In Re: New Times Securities Services, Inc. And New Age Financial Services, Inc., Debtors. Myrna K. Jacobs, Simon and Helga Noveck, Miriam Seidenberg, Felice Linder, Angelo Scarlata, the Rose Marie Ceparano Irrevocable Trust, the Estate of Allan A. Blynd, Salvatore and Stella Digiorgio, Project Earth Environmental Fundraisers, Inc., New York Optical, Inc., the Carl Carter Irrevocable Trust, Craig Roffman, Ellen Eschen, and Jill Gundry, Claimants-Appellees
Docket: 02-6166
Court: Court of Appeals for the Second Circuit; June 8, 2004; Federal Appellate Court
Claimants-Appellees, defrauded by William Goren into purchasing shares in fraudulent mutual funds offered by New Times Securities Services, Inc. and New Age Financial Services, Inc., sought reimbursement under the Securities Investor Protection Act of 1970 (SIPA). The SIPA Trustee initially classified their claims as "claims for cash," subject to a $100,000 limit, based on the amount paid for the bogus funds. However, the U.S. District Court for the Eastern District of New York later ruled that the Claimants had "claims for securities," allowing for higher advances of up to $500,000 and valuing the claims according to the equity reflected in the Claimants' final account statements, including fictitious dividends.
Upon appeal, the Second Circuit affirmed that the Claimants had "claims for securities" but held that the District Court incorrectly calculated claim values using fictitious account statements. The Court ruled that the net equity for each Claimant should be based solely on their original investments, excluding any fictitious amounts. The Court rejected the narrower interpretation of SIPA proposed by the SIPC, favoring the SEC's broader interpretation of the statute.
Goren defrauded Long Island and Queens investors of approximately $32.7 million from 1983 to 2000 through his companies, New Times and New Age. His fraudulent activities included soliciting investments in fictitious money market funds, non-existent shares of legitimate mutual funds, and fraudulent promissory notes, while misappropriating the invested funds. In response to his actions, the SEC filed a complaint against Goren and his companies on February 17, 2000, leading to a preliminary injunction that froze Goren's assets and appointed a temporary receiver. Goren ultimately pleaded guilty to securities fraud and is serving an 87-month prison sentence.
Following these events, on May 18, 2000, the court ordered the liquidation of New Times under the Securities Investor Protection Act (SIPA), appointing James W. Giddens as Trustee. The liquidation process was referred to the Bankruptcy Court, while New Age remained under the District Court's receivership. During SIPA liquidation, the trustee must address customers' net equity claims, defined as the total amount owed to customers based on their accounts at the time of liquidation, adjusted for any debts owed by the customers. Claims are satisfied first through a pro rata distribution of "customer property," which includes cash and securities held by the failed broker-dealer.
SIPC maintains a reserve fund, funded by assessments on member revenues and Treasury note investments. If a customer's net equity exceeds their share of customer property, the trustee can use SIPC funds to fulfill claims. SIPA limits SIPC advances to $500,000 per customer for net equity claims, with a maximum of $100,000 for cash claims. Claims for securities may be satisfied without the cash limit.
Early in the New Times liquidation, the Trustee discovered significant overlapping operations between New Times and New Age in their public communications. With SIPC's approval, the Trustee sought a court order to substantively consolidate the estates of the two entities to enhance recovery for victims of Goren's fraudulent activities, regardless of whether they had transacted with New Times or New Age. This motion received support from the SEC and was granted by the Bankruptcy Court on November 27, 2000, resulting in the pooling of the assets and liabilities of both entities, which are now administered under the Bankruptcy Court's jurisdiction.
A total of over 900 claims have been filed in the liquidation process, including 174 claims from individuals, primarily elderly retirees, who were fraudulently induced by Goren to invest in fictitious money market funds. The Claimants believed they were investing in legitimate, low-risk mutual funds, unaware that the New Age Funds did not exist, were never organized or registered with the SEC, and lacked necessary prospectuses. Goren had embezzled their investments, and despite receiving confirmations and monthly statements, the funds were non-existent.
The Trustee classified the claims as "claims for cash" due to the non-existence of the securities, limiting them to $100,000 in cash advances based on the amounts paid for the fictitious shares, excluding any reported dividends or interest. Any claims exceeding this amount would be considered general unsecured claims, with the Trustee cautioning that the consolidated estate would likely not have sufficient funds to cover these claims.
Investors misled by Goren believed they were investing in real mutual funds, receiving account statements that reflected hypothetical transactions. Despite not actually being invested, these claims were classified as "securities claims," making them eligible for up to $500,000 in SIPC advances, as the Trustee could procure real securities to satisfy these claims. This treatment contrasted with "cash claimants," who lacked the ability to verify the existence of mutual funds.
The Claimants objected to the Trustee's classification of their claims as cash claims and sought compensation for interest and dividend reinvestments. Following a recusal by Bankruptcy Judge Bernstein, District Court Judge Platt assumed exclusive jurisdiction. The District Court upheld the Claimants' objections, determining their claims were for securities, valuing them based on the equity stated in their final account statements, which included fictitious earnings. This decision was aligned with SIPA's goals to promote investor confidence and was based on the "Series 500 Rules," which address customer claims based on written confirmations of securities transactions.
The Trustee's initial determination was criticized for relying on the actions of the fraud perpetrator, Goren. Following the District Court's ruling, the Trustee and SIPC appealed, leading to an examination of whether the Claimants should be classified as having "claims for securities" under SIPA, the appropriate calculation of their "net equity," and the level of deference to the SEC’s interpretation of SIPA in contrast to SIPC's interpretation.
The District Court's legal conclusions regarding SIPA and the Series 500 Rules are reviewed de novo. There is a clear conflict in interpretations between the SEC and SIPC concerning section 9(a)(1) of SIPA. All parties, including the Claimants, agree on several points: (1) Claimants qualify as "customers" under SIPA due to cash deposits for securities purchase; (2) the securities in question do not exist; (3) Series 500 Rules are inapplicable; and (4) the Trustee correctly assessed the Claimants' "net equity" based on the cash amounts paid to the Debtors. The Trustee and SIPC calculate net equity based on what would have been owed had the securities been liquidated, leading to the conclusion that claims are cash claims limited to $100,000 in SIPC advances. In contrast, the SEC argues that the Claimants should be viewed as having "claims for securities" due to the purchase confirmations and account statements, despite the securities being fictitious.
The document further discusses the relationship between SIPC and the SEC. SIPA explicitly states that SIPC is not a government agency but an independent corporation with specific responsibilities for liquidations and net equity claims. While SIPC acknowledges some supervisory authority of the SEC, it asserts its independence. However, Congress has limited SIPC's authority compared to the SEC, which has been granted "plenary authority" to oversee SIPC, as established by the Supreme Court. The legislative intent was for the SEC to provide substantial oversight over SIPC's operations.
SIPA grants SIPC the authority to adopt, amend, or repeal bylaws and rules deemed necessary to fulfill its purposes, but any such actions can be disapproved by the SEC, which must also approve proposed rules before they become effective. The Series 500 Rules governing this case were proposed by SIPC and subsequently approved by the SEC. SIPA further allows the SEC to compel SIPC to adopt or amend rules in the public interest and enables the SEC to intervene in SIPC proceedings. If SIPC refuses to act in protecting customer interests, the SEC can seek a court order to ensure SIPC fulfills its obligations.
In a previous case, the court evaluated the deference given to SIPC's interpretations compared to the SEC's. While acknowledging SIPC's experience with SIPA liquidations, the court was reluctant to equate SIPC's authority with that of the SEC due to SIPC's non-agency status. Although SIPC has since developed a history of performance, it remains distinct from the SEC. SIPC argues for similar deference as other government-created entities, but the court distinguishes SIPC from those entities based on critical differences, particularly noting that SIPC lacks the comprehensive regulatory authority held by federal agencies like the Pension Benefit Guaranty Corporation.
The Legal Services Corporation (LSC), while not a government agency, possesses rule-making authority granted by its enabling statute, allowing it to interpret the Legal Services Corporation Act through notice-and-comment rulemaking, akin to an agency. This distinguishes it from SIPC, as the SEC, which has plenary authority over SIPC, has provided a competing interpretation of the statute governing SIPC (SIPA). SIPC and the Trustee claim that SEC's oversight has diminished due to its lack of meaningful exercise in over thirty years, but this does not alter the power dynamics between the two entities. The court references Chao v. Russell P. Le Frois Builder, Inc. to illustrate that a choice must first be made regarding which agency Congress has entrusted with rule-making authority before determining the extent of deference. Ultimately, it agrees with the SEC that Congress did not intend for SIPC's interpretations to override those of the SEC. Furthermore, if SIPC proposes a rule based on its interpretation of SIPA, the SEC has the authority to deny approval if it finds the rule inconsistent with SIPA or not in the public interest, and could even mandate SIPC to adopt a rule reflecting the SEC's interpretation. Thus, granting deference to SIPC in this context would undermine the established statutory hierarchy.
The SEC's interpretation of the Securities Investor Protection Act (SIPA) warrants Skidmore deference rather than mandatory Chevron deference due to the ambiguity in the statute regarding what constitutes a "claim for cash." SIPA does not explicitly define this term or address how Claimants misled into investing in fraudulent securities should be treated, indicating a need for agency interpretation of an "interstitial" question. Under Chevron's second step, the court must assess whether the SEC's interpretation is a permissible construction of the statute. Although the SEC has the authority to create rules addressing this ambiguity, its interpretation has not been formalized in any regulation. The absence of an articulated rule, particularly in light of the Supreme Court's guidance in United States v. Mead Corp. regarding the need for express congressional delegation for Chevron treatment, suggests that Chevron deference is inappropriate here. Factors surrounding the SEC's interpretation further support the conclusion that it should be evaluated under Skidmore deference, which considers the agency's reasoning and consistency rather than automatic weight.
The SEC has introduced a new position in its amicus brief that diverges from its previously consistent interpretations, which could limit its entitlement to Chevron deference. The SEC acknowledges that the Securities Investor Protection Corporation (SIPC) has maintained a longstanding view regarding the treatment of non-existent securities for over a decade, categorizing claims for such securities as claims for cash. This position was articulated in various cases, including a 1994 unpublished decision which confirmed that claims for securities that "never existed" should be treated as cash claims. The SEC's new interpretation, presented at the request of the Court, raises questions about its validity since it emerged only during the appellate process. Although the Supreme Court has occasionally granted deference to new agency interpretations appearing for the first time in amicus briefs, this is contingent on the interpretation reflecting the agency's considered judgment. The SEC's familiarity with the case strengthens its position, yet the context of its submission—only after an invitation—along with the timing of its introduction in appellate proceedings, suggests that Chevron deference may not be warranted. Additionally, the Court has previously declined to consider arguments first raised in amicus briefs, further complicating the SEC's reliance on its new interpretation for deference.
The SEC’s historical relationship with SIPC, along with SIPC's greater familiarity with the Securities Investor Protection Act (SIPA), justifies not applying Chevron deference to the SEC's interpretation of SIPA. Chevron deference relies on an agency's superior expertise, which is diminished in this context due to the SEC's more passive oversight role in SIPC liquidations, contrasting with its active involvement in other areas of the Securities Exchange Act. Consequently, the SEC's informal opinion presented in its amicus brief lacks the force of law and does not merit Chevron deference.
However, the SEC's interpretation still receives a more limited form of deference under Skidmore v. Swift, which allows for consideration of the agency's specialized experience and thoroughness in its reasoning. Factors influencing Skidmore deference include the agency's expertise, the care taken in its conclusions, the formality of its interpretations, consistency over time, and overall persuasiveness.
Applying these factors to the SEC's interpretation of section 9(a)(1) of SIPA, there is some support for deference due to the SEC's regulatory responsibilities over broker-dealers and securities exchanges, although the SEC has not consistently interpreted this section. Therefore, while some deference is appropriate, it is not at the level the SEC seeks, given the lack of a consistent interpretative history.
The excerpt evaluates the SEC's interpretation of the "claims for cash" and "claims for securities" under SIPA, emphasizing the SEC's persuasive analysis over SIPC's approach. The SEC contends that determining claimants' net equity based solely on cash paid for securities does not equate to having claims for cash as defined by section 9(a)(1) of SIPA. The SEC argues that SIPC's reliance on definitions that do not explicitly mention "claim for cash" or "claim for securities" is flawed.
The SEC's interpretation aligns with SIPA's legislative history, which aimed to protect investors following significant losses from broker-dealer failures in the late 1960s. SIPA was designed to establish a reserve fund for investor protection and to reinforce broker-dealers' financial responsibilities. Amendments in 1978 further enhanced this protection, increasing the amounts available for distribution to customers. The SEC's broader interpretation of section 9(a)(1) better serves these statutory goals of promoting investor confidence and protection, adhering to the principle that remedial legislation should be construed broadly to fulfill its intended purposes. The legislative history indicates that the distinction between claims for cash and securities was introduced shortly before SIPA's passage, supporting the SEC's interpretation.
Concerns were raised during the drafting of legislation by the Department of the Treasury and the Federal Reserve Board regarding proposed cash advance limits. In April 1970, the Acting General Counsel of the Treasury expressed opposition to bills that set a cash advance limit of $50,000 per account, arguing it surpassed the $20,000 limit provided by the FDIC and FSLIC, potentially signaling a greater governmental priority on broker-dealer confidence over banking system stability. The Vice Chairman of the Federal Reserve echoed this concern, noting the proposed SIPC insurance would be more generous than FDIC and FSLIC coverage. He recognized, however, that broker-dealer customer coverage could not be entirely aligned with banking deposit coverage due to the distinct custodial role of broker-dealers. Despite these concerns, both legislative bills advanced without changes to the $50,000 limit. Ultimately, during a Senate debate on December 10, 1970, an amendment was adopted to reduce SIPA claims coverage from $50,000 to $20,000 to align investor protection with existing bank deposit protections. A proposal to maintain the higher limit for securities while applying the lower limit to cash was discussed but ultimately not adopted. The Senate passed the amended version, standardizing all claims at $20,000.
The Conference Committee adopted a two-tiered protection system for claims under SIPA, distinguishing between cash and securities claims. A $50,000 limit remains, but cash claims are capped at $20,000. This separation was intended to differentiate between the custodial roles of broker-dealers for securities and their depository functions for cash. The SEC interprets the "claims for cash" provision to limit brokerage protection for cash depositors to the same level as FDIC coverage. Claimants who directed their funds for securities purchases and received confirmations are not considered cash depositors as defined by the statute. Additionally, the Series 500 Rules dictate that a claim's classification relies on the debtor's written confirmations rather than the actual contents of the account. If a customer receives confirmation of a securities sale, they are classified as having a "claim for cash," even if the sale did not occur. Conversely, if a customer has cash but receives confirmation of a securities purchase, they are treated as having a "claim for securities." The Claimants argue that the Series 500 Rules clearly address the classification issue, but the rules do not explicitly apply to scenarios involving non-existent securities.
The SEC and SIPC clarify that the Series 500 Rules are intended to determine whether a claim pertains to securities or cash when real securities transactions overlap with the filing date, explicitly excluding transactions involving fictitious securities. Their interpretation is upheld because it is not "plainly erroneous or inconsistent" with existing regulations. The SEC emphasizes that customers' legitimate expectations, based on transaction confirmations, should be safeguarded, arguing that claimants should be viewed as having claims for securities since their account statements indicated such holdings. While SIPC challenges the legitimacy of expectations concerning non-existent securities, it recognizes the importance of encouraging investor diligence—though this goal is not the primary focus of SIPA's legislative history. The court aligns with the SEC's interpretation, which is consistent with the statute’s intent to protect investors and bolster confidence in the securities market. Furthermore, the SEC asserts that when customers have confirmations indicating they hold securities, their claims should be treated as securities claims entitled to SIPC protection up to $500,000. In contrast, claims for cash, indicated by account statements showing the account as a cash depository, are limited to $100,000 protection. Lastly, the valuation of claims should be based on the initial amounts paid by the claimants for their investments, excluding fictitious interest or dividend reinvestments.
The District Court determined the value of the Claimants' claims based on the actual cash they initially invested in the Debtors, excluding any artificial interest or dividends from fictitious account statements. This approach was supported by both the SEC and SIPC, which argued that including bogus figures would result in arbitrary recoveries disconnected from reality and jeopardize the SIPC fund. The court acknowledged that the Claimants' net equity should reflect only their original investments in the New Age Funds, aligning with precedents that indicate net equity should not factor in phony payments from Ponzi schemes. Consequently, while affirming that the Claimants possess "claims for securities" under SIPA, the court vacated the District Court's valuation and remanded for further proceedings. The Claimants are awarded two-thirds of their appeal costs.
SIPC, as established under 15 U.S.C. 78ccc, oversees broker-dealers' activities and insures customers in cases of liquidation. SIPA defines "securities" broadly, including various financial instruments such as stocks, bonds, options, and investment contracts (15 U.S.C. 78lll (14)). The District Court ruled that shares in money market funds, when held in customer accounts, qualify as securities (SEC v. Goren, 206 F.Supp.2d 344, 350). The SIPA filing date for the relevant case was February 17, 2000, coinciding with the SEC’s initial complaint (15 U.S.C. 78lll (7)). As of December 31, 2002, the SIPC fund was valued at $1.26 billion, with SIPC members assessed a consistent $150 per year since 1996 (SEC. INVESTOR PROT. CORP. 2002 ANNUAL REPORT). The parties agree that the non-existence of the securities in question necessitates cash payments to Claimants (15 U.S.C. 78fff-1(b)(1)). Some Claimants believed they had made other investments through Goren, classified as "claims for securities," but these are not part of the current appeal. The Series 500 Rules guide the determination of cash versus securities claims, focusing on customers' "legitimate expectations" and the significance of written confirmations. The Claimants contend that these rules dictate their net equity calculation based on fictitious account statements. Moreover, the lack of consensus between SIPC and the SEC raises concerns regarding the anticipated cooperation highlighted in SIPA's legislative history. Claimants assert that the dispute over deference owed to the SEC or SIPC is moot, as the Series 500 Rules resolve the classification issue directly.
The conclusion of the District Court, affirming that the Series 500 Rules govern the case, is rejected based on analyses from SIPC and SEC. Instead, it is determined that the Series 500 Rules are meant for transactions involving real securities, not fictitious ones. Agreement is reached with the SEC that these Rules can be interpreted broadly to align with SIPA's remedial goals. The recent amendment to SIPA, which emphasizes reliance on SIPC's views for trustee fee determinations, is noted but is deemed irrelevant to the current case. The SEC's historical lack of substantial oversight over SIPC is acknowledged, despite recent efforts to enhance such oversight. The SEC's previous silence on interpreting Section 9(a) concerning fictitious securities is not seen as a valid reason to defer to its interpretation, given its statutory role in SIPC proceedings. The limited relevant case law cited does not provide strong support for SIPC’s position. The decision emphasizes that even if the Series 500 Rules were ambiguous, deference would be given to the SEC's and SIPC's shared interpretation.
