By Sarah N. Lynch
WASHINGTON (Reuters) - A federal district judge on Tuesday delivered a blow to the victims of Allen Stanford's $7 billion Ponzi scheme, rejecting a request for an industry-backed fund to start a court proceeding that could lead to victim compensation.
The Securities and Exchange Commission had sought to force the Securities Investor Protection Corp to start liquidation proceedings for the victims, some of whom lost millions of dollars to the fraud.
The judge found that the SEC did not meet its legal burden of showing why SIPC should be compelled to act.
SIPC, which has handled high-profile liquidations such as Bernard Madoff's Ponzi scheme, contended that Stanford's offshore bank fell outside the scope of its authority.
The law, SIPC argued, limits it to protecting customers against the loss of missing cash or securities in the custody of failing or insolvent SIPC-member brokerage firms.
While Stanford's Texas-based brokerage Stanford Group Company was a SIPC member, its offshore bank was not. And in any case, SIPC said it was not chartered by Congress to combat fraud or guarantee an investment's value.
Allen Stanford was sentenced in June to 110 years in prison for bilking investors with fraudulent certificates of deposit issued by Stanford International Bank, his bank in Antigua.
Since 2009 when Stanford was first arrested and charged, victims of the fraud have been fighting for SIPC to start a liquidation proceeding in the hope of getting back at least some of the funds they lost.
"The court is truly sympathetic to the plight" of the victims, Judge Robert Wilkins for the U.S. District Court for the District of Columbia wrote in dismissing the SEC's case. "But this court has a duty to apply the SIPA statute as written by Congress."
This marks the first time in the 42-year-history of the Securities Investor Protection law that the SEC asked a court to try and force SIPC to start a liquidation proceeding.
In a brokerage liquidation, a trustee winds down the business, returns securities and other assets to customers and creditors, and often tries to recover additional assets. The goal is to maximize what customers and creditors recover, and distribute assets fairly.
Stephen Harbeck, the president and CEO of SIPC, called the judge's order the "right ruling," but noted that SIPC doesn't "take a lot of joy" out of it because of the plight of the victims.
"We never crossed swords with the SEC to start a case in 40 years," he said. "We did it with great seriousness."
The SEC now has 60 days to decide whether or not to appeal the judge's ruling.
SEC spokesman John Nester said the agency is "reviewing the decision."
Angela Shaw, the director of the Stanford Victims Coalition, said she was "floored" by the decision, and urged the SEC to appeal and keep on fighting for the victims.
"I hope the SEC does go back to bat for investors," she said. "I am upset, but I am still hopeful."
In his first-of-its-kind ruling, Judge Wilkins found that the SEC relied on an "extraordinarily broad" interpretation of the law on which to base its case.
He also criticized the agency, saying its argument for why SIPC should act "cannot be squared with the SEC's longstanding interpretation" of the law over the years.
Republican Senator David Vitter, who has been a vocal advocate for the victims, sought to apply some pressure on the SEC on Tuesday to continue fighting the matter in court. "This is horribly disappointing news, especially since it's clear that Allen Stanford was more than guilty in fraudulently losing the victims investments," he said.
"I will be encouraging the Securities and Exchange Commission Chairwoman Mary Schapiro to explore every possible appeal option. The Stanford Ponzi scheme victims should not take the fall over SIPC's concerns to cover their own losses."
(This version of the story has been corrected to change "chairwomen" to "chairwoman" in last paragraph)
(Reporting by Sarah N. Lynch; editing by John Wallace and Sofina Mirza-Reid)