investors transferred funds for the purchase CDs, noted SIFMA, and CDs were in fact purchased with those funds.
The SEC Analysis is based on the use of a similar net investment measure for net equity claims in prior Ponzi scheme cases, including most recently in the case of the Madoff Ponzi scheme. In those cases, customers intended for securities to be purchased for their accounts but such securities were not actually purchased. In some cases, purchases of fictitious securities were reported to the customers; in other cases, fictional purchases of real securities were reported to the customers; and in still other cases, the securities to be purchased were only identified by general type and were not actually purchased for the customers‘ accounts The rationale for applying the net investment measure of net equity in these cases is that the broker-dealer accepted the customer‘s cash but failed to execute the trade the customer intended to accomplish or that was reported to the customer.
By contrast, here, unlike the situation in Madoff, customers acquired the securities they intended to purchase, but the security turned out to be essentially worthless. The risk that customers will purchase worthless securities, the value of which has been misrepresented by their issuer and/or a broker who recommends the purchase, is not a risk against which SIPC insures. This is true even if the fraudulent securities are issued or deemed to be issued by the broker-dealer.
According to SIFMA, never before has the net investment measure been applied when the investors‘ funds were actually used to purchase the very securities they intended to purchase. Here, unlike the investors in Madoff, the investors were able to procure the exact debt security they sought to purchase. Thus, the loss suffered by the purchasers of the CDs is an investment loss. The remedy for this loss is not within the scope of SIPA, noted SIFMA, but rather through more traditional securities fraud and breach of fiduciary duties claims.