Stanford International Bank Fraud

While Bernie Madoff was busy having his face shown all over the news last year, a smaller but equally devastating Ponzi scheme was discovered by federal authorities: Standford International Bank (“SIB”). Because of the dollars involved in Madoff’s scam ($65 billion), the Stanford fraud ($7.2 billion) didn’t get much press coverage. However, for the victims of this fraud, the outcome may be worse.

Stanford International Bank was started in 1986 by Allen Stanford. Based out of Antigua in the Carribean, the bank primarily sold CDs and offered better than average rates of return on their products. In February 2009, federal agents raided the headquarters in Texas with a court order to place the company in the hands of a receiver. Assets were frozen and records seized. In the interim receiver’s report dated July 1, 2010, SIB had $7.2 billion in outstanding CDs and only $46 million in cash. The rest, the SEC alleges, was used to pay previous investor distributions and line the pockets of Allen Stanford and other employees.

The protections provided for victims of fraud in the United States are overseen by two agencies: 1) Federal Deposit Insurance Corporation (“FDIC”) and 2) Securities Investor Protection Corporation (“SIPC”). However, for victims of the Stanford fraud, it appears that neither of these agencies will be able to assist. FDIC is charged with regulating US banks and providing insurance for depositors in the case of fraud or insolvency. However, since SIB was headquartered in Antigua, this falls outside FDIC’s jurisdiction. SIPC is a lesser known organization that is charged with protecting investors from harm if a securities dealer fails. It was created in 1970, and is operated as a nonprofit funded by its members. This is the organization that is helping to make whole a good deal of Bernie Madoff’s victims. Stanford’s parent company was headquartered in Texas, so at first it looked as if there might be some coverage. However, this was proven not to be the case due to a crucial distinction in the coverage SIPC provides. This is from the same report referenced above.

Question 2. I understand that the U.S. Securities Investor Protection Corporation (“SIPC”) provides protection for securities in customer accounts when a brokerage firm is closed due to financial difficulties. Is SIPC protection available to cover the losses on my SIB CDs? First, SIPC coverage is very different from FDIC coverage. SIPC protects only the custodial function of an insolvent member firm. Thus, SIPC only provides protection for securities and cash that are missing from a customer’s account at a SIPC member firm. That is, SIPC only ensures that securities and cash that are contained in a customer account at a SIPC member firm remain in the customer’s account. SIPC does not insure or otherwise provide protection for a loss in the value of the securities that are in the customer’s account, whether the loss in value occurs because of changed business conditions, fraud on the part of the issuer, or any other reasons. In this case, the securities themselves – the certificates of deposit – are not missing. The problem instead is that they are not backed by cash or other assets sufficient to repay any significant portion of the amount owed. Although there has been a substantial loss in the value of the SIB CDs, SIPC provides no protection for such a loss in value.

So, in summary, because the securities (SIB CDs) were not missing from customers’ accounts, SIPC disclaims any obligation to offer assistance. While I understand the distinction, this feels like a loophole. In addition to the $80.5 million in cash on hand as of June 24, 2010, the receiver lists $847.3 million in potential assets, so at best victims are looking at 10%-12% recovery. At worst, nothing. The lesson of the wave of 2008/2009 Ponzi schemes is that no matter how well run they are, in a down market, the frauds will be uncovered. So, by all means, if you feel like spending your golden years in prison, give it a shot. Skilling, Ebbers, Madoff, Kozlowski, and others will be there to keep you company.