# Unite d States Court of Appe als

F O R T H E D I S T R

I C T O F C O L U M B I A

C I R C U I T

Arg ued Oc tober 16, 2013 Dec ided J uly 18, 2014

No. 12-5286

S E C U R I TI E S A N D E X C H A

N G E C O M M I S S I O N , A P P E L L A N T

v.

S E C U R I TI E S I N V E S TO R P R

O TE C TI O

N C O R P O R A TI O N , A P P E L L E E

Appea l from the United States District Court for the D istrict of Columbia (No. 1:11-mc- 00678)

John W

. Ave ry , Deputy

Solicitor, S ecur ities and Ex chang e Commi ssion, argue d t h e cause for appellant. Wit h him on the briefs wer e Michae l A. Conley
, Deputy Gene ral Counsel, Jacob H. Stillman
, Solicitor, Tracey A. Hard in
, Assistant Gene ral Counsel, and Michae l L. Post , Senior L itigation Counsel.

Robertson Park
, John He

ffner , and Mark J. Andrews wer e

on the brief for amici curiae Sta n fo rd Victims Coalition, et al. in support of petitioner.

Michae l W

. McConnell arg ued the cause for appellee

. Wit h him on t h e b rief wer e Eugene F. Assaf
, Edwin J. U

, John C. O'Quinn
, Elizabeth M. Locke , and Josephine W ang

.2

Thomas J. Moloney
, David Y

. Livshiz
, Darryl G. Stein
, and Sarah E. Edwards wer e on the brief for amicus curiae Securities I ndustry and Financ ial Marke ts Association in suppo rt o f appellee

.

Steve n P. Lehotsky
, Joshua S. Press
, and Noah Levine wer e

on the brief for amici curiae former SEC officia ls and profe ssors of law in support of a

ppellee.

Steuart Thomsen was on the brief for amicus curiae Financ ial Service s I nstitut e, I nc. in support of a ppellee.

Be fore : G A R

L A N D , Chief Judge
, S R I N I V A S A N , Circ uit Judge , and S E

N TE L L E , Senior Circuit Judge

. Opinion for the Court filed by Circuit Judge S R I N I V A S A N

.

S R I N I V A S A N , Circuit Judge : When a broker ag e firm face s insolvency
, the cash and secur ities it holds for its customers can become ensnar ed in bankruptc y liquidation proce ed ings or otherwise b e p u t at risk. Congr ess established the Securities I nvestor Protection Corporation (SI PC) to protec t investors’
assets held on deposit by financ ially distressed broker ag e firms. SI PC can initiate its own liquidation proce edin gs wi th the aim of secur ing the return o f customers’ proper ty held by the brok er age. SI PC, howeve r, possesses authority to underta ke
t h o se protec tive measure s only with respe ct to member broker ag e firms. I ts authority does not ex tend to non-member instit utions.

I n this case , the Securities and Ex chang e Commi ssion seeks

a court order compelling SI PC to liquidate a member broker

deale r, Stanford Group Company (SGC). SGC play ed an integ ral role in a multibi llion-dollar financ ial fra ud car ried out throug h a web of companies. SGC’s financ ial advisors3

counsele d investors to p u rchase cer tificates of deposit from an Antigua n bank that was part of the same corpor ate family

. The Antigua n bank’s CDs eventua lly beca me worthless. The massive Stanford fra

ud spawne d a varie ty o f leg al actions in a number of a

rena s, the bulk of which a re not a t issue here

. This

case involves the authority of a specific e ntity —SI PC—t o take

measure s within it s own statutorily bounded sphere

. As to that issue, beca

use the Antig uan bank, unlike SGC, wa s not a SI PC member
, SI PC had no ability to initiate measure s direc tly
ag ains t t h e bank to protec t the proper ty of investors who purcha sed the ba

nk’s CDs.

The question in this case i s wh ether SI PC can instead be order ed to proce ed ag ainst SGC—rather than the Ant igua n bank—to prot ec t t h e CD investors’ proper ty

. I t is common g round that SI PC can be compelled t o d o s o only if those investors qualify as “customer s” of SGC within the meaning of the g overning statute. SI PC conclude d that they do not, and the district court ag ree d. The court rea soned th at the investors obtained the Antigua

n bank’s CDs by depositing funds with the bank itself, not with SGC, and they thus cannot be considere d customers of the l atter. We ag ree that the C D investors do not qualify as customers of SGC under the opera tive statutory definition. We theref

ore a ffirm the de nial of t he application to order SI PC t o liquidate SGC.

I

.

A.

I n 1970, Congr ess enac ted the Securities I nvestor Protection Act (t h e Act or SI PA) in response to the “failure or instabilit y of a signific ant number of broke rage firms.” Sec. Inve stor Prot. Corp. v. Barbour
, 421 U.S. 412, 4 1 5 (1975). Be fore the Act, customers of a broker ag e firm that fell int o4

insolvency often “found their cash and secur ities o n d eposit either dissipated or tied up in leng thy bankruptc y proce eding s.” Id. The Act cre ated SI PC, a nonprofit, private membership
corpor ation established “for the purpose, inter alia
, of providing financ ial relief to the customers of failing broker -dea lers with whom they had left cash or secur ities on deposit

. ” Id

. at 413;

see 15 U.S.C. § 78ccc (a) (1). Congr ess require d most reg istered U.S. broker -dea lers to beco m e members of SI PC and to pay assessments used to fund SI PC’s investor protec tion measure s. See 15 U.S.C. §§ 78ccc( a)( 2)(A) , 78ddd(c)

.

The Act require s the S E C and various industry selfreg ulatory org anizations to notify SI PC upon lear ning that a SI PC-member firm “is in or is approa ching financ ial difficulty .” 15 U.S.C. § 78 ee e( a) (1). SI PC may file an action for a protec tive decr ee in fede ral district court afte r deter mining,
among other thi ng s, that the member firm “has failed o r is in dang er of failing to meet i t s obliga tions to customers.” 15 U.S.C. § 78eee (a) (3)( A). I f the court g rants SI PC’s application, the co u rt must appoint a trustee and order the proce eding s

remove d to bankruptc y court. 15 U. S

. C

. § 78eee (b)( 3), (4). The trustee then overse es the liquidatio n of the member firm, returning any customer cash and securities on deposit with the broker

. 15 U.S.C. § 78fff

. I f the insolvent broker ’s funds prove inadequa te to pay al l customer claims, SI PC itself must cover any shortfalls up to statutory

limit s. 15 U.S.C. § 78fff-3.

The Act g ives the SEC “plena ry authority to supe rvise

. . . SI PC” in its im plementation of the statute. Barbour
, 421 U.S.
at 417 (interna l quotation marks omitted). For instance, the SEC “may disapprove in whole or in part any b y law or rule adopted by the Board of Direc tors of

. . . SI PC, or require the adoption of any rule it deems appropr iate.” Id. (citing 15 U.S.C. § 78ccc (e) ). The SEC may also “par ticipate in any

liquidation
proce eding initiated by

. . . SI PC.” Id. Of particula r rele vance5

here
, if SI PC declines to initiate the liquidation of a member firm, the SEC can apply to the district court for an order requiring SI PC to commence liquidation. See 15 U.S.C. § 78g g g (b). This case marks the SEC’s first eff ort to invoke its authority under § 78g g g (b) to co mpel SI PC to initiate liquidation procee dings a g ainst a member broker ag e.

For the district c ourt to issue such an or der, the SEC mus t show that SI PC has failed to “ac t for the protec tion” of the member firm’s “customer s.” Id. The statutory term “customer ”
encompa sses persons for whom the member firm holds

secur ities or cash on deposit. The Act states th at the “ter m ‘customer ’ of a debtor means any person

. . . who has a claim on

acc ount of secur ities re ceive d, acquir ed, or held by the debtor in the ordinary course of its business as a broker or deale r from

or for the secur ities acc ounts of such person for safe keeping
, with a view to sale, to cover consum mated sales, pursuant to purcha ses, as collater al, secur i t y , or for purposes of eff ecting transfe r.” 15 U.S.C. § 78 lll (2)( A). The Act further explains that t h e t erm “customer ” includes “any person who has deposited ca s h with the debtor for the purpose of purcha sing

sec u rities.” 15 U.S.C. § 78 lll (2)( B) (i). The Act there by includes wi t h i n the definition of “customer ” those persons for whom the m ember firm hol ds cash or secur ities on deposi t for the customer ’s use. Significa ntly
, howeve r, the Act specific ally

ex cl udes persons who g ive cash or secur ities to the memb er firm for the firm ’s use as part of the firm’s capital (e.g
., as a loan to the member firm): “The term ‘customer ’ does not include any person , to the extent that

. . . such person has a claim for cash or secur ities which

. . . is part of the capital of the debtor.” 15 U.S.C. § 78 lll (2)( C).6

B.

This case arises out of a massive financ ial fra ud perpe trated by Robert All en S tanford. As descr i b ed by the S EC, Stanford conducte d a “Ponzi scheme ,” selling cer tificates o f deposit to investors but then misappropriating billions of dollars in deposited funds to repa

y ear lier inves t o rs and financ e a lavish lifesty le. See g enerally Chadbourne & Parke LLP v. Troice
, 134 S. Ct . 1058, 1064-65 (2014)

.

Stanford employ ed a complex web of companies he owned

or controlled to car

ry out the fra

udulent enter

prise. Two entities

are primarily at issue here : (i) Stanford I nterna tional Ba nk, L td. (SI BL ), a bank org anized under Antigua n law, and (ii) Stanford Group Com pany (SGC), a Houston-base d broker -dea ler
reg istered with the SEC. SI BL sold cer tificates of deposit, “debt assets that promised a fix ed rate of return.” Chadbourne
, 134 S. Ct. at 1064 (interna l quotation marks omitted). SGC employ ees actively promoted the SI BL CDs to investors. SGC

was a member of

SI PC, whil e SI BL

was not.

The pa rties stipulated to cer

tain fac ts conce rning the sales of SI BL CDs. To purcha se a CD, “an investor had to open an

acc o u n t with SI BL

. CD investors wrote chec ks that wer e deposited into SI BL acc ounts and/or filled out or au t horized wire transfer re q u est s asking that money be wired to SI BL for the purpose of opening their acc ounts at SI BL and purcha sing CDs.” J .A. 9 5 2

. “M ost

. . . investors either rec eived the phy sical CD cer

tificates or had them held by an author i z ed desi gn ee.” J .A. 953. SGC, for its part, did not itself hold CD

cer tificates for investors. “To the ex t en t t h at some SI BL CD investors did not rec eive the phy sical cer tificates, the SEC is not rely ing on that fac t to support its claims in this proce eding .” Id. CD investors “re ceive d periodic statements from SI BL ref lecting the balanc es in their SI BL acc ounts.” Id.7

Disclosure statements fo r S I BL CDs sold in the United States stated that “SI BL’s p roducts are not subject to the
repor ting require ments of any jurisdiction, nor are they cover ed by the investor protec tion or secur ities insurance laws of any jurisdiction such as the U.S. S ecurities I nvestor Protection I nsuranc e [si c] Corporati o n

. ” Id. A version of the CD marke ting brochur e reiter ated that the CDs wer e not cover ed by U.S. investor protec tion laws, and fur ther stated tha t there was “no g uara ntee investors will rec eive interest distributions or the return of thei r p ri n cipal.” Id. Despite those written warning s,

some investors repor

t being told by SGC repr esenta tives that the SI BL CDs wer e cover ed by U.S. investor protec tion laws, including the Act.

Stanford’s extensive financ ial fra ud was met with a varie ty

o f leg al responses. I n 2009, the S EC filed a civil enfor ceme nt action in fede ral district court ag ainst Stanford, SGC, SI BL
, and others. The court appointed a re ceiver for SGC and other entities. Th e rec eiver deter mined that SI BL CDs worth approximately $7.2 billion wer e outst an d ing worldwide as of Fe bruar y 2009. The SEC ultimately p re vailed, and the court imposed a civil pena lty

of $6 bi llion. See Chadbourne , 134 S. C t

. at 1064-65. Stanford himself was convicted in 2012 of conspirac y , wire fra

ud, mail fra

ud, obs t ruction of justice, and

m o n ey launder ing. He was sentenc ed to 110 y ear s of imprisonment and order ed to forf eit approximately $6 billion. Id

. at 1 064, 1070. Antigua n authorities separ ately initiated
proce eding s to liquidate SI BL and p ro ce s s claims ag ainst the bank. SI BL CD investors also broug ht class action lawsuits
ag ainst law firms, investment adviso rs , and other entities that allege d l y assisted Stanford in perpe trating the fra ud. See Chadbourne
, 13 4 S

. C t

. at 1062, 1065 (finding that four such class action suits wer e not barr ed by fede ral secur ities st atut es and could pr ocee d).8

C.

This case involves the prospec t of a distinct response to the Stanford fra

ud: an action by SI PC to liquidate SGC. I n Aug ust 2009, the court-a

ppointed recei v er in the SEC’s civil enfor ceme nt action a sked S I PC to deter mine whether it would liquidate SGC in order to protec t the assets of investors who had purcha sed SI BL CDs at the sug g estion of SGC em p l o y ees. SI PC responde d that it found no basis under the Act to initiate

a li q u i d ati on of SGC. I n SI PC’s view, the CD investors wer e

n o t S GC “customer s” within the meaning of the Act, a prec ondition to liquidation of SGC. SI PC explained th at the Act “prote cts the ‘custody ’ function that broker ag e firms perf orm for customers.” J .A. 158. Her e, S I PC conclude d, the circ umstances fell outside t he Act’s custody function beca use SGC itself never held investors’ cash or secur ities in connec tion wi t h t heir purcha se of the CDs. Rather, “ca sh for the purpose of purcha sing CDs

. . . was sent to SI BL
, which is prec isely wh at t he customer intended.” J .A. 160. As for the “phy sical CDs,” they pres u mably “we re issued to, and delivere d to” the investors, and SGC did not “maintain[] possession or control of the CDs.” J .A. 159-60. I n short, “SGC is not, nor should it be, holding any

thing for

. . . a customer.” J .A. 160. “The fac t tha t the secur ity has g one down in value, even beca use of a fra

ud in which SGC is complicit,” SI PC added, “does not chang e that result.” J .A. 160. Be cause the CD investors failed to qualify as “customer s” of S GC within the meaning of the Act, SI PC conclude d, the investors wer e i n eli g ible for liquidation protec tion.

Two y ear s later, the SEC rea ched the opposite conclusion. I n J une 2011, the Commission issued a formal analy sis stating that investors who had purcha sed SI BL CDs at the u rgi ng of SGC employ ees qualified as SGC “customer s” und er t he Act. Citi ng evidenc e that Stanford had “structur ed t h e v arious9

entities in his financ ial empire .

. . for the principal, if not sole
, purpose of car

ry ing out a single fra udulent Ponz i scheme,” the Commi ssion deter

mined that th e “separate ex istence” of S I BL and SGC “should be disreg arde d.” J .A. 242. The Commi ssion also cited evidenc e that investors might have believed that they

wer e depositing cash with SGC when they purcha sed their SI BL CDs, and that some SI BL C D d eposits wer e diverted to pay SGC’s expenses. “B ased on the totality of the fac ts and circ umstances,” the SEC conclude d, “investors with broker ag e

acc ounts at SGC who purcha sed SI BL CDs throug h SGC should be deeme d to have deposited cash with SGC for purposes of SI PA cover ag e.” J .A. 244. SI PC rema ined unpersua ded by the SEC’s analy sis, howeve r, and declined to initiate a li quidation
proce eding

.

The SEC then filed an application with the di strict court under 15 U.S.C. § 78g g g (b), seeking an order compelling SI PC
to commence liquidation proceed ings for SGC. The court addres s ed sever al preliminary questions in a Fe bruar y 2012 decision. See SEC v. Sec. Inve stor Prot. Corp.
, 842 F. Supp. 2d 321 (D.D.C. 2012). The court held that § 78g g g (b) require d the
court to evalua te de novo whether there wer e SGC “customer s” in need of protec tion, rathe r than simply acc epting the SEC’s views without judicial revie w. Id. at 328-29. The court further held that § 78g g g (b) mandated a “summary proce eding ,” not the “full, fo rm al proce dures of the Fe dera l Rules of Civil Procedur e.” Id. at 327. T h e co u rt order ed supplemental briefing on the appropr iate “proc edure s, burdens, and discovery ” in the cir cumstance s. Id. at 329.

I n a second opinion, the district court d en i ed the SEC’s application on the merits. See SEC v. Sec. Inve stor Prot. Corp.
, 872 F. Supp. 2d 1 (D.D.C. 2012). The court adopte d S I PC’s view that SI BL CD investors fail to qualify as SGC “customer s” wi t h i n the meaning of the statute beca use CD investors never10

direc tly deposited funds or se curities with SGC itself. Id. at 8. The court distinguished case s in which a broker had misappropria ted funds without completing the promised

secur ities purcha se. Her e, by contra st, the court rea soned, the “SI BL CDs were in fac t purcha sed and did in fac t exis t for the SGC clients.” Id. at 11. The court also adopted SI PC’s view that a preponde ranc e-of -the-e vidence standard applies in § 78g g g (b) proc ee d i n g s, id. at 5, but it conclude d that the evidentiar y standard ultimately did not matter beca use the case turn ed on “unconte sted fac ts and an interpre tation of law,” id. at 12.

I I

.

The SEC ap peals the denial of its application under § 78g g g (b) to order SI PC to commence liquidation o f SGC. T h at p ro v i sion comes into play only if SI PC has failed to “ac t for the pr otection of [S GC] customers .” 15 U.S.C. § 78gg g (b) (empha sis added) ; see also 15 U.S.C. § 78eee (a) (3) (A) (author i z i ng SI PC to file an application to liquidate only if it deter mines that the member broker “has failed or is in dang er of failing to meet its obliga

tions to customers ” (empha sis added) ). The centr al issue in this appea l is whether investors who purcha sed SI BL CDs at the sug g estion of SGC employ ees qualify as SGC “customers” under the Act.

Be cause the district court rested its decision on uncontested fac ts and an interpre tatio n of law, we revie w that decision de

novo. See In re New Times Sec. Servs., Inc. ( New Times I

), 371 F.3d 68
, 7 5 (2d Cir. 2004); Gordon v. Holder
, 632 F.3d 722, 724 (D.C. Cir. 2011). We do not rea ch the question o f the
appropr iate evidentiar

y burden, as we resolve the case based on the stipulated fac ts. We conclude
, in ag ree ment with the district court, that SI BL CD investors are not SGC “customer s” within the meaning of the Ac t.11

A.

The “princ ipal purpose of SI PA is t o protec t investors
ag ainst financ ial losses arising from the in s o lvency of their broker s.” In re New Times Sec. Servs., Inc. ( New Times II

), 463 F.3d 125, 127 (2d Cir. 2006) (interna l quotation marks omitted). Be fore SI PA, when a broker ag e firm failed, customer funds and

secur ities held o n deposit with the broker ag e often beca me depleted or enmeshe d in bankruptc y proce eding s. See Barbour
, 421 U.S. at 415. The Act addre sses that issue by protec ting the

cu s t o dy function of broker s, i.e., by “prote ct[ing] customer interests in secur ities and cash left with broker -dea lers.” L ouis L oss & J oel Seligman, Securities Reg ulation § 8.B.5.A
, at 3290 (3d ed. 2003) (citing l eg islative history ). SI PA thus aims “to protec t secur ities i n v estors ag ainst losses resulting from the failure of an insolvent or otherwise failed broker -dea ler to proper ly perf

orm its role as the custodian of customer cash and

secur ities.” 1 Collier on Ba nkruptcy ¶ 12.01, at 12-4 (16th ed. 2014).

The Act g ener ally aff

ords no protec tion ag ainst other ty pes of losses, such as those stemming from a decline in investment

v al u e. That is so even if a broker fra udulently induced th e losing investment in the first place

. Consequently
, “if a broker

u s ed fra udulent means to convince a customer to purcha se a stock and the custo m er l ef t that stock with the broker
, who subsequently beca

me insolvent, SI PC would be require d by SI PA only to return the st o ck t o t he customer.” Sec. Inve stor Prot. Corp. v. Vigman
, 803 F.2d 1513, 1517 n.1 (9th Cir. 1986). I n that fashion, the statute “‘w orks to expose the customer to the

same risks and rew ards that would be enjoy ed had there been no liquidation.’” New Times II
, 463 F.3d at 128 (quoting 6 Colli er

on Ba nkruptcy ¶ 741.06[6] (15th ed. rev.) ). I nves t o rs who suffe r losses in investment value resulting from fra ud may have claims under other provisions of the secur ities l aws. See12

Vigman
, 803 F.2d at 151 7 n.1. SI PA, howeve r, is centr ally addre ssed to a broke r’s c ustody function.

SI PA’s definition of “customer ” embodies the Act’s focus

on a broker ’s role as custodian of its customers’ proper ty

. SI PA define s “customer ” as

any person

. . . wh o has a claim on acc ount of

secur ities rec eived, acquir ed, or held by the debtor in the ordinary course of its business as a broker or deale r from or for the secur ities accou n t s of such
person for safek eeping
, with a view to sale, to cover

consum m ated sales, pursuant to purcha ses, as collater al, secur ity
, or for purp o s es of eff ecting transfe r.

15 U.S.C. § 7 8 l l l (2 )(A)

. The Act further provides that a “customer ” includes “any per s on who has deposited cash with the debtor for the purpose of purcha sing secur ities.” 15 U.S.C. § 78 lll (2)( B) (i). The “‘c ritical aspec t of th e “customer ” definition is the e ntrustment of cash or secur ities to the brokerdeale r for the purposes of trading secur ities.’” In re Bernard L. Madoff Inv. Sec. LLC
, 654 F. 3 d 229, 236 (2d Cir. 2011) (empha sis omitted) (quoting Appleton v. First Nat’l Bank of Ohio
, 62 F.3d 791, 801 (6th Cir. 1 9 9 5 )) ; see In re Brentwood Sec., Inc.
, 925 F.2d 325, 327 (9th Cir. 1991) (“[The ‘customer ’] definition embodies a common-sense concep t : An investor is entitled to compensa tion from the SI PC only if he has entrusted cash or secur ities to a broker -dea ler who be comes insolvent.”)

. To come within the fold of SI PA’s protec tions, an investor thus ordinarily must demonstrate both that t h e broker “ac tually

. . . rec eived, acquire d or held the claimant’s proper ty , and that the
transac tion g iving rise to the claim

. . . contain[ed] the indicia of

a fiduciar y rela tionship” betwee n the investor and the broker

. 1 Colli er on Ba

nkruptcy ¶ 12.12[2 ]
, at 12-50. An investor’s13

“customer ” status is evalua ted on an asset-by -asse t basis and
may chang e over

time. See Ne w Ti mes II

, 463 F.3d a t 130.

Her e, inso fa r as the analy sis focuse s on the entity that in fac t held custody over the proper ty of the SI BL CD investors, the investors fail to qualify as “customer s” of SGC under the statutory definition. That is beca use SGC never “re ceive d, acquir ed, or held” t he investors’ cash or secur ities. 15 U.S.C. § 78 lll (2)( A); see 15 U.S.C. § 78 lll (2)( B) (i). Wit h reg ard to the investors’ cash, it is undisputed that investors at n o time deposited funds with SGC to purcha s e t he SI BL CDs. The funds instead went to S I BL. Under the stipulated fac ts, investors either “wr ote chec ks th at wer e deposited into SI BL

acc ount s and/or filled out or authorized wire transfe r reque sts asking that money be wired to SI BL for the purpose of opening their acc ounts at S I BL and purcha sing CDs.” J .A. 952. Wit h
respe ct to the investors’ secur ities, the SEC makes no contention that SGC held the CD cer tificates for investors. Ra t h er , t he stipulated fac ts pr ovide that most “ investors either rec eived the phy sical CD cer

tificates or had them held by an authorized desig nee.” J .A. 953. And “[ t] o the ex tent that some SI BL CD investors did not rec eive the phy sical cer tificates, the SEC is not rely ing on that fac t to support its claims in this proce eding .” Id. Be cause SGC had no custody over the investors’ cash or

secur ities, the investors do not qualify as SGC “customer s” under the ordinary

opera tion of the statutory definition.

B.

The Commi ssion’s principal response is that we should disreg ard the leg al separ atene ss of SGC and SI BL and trea t them

as a combined entity

. Acc ord i n g to the Commi ssion, the companies opera ted in a highly i n t erc onnecte d fashion in further ance of the fra

udulent Ponz i sch e me , e s c h e w in g corpor ate formalities. As a result, the Commi ssion contends, inv es t o rs14

who deposited funds with SI BL for the purcha se of CDs in eff ect deposited fu n d s with SGC. I n the Commi ssion’s view, the i nvestors thus qualify as “customer s” of a SI PC-member firm fo r purposes of trig g ering the Act’s protec tions. We conclude , howeve r, that even if SGC and S I BL wer e treated as

a combin ed en t ity
, investors still would not qualify as “customer s” of a

SI PC-member firm.

The Commi ssion g rounds its arg ument for disreg arding the corporat e separ atene ss of SI BL and SGC in the doctrine of “substantive consolidation,” an equitable doctrine ty pically applied in bankruptc y proce eding s. “I n general, substantive consolidation resul t s i n the combination of the assets of [t wo] debtors into a single pool from which the claims of cre ditors of both debtors ar e s atisfied rata bly .” 2 Colli er on Ba

nkruptcy ¶ 105.09[3]
, at 105-110–11; see In re Auto-Train Corp.
, 810 F.2d 270, 276 (D.C. Cir. 1987). Courts have employ ed a “var iety ” of tests when assessing wheth er to g rant substantive consolidation. 2 Colli er on B ankruptc y ¶ 105.09[2] [a] , at 105- 9 6 ; e. g

. , In re Owens Corning
, 419 F.3d 195, 210-11 (3d Ci r. 2005). Wit h reg ard to the Stanford companies, th e co urt

ov erseeing the rec eiver ship in connec tion with the SEC’s civil

e n forc ement action conclude d that s u b s ta n ti v e c o n s o li d a

ti o n w a s

war rante d.

The doctrine of substantive consolidation has been applied in SI PA liq uidations. I n New Times I
, for instance, the bankruptc y court substan t i vely consolidated a SI PC-member broker underg oing liquidation with a rela ted, non-broke r entity

. 371 F.3d at 73. The assets of the rela ted entity wer e b ro ug ht into the SI PC member’ s l i q uidation estate, enlar g ing the available pool for customer rec overy

. Id. I nvestors with cash

o n deposit with the non-broke r entity wer e trea ted as “customer s” in the liquidation, even though the member broker itself never held those investors’ funds. Id. Her e, t h e SEC15

contends, substantive consolidation of SI BL and SGC wou l d simil arly mean that investors who deposited funds with a nonSI PC member (SI BL ) would be trea ted as “customers ” o f a SI PC member (S GC ) for purposes of invoking the Act’s protec tions.

Even if we wer e to consolid at e, howeve r, SI BL CD i n v estors would not be “customer s” of a SI PC-member entity under the statutory definition. The Act specific ally exc l u d es from “customer” status “any person, to the e x tent that . . . such
person has a claim for cash or secur ities wh i ch by contra ct, ag ree ment, or understanding
, o r b y opera tion of law, is part of the capital of the debtor

. ” 1 5 U.S.C. § 78 lll (2)( C), (C)(ii) (empha sis ad d ed ). We, like other courts, understand that provision to establish that “a claimant cannot quali fy for
customer status under SI PA to the extent that he or she is a lender rathe r than an investor. ” 1 Colli er on Ba nkruptcy ¶ 12.12[4] [a]
, at 12-56 (collec ting case s). As the Eleventh Circuit has explained, “[c]ash that is simply lent to the broker ag e cannot form the basis of a SI PA customer claim beca use the statute’s definition of ‘customer ’ excludes individuals whose claims are for ‘ cash . . . w hich . . . is part of the capital of the debtor.’ ” In

re Old Naples Sec.

, In c. , 223 F.3d 1296, 1304 n.18 (11th Cir. 2000) (elli p ses in orig inal) (quoting 15 U.S.C. § 78 lll (2)( B) (2000), now codified at 15 U.S.C. § 78 lll (2)( C)(ii) (2012))

. I n

o ther words, “individuals must have a fiduciar y rela tions h i p , rathe r t han a cre ditor-debtor arra ng ement, with their brokerag e to state a claim under SI PA.” Id .; accord In r e P r imeline Sec. Corp.
, 295 F.3d 1100, 1110 (10th Cir. 2002). The upshot is that

a “per son is excluded from elig ibilit y for customer protec tion to the extent that person i n v es ts in the SI PA debtor by making a loan to the debtor, rathe r than investing through the SI PA debtor in the secur ities marke t as part of the debtor’s ordinary course of business as a broker -dea ler.” 1 Colli er on Ba nk ru ptcy ¶ 12.12[4] [a] , at 12-56–57 (e mphasis added)

.16

Her e, investors who purcha s ed SI BL CDs lent funds to SI BL that beca

me part of S I BL ’s capital: Those investors g ave cash to SI BL in exchang e for a promise to be repa id with a fix ed
rate of re turn. See Chadbourne
, 134 S. Ct. at 1064 (SI BL CDs “we re debt assets that promised a fix ed rate of return” ) (interna l quot ati on marks omitted). The investors invested “in,” not “through,” SI BL

. 1 Colli er on Ba nkruptcy ¶ 12.12[4] [a]
, at 12-56. The basic nature of those investors’ rela tionship with the

rec ipient of their cash would not chang e if the rec ipient wer e d ee m ed to be a consolidated entity rathe r than SI BL alone

. Under a consolidated view, investors who purcha sed SI BL CDs lent mon ey t o the consolidated SI BL /SGC entity
, forming a “cr editor-de btor arr ang ement.” Ol d N aples
, 223 F.3d at 1304 n.18. The CD proce eds thus beca me part o f the consolidated entity ’s “ca

pital,” trig g ering the s t at utory exclusion from “customer ” status for le nders. 15 U.S.C. § 78 lll (2)( C)(ii).

The circumstance s are d irec tly analog ous to those in New Times II

. I n that case , SI PC had liquidated a member broker ag e firm, New Times Securities Service s, I nc. (Ne w Times), whose principal ha d defr auded investors. See Ne w Ti mes II
, 463 F.3d
at 126-27; New T

i me s I
, 371 F.3d at 71-72. A rela ted, nonSI PC-member entity
, Ne w Ag e Financ ial Service s, I nc. (Ne w Ag e), was broug ht into the liquidation thr o u gh substantive consolidation. See New Times I
, 371 F. 3 d at 73. The issue in New Times II was whether individuals who had been defr auded into investing in “promissory notes” iss ued by New Times and New Ag e could rec over as “customer s” i n the liquidation. See New Times II

, 463 F.3d at 126-27. The Second Circuit held that they could not. Id. at 127-30. The court explained that the Act’s “customer ” definition “distinguishes betwee n (i) claimants (protec ted as customers) who are eng ag ed thr oug h broker s in trading activities in the secur ities marke t s an d (ii) those (unprotec ted) claimants who are rely ing on the ability of a business enter

prise to repa

y a loan.” Id. at 128 (citing 15 U.S.C.17

§ 78 lll (2)( C)(ii)). The New Times and New Ag e promiss o ry notes wer e “just the ty

pe of debt instruments w hose possession bring s claimants within the cate g ory of unprotec ted lender s,”

even under a consolidated view. Id. at 129. Her e, the SI BL CDs likewise are “just the ty

pe of debt instruments whose possession bring s claimant s within the cate g ory of unprotec ted lender s.” Id. Section 78 lll (2)( C)(ii) there fore excludes SI BL CD holders from “customer ” status, even assuming SGC and SI BL should be substantively

consolidated.

The SEC does not dispute that funds loaned to an entity
g ener ally become part of the entity ’s “ca pital” within the meaning of § 78 lll (2)( C)(ii). The SEC instead contends that the § 78 l l l (2)( C)(ii) exclusion is “inapplica ble wher e, as here
, the claimants di d n o t intend to loan money to the broker -dea ler.” Pet’r’s Br

. 49-50 n.20. Acc ording to the SEC, beca use investors intended to loan money to SI BL —not SG C—the CD proce eds could no t b ec o me part of S GC’s “ca pital” even if they beca

me part of SI BL ’s. But if SGC and SI BL are consolidated, investors did intend to loan money to the consolidated en t ity

. That intention puts t his case in a lignment with New Times II

.

That intention also sets this c ase materia lly apar t from the decisions on which the SEC relies, Pri meline
, 295 F.3d 1100, Old Naples
, 223 F.3d 1296, and In re C.J. W right & Co. Inc.
, 162 B.R. 597 (Bankr

. M.D. Fla. 1993). I n eac h of t hose cases, the investors had no intention to loan their funds to any aff iliated

en t ity that might be considere d consolidated with the SI P C

member firm. I nstead, the indi v i d u al s soug ht to invest cash to obtain debt instruments issued by an unre lated third party

. See Primeline
, 295 F.3d at 1104, 1110; Ol d N a p l es , 223 F.3d at 1300-01, 1304-05; C.J. W right
, 162 B.R. at 606. The investors
soug ht to invest “throug h” the consolidated entity
, not “in” the consolidated entity

. 1 Colli er on Ba nk ru p t cy ¶ 12.12[4] [a]
, at 12-56. T he investors’ funds there fore could not be considere d18

“par t of the capital” of any consolidated enti t y for purposes of § 78 lll (2)( C)(ii): The consolidated entity would hold the funds, in a strictly custodial capa city
, for investment in a secur ity i s sued by a third party

. The opposite is true here : T h e consolidated entity

—S I BL and SGC—held the funds in a

non -custodial ca

pacity , i.e., as pa

rt of its capital.

I ndeed, the § 78 lll (2)( C)(ii) exclusion specific all y

en compasses deposits that become “par t of the capital” o f a SI PC-member firm “by opera tion of law.” I t is undisputed that SI BL CD proce eds wer e “par t of the capital” of

SIBL

. Under the SEC’s view, those proce eds eff ectively also beca

me part of SGC under the leg al doctrine of substantive consolidation. But if so, the “ca pital” of SI BL would become “par t of the capital” of SGC “by opera tion of law,” placing t h e CD proce eds square ly within the ambit of § 78 lll (2)( C)(ii). Be cause we believ e the SEC’s con t rar

y understanding of the Act’s definition of “customer ” can n ot be square d with the § 78 lll (2)( C)(ii)

exc lusion, we need not addre ss whether
, as the SEC contends, its formal analy sis letter should be acc orded Chevron defe renc e.

The SEC makes one additional arg ument in contending that the § 78 lll (2)( C)(ii) exclusion should not apply here

. The
ag ency asser ts—for the fir st tim e in its reply brief, a nd with no further elabor ation—that “funds g iven t o a consolidated entity i n exchang e for SI BL CDs should not become part of th at entity ’s capital beca

use the SI BL CDs wer e mere ly participa tory interests in a Ponz i scheme .” Pet’r’s Repl y Br

. 16. The SEC made no such contention in its formal an al y s is letter, and we there fore need not consider whether the arg ument would amount to a rea sonable construction of the statute for Chevron purposes. Considering the arg ument without any overla y of defe renc e, we find it unpersua sive. The SE C o ff ers no explanation why investment proce eds that would otherwise become part of the issuing entity ’s “ca

pital” lose t hat char acte ristic if the19

investment is induced by

fra ud as par t of a P onzi scheme

. Nor

are we awa

re of any leg al support for that proposition. To the
contra ry , any such concl u sion would be inconsistent with New Times II

. There
, t h e S econd Circuit held that purcha sers of promissory notes from a

consolidated e ntity

wer e “unpr otected lender s” to the entity

— rather than “customer s” of the entity

— e ven though the investment was “fr audulently induced.” 463 F.3d at 129; s ee i d. at 126 (investors wer e “issued fra udulent promissory notes”). There is no rea son to reach a differ ent conc lusion here.

C.

The SEC raises a fallbac k arg ument in the event we reje ct its eff ort to trea t SGC an d SI BL as one consolidated entity

. Acc ording to the SEC, reg ardle ss of whether the companies are consolidated, investors who gave cash to S I BL for CDs should be deeme d to have deposited cash with SGC under the approa ch
set forth in Old Naples and Primeline

. Tho s e d ec isions, howeve r, do not support concluding that the CD investors may be considere d “customer s” of SGC. The decisions instead reinfor ce our concl usion that the capital exclusion in § 78 lll (2)( C)(ii) prec ludes finding the Act’s “customer” definition satisfied her e.

I n Old Naples
, the Eleventh Circui t consi dere d another financ ial fra

ud involving both a SI PC-member broker and a nonSI PC-member entity

. 223 F.3d at 1299-1300. I nvestors

rec eived instructions to send money t o b oth entities with the understanding that the broker would then purcha se bonds in the investors’ names. Id. at 1301. I nstead of buy ing the bonds, the

o wner of the entities misappropriate d investor funds for h i s persona l use and for pay

ment of the broker ag e firm’s expenses. Id. at 1300. The E l ev en t h Circuit held that investors who had
sent money to the non-SI PC-member entity could rec over in the20

liquidation as “customer s ” e ven though they had never deposited funds with the SI PC-member broker itself. Id. at 1302-06. The
court found that customer status “does not

. . . depend simply on t o whom the claimant handed her cash or made her chec k
pay able.” Id. at 1302. I nstead, “[i] f an investor intended to have the brokerag e purchase secur ities on her behalf and rea sonably followed the broker ’s instructions reg arding pay ment, she can be

co n sidered a ‘customer ’ under SI PA if the broker ag e or its
ag ents then misappropriate the funds.” Id. at 1303. I nvestors who had sent funds to the non-SI PC-member entity qualified as “customer s” under the Act beca use they “had no rea son to know that they wer e not dealing with” the SI PC-mem b er broker and beca use t h e broker had “ac quired control over all of” the deposited funds. Id. at 1303-04 (interna l quotation m ar ks omitted).

The Tenth Circuit ’s decision in Primeline is to the same eff ect. T h ere, an employ ee of a S I PC-member firm opera ted a Ponz i scheme involving the sal e to investors of “debe ntures in ficti tious corpor ations.” 295 F.3d at 1104 (interna l quotation marks omitted). At the employ ee’ s direc tion, investors made
out chec ks to third-par

ty acc ounts—not to the bro k er ag e firm itself—from which the employ ee misappro priated investor funds. Id. Citi ng Old Naples
, the Tenth Circuit reiter ated the principle that, “[i] f a claimant intended to have the broker ag e purc hase secur ities on the claimant’s behalf and rea sonably followed the broker ’s i n s t ructions reg arding pay ment, the claimant is a ‘customer ’ under SI PA even if the broker ag e or its
ag ents misappropriate the funds.” Id. at 1 107. The court aff irmed the bankruptc y court’s find i n g t hat investors had “re asonably thought” that the employ ee was “ac ting as an ag ent of [t he broke r] when he dire cted them to make out the ir chec ks
to one of his third-par

ty companies.” Id. (interna l quotation marks omitted). As a result, the court held, those investors wer e entitled to rec over as “customer s” in the liquidation. Id. at 1109.21

Her e, the SEC points t o fa ct s that “could have led SGC

acc ount holders who purcha sed SI BL CDs t h roug h SGC to believe the y

wer e depositi ng cash with SGC for the pur pose of purcha sing the CDs,” J .A. 243—even though, pursuant to the stipulated fac ts, those investors in fac t sen t t heir funds direc tly
to S I BL

. The SEC notes that cer tain SI BL CD investors “had
accounts at SGC, dealt solely with SGC repr esenta tives, and paid for their CDs in acc ordanc e with SGC’s instructions.” Pet’r’s Br

. 52. The SEC highlig hts investor aff idavits repor

ting that SGC employ ees blurred the lines between SGC and S I BL
, “fr equently ref

er[ring ] simply to ‘Stanford’ wi thout clea rly distinguishing betwee n” the two entities. J .A. 243. I n addition, the SEC observe s, cer

tain cu s t o mers “made chec ks for the purcha se of the CDs pay able to ‘Stanford,’ ” possibly indicating “investor con fu s ion reg arding the entity with which they wer e depositing money .” J .A. 244. Th o se considerations, in the S E C ’s view, bring this case within the fold of Old Naples an d Primeline for investors who intended to deposit funds with SGC and rea sonably believed they wer e doing so. As in those case s, the SEC contends, the fac t that the CD investo rs in fac t deposited cash with SI BL sho u l d n ot stand in the way of deeming them to have deposited cash with SGC for purposes of
trea ting them as protec ted “customer s.” SI PC disag ree s, contending
, for example, that investors could not reasonably have b eli eved they wer e depositi ng funds wit h SGC in light of CD disclosure statements clea rly stating t h at the CDs wer e issued by a non-SI PC m ember

.

We need not resolve that disag ree ment. Even if cer t ai n SI BL CD investors rea sonably believed that they had deposited cash with SGC, Old Naples and Primeline still wo u l d fail to support concluding that those invest o rs qualify as “customers” under the Act’s definition. The SEC’s arg ument disregar ds a subsequent inquiry underta ken in both Old Naples and Primeline : whether the investors intended to deposit their funds22

as a loan so as to trig g er the § 78 lll (2)( C)(ii) exclusion for funds that become part of the rec ipient’s “ca pital.” I n Old Nap l es , SI PC arg ued that the i nvestors failed to qualify as “customers” beca use they intended to g ive a loan to the rec ipient rathe r than
to deposit cash for i nvestment on their behalf. See 223 F.3d at 13 0 4

. The court reje cted that arg ument, holding that the investors intended the broker to use the funds to invest in bonds issued by a third party

. Id. at 1304-05. I n Primeline
, simil arly
, SI PC arg ued t h at the investors “we re lender s rathe r than investors” and thus fell outside the “customer ” d efinit ion by virtue of the § 78 lll (2)( C)(ii) exclusion. 295 F.3d at 1110. The
court disag ree d, aff

irming the bankruptc y court’s finding that the investors “intended to invest, not loan
, the funds eac h entrusted to [the broker ].” Id.

This case stands on a marke dly differ ent footing

. Her e, as explained, the investors who purcha sed SI BL CDs acte d as lender s. Even assuming tho se investors rea sonably believed SI BL and SGC wer e p art of a unified Stanford entity
, they deposited their cash with tha t entity as lende rs: in e x chang e for

a promise of repa

y ment in the form of a CD. Their funds thus beca me part of the Stanford entity ’s “ca pital” for purposes of the § 78 lll (2)( C)(ii) exclusion. Acc o rd i n g ly
, even if we adher e to the approa ch set forth in Old Naples and Primeline —as the SEC requests we do—that approa ch compels concluding that the investors in SI BL CDs fail t o qualify as “customers” under t he Act.

* * * * *

I n declining to g rant the SEC’s reque sted relief
, the district
court expressed that it was “truly sy mpathetic to the plight of the SGC clients who purcha sed the SI BL CDs and now find themselves sear ching desper ately for relief .” 872 F. Supp. 2d at 12. We fully

ag ree . But we also ag ree with the district court’s23

conclusion that SI BL

CD investors wer e not SGC “customer s” under the Act. We there fore aff irm the district court’s denial of the SEC’s application for an order compelling SI PC to

commence liquidation of SGC.

So ordered.