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The U.S. Bankruptcy Court for the Southern District of New York has decided that claims stemming from soft dollar credits aren’t qualified to avail of Securities Investor Protection Act. According to Judge James Peck, this is the first time a court has had to determine whether soft dollar claims qualify as customer claims under SIPA.

The motion was filed by James Giddens, the Lehman Brothers Inc. trustee, who sought to affirm the denial of securities claims made by dozens of hedge funds and money managers seeking to get back soft dollar credits in their accounts with Lehman. Soft dollars are commission credits that can be used for buying research and brokers services that fall under the Securities Exchange Act of 1934’s Section 28(e)’s “safe harbor” parameters. (Generally, a soft dollar arrangement includes an understanding or agreement through which a discretionary money manager obtains research or other services from a broker-dealer. This is done in return for brokerage commission from transactions involving the accounts of discretionary clients.) While Giddens decided that these claims did not have SIPA protection and were “general unsecured claims,” a number of claimants disagreed.

The bankruptcy court, however, sided with Giddens. The court said that not only are soft dollar credits not securities and can only be used for the purposes identified under the Securities Exchange Act of 1934’s Section 28(e), but also, soft dollar accounts are “exclusively” available to “brokerage and research services” that a broker provides and cannot go toward the purchase of securities. Therefore, said Judge James Peck, Soft Dollar Claimants’ claims involving their Soft Dollar Accounts can’t be dealt with as if they were customer claims made under SIPA.

The bankruptcy court disagreed with claimants’ argument that because the credits could be used for research that would direct the clients in their purchase of securities there was a “sufficient connection” between a securities purchase and the soft dollars. The claimants had argued that this type of link made them customers under SIPA’s meaning. The court said no, finding that under the statute, the definition of a customer is meant to be “narrowly construed” and credits that can only go toward market research expenses are not tangential or direct enough to fulfill SIPA’s definition of what is a customer.

The court also disagreed with the claimants’ argument that the credits, which are proceeds of securities that have been sold or converted, should be considered customer property under SIPA. The court said that soft dollar credits are associated not with securities trade proceeds but with broker-dealer commissions. Peck also said that considering their character and source, the “credits are not customer property.” The court said that the claims were “really breach of contract claims” falling under the unsecured claims umbrella.

More Blog Posts:

Montana Supreme Court Says Lower Court’s Finding that Tenancy-in-Common Investment Is Not A Securities Was In Error, Stockbroker Fraud Blog, July 20, 2012

The Securities and Exchange Commission and the Securities Investor Protection Corporation are at odds over what the standard of proof should be used for the SEC’s application to make SIPC start liquidation proceedings for Stanford Group Co. The SEC recently sued the non-profit corporation, which is supposed to provide coverage protection for investors in the event that the brokerage firm they are working with fails. The SIPC has so far refused to provide the defrauded investors of R. Allen Stanford’s $7 billion Ponzi scam with any compensation, contending that the Stanford bank involved in the scam was Stanford International Bank Ltd. in Antigua and not SIPC member Stanford Group. Stanford has been convicted on 13 criminal counts related to the financial fraud.

During a U.S. District Court for the District of Columbia hearing, SC chief litigation counsel Matthew Martens said the probable cause standard is sensible in light of the Securities Investor Protection Act’s structure. SIPC lawyer Eugene Frank Assaf Jr., however, contended that the preponderance of the evidence standard is the one that should be used. Assaf said this should be the standard because this is SIPC’s only chance to seriously challenge the “compulsion issue.”

The SEC and SIPC have been battling it out since June 2011 when the Commission asked the latter to start liquidation proceedings on the grounds that individuals who had invested in the Ponzi scam through SGC deserved protection under SIPA. SIPC, however, did not act on this request. So the SEC went to court to get an order compelling the nonprofit organization to begin liquidating. The Commission was granted a partial win last month when the court found that a summary proceeding would be enough to resolve the SEC’s application.

Some 21,000 clients who purchased CD’s through SGC would be able to file claims for reimbursement through SIPA if the SEC prevails in this case.

Earlier this month, SIPC CEO and President Stephen Harbeck stood by the entity’s decision to not provide loss coverage to the victims of R. Allen Stanford’s Ponzi scam. When giving testimony to the House Financial Services Capital Markets Subcommittee, Harbeck noted that Stanford’s investors made the choice to send their assets to an offshore bank that wasn’t protected by the US government.

He pointed to the SEC’s own statements regarding how the CDs these investors purchased paid return rates that were “excessive” and likely “impossible.” He said that SIPA has never been interpreted to “pay back the purchase price of a bad investment. ”

SEC Suit Pursues Payouts by SIPC, The Wall Street Journal, December 13, 2011

Securities Investor Protection Corporation

More Blog Posts:

SEC and SIPC Go to Court Over Whether SIPA Protects Stanford Ponzi Fraud Investors, Stockbroker Fraud Blog, February 6, 2012

SEC Sues SIPC Over R. Allen Stanford Ponzi Payouts, Stockbroker Fraud Blog, December 20, 2011

SEC Gets Initial Victory in Lawsuit Against SIPC Over Payments Owed to Stanford Ponzi Scam Investors, Institutional Investor Securities Blog, February 10, 2012 Continue Reading ›

Articles Tagged with SIPA

No SIPA Coverage for Soft Dollar Credits, Says Bankruptcy Court

SEC and SIPC Clash Over Standard of Proof Necessary to Insure Investors For Stanford Ponzi Fraud Losses