February 24, 2009
SEC v. Stanford International Bank, Ltd. -- Notes, Securities and Legal Strategy
Posted by Christine Hurt

Only once in a blue moon does this happen -- we were scheduled to talk about the "Reves test" for whether notes are securities, and I happened upon the complaint and memorandum of law asking to freeze Stanford International Bank (and related) assets, which has a Reves test analysis for the certificates of deposit that SIB was selling through its affiliates.  Yay!

The SEC seems to have two easy arguments as to why the misrepresentation of returns by SIB and its affiliates was in connection with the purchase or sale of a security.  Then, they make a harder argument, which I'll save for the end.  But first, the SEC argues the misrepresentations were made in connection with the customers purchasing "securities," i.e., the CDs.  Under the Reves test and progeny, it seems like an easy argument that since the CDs has no layer of protection or guarantee (unlike CDs at U.S. banks that are insured by the FDIC), then they are securities.  The CDs issued by this Antiguan bank, SIB, without real monitoring or regulation by any true banking regime in Antigua, seem like good candidates for SEC protection once they are sold to U.S. citizens.  The second argument, which the SEC barely makes in a footnote, is that SIB actually filed on Form D for private placement exemptions under Rule 506.  The last such filing was in November 2007 for $2B worth of CDs.  Shouldn't this "estop" SIB from arguing that the CDs weren't securities?  Can SIB claim that the CDs weren't securities, but they went ahead and filed for the exemption anyway just to save the hassle?

The third argument that the SEC makes, and it makes this argument first, is that the misrepresentations by SIB and its affiliates were in connection with the customers selling non-SIB securities.  Stay with me.  So, because these customers of SIB affiliates presumably sold unidentified stocks and bonds to free up cash to put in these SIB CDs, the lies they were told by SIB affiliates were "in connection with the sale of securities."  Hmmm.  My colleague Larry Ribstein tells me that the SEC has made this argument before, although it has never been blessed by a court.

I have a very negative reaction for at least two reasons.  On a practical level, any purchase can then come under the auspices of the SEC.  Residential homes are purchased with cash received from the sale of securities.  Cars.  College tuition.  Other financial products -- annuities, whole life insurance, money market accounts, savings accounts.  As people retire and cash out 401(k)s, I guess anything they buy would then be subject to SEC regulation.  On a conceptual level, I also disagree.  The misrepresentation (or omission) should be in connection with the purchase or sale of the securities, but it should also relate to the issuer of those securities, right?  If you lie to me about Issuer A, and that makes me buy or sell Issuer A, OK.  But if you lie to me about the nifty boat you have for sale, so I sell Issuer A to buy it, that seems completely different.

The SEC cites to SEC v. Zandford, 535 U.S. 813, 825 (2002), which applied 10b-5 to the case of a financial advisor, who encouraged appropriately-sympathetic plaintiffs to create an investment account with him.  Thereafter, he sold their holdings and took off with the money.  Here, the misrepresentation was not about the issuer of the securities sold, but about his assurances not to steal their money.  Although his lie was in connection with the purchase and sale of securities, it did not have to be a lie in connection with any particular security.  I understand this argument, but I'm not sure it convinces me of the SEC's argument in Stanford.  (It does, however, remind me of Jill Anderson's work on the de dicta/de re distinctions in statutory interpretation, Just Semantics:  The Lost Readings of the ADA, forthcoming in the Yale Law Journal.)

Thoughts?  More information on the use of this theory elsewhere?

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