ACT OF 1970 (SIPA)(15 USC §78AAA LLL) TO PROTECT CUSTOMERS OF BROKER DEALERS AND MAINTAIN CONFIDENCE IN THE UNITED STATES SECURITIES MARKETS. THESE GOALS ARE ACCOMPLISHED IN TWO PRINCIPAL WAYS. FIRST, WHEN A BROKER IS IN OR APPROACHING FINANCIAL DIFFICULTY, SIPC HAS THE AUTHORITY TO PETITION THE COURTS FOR PROTECTION OF THE BROKER'S CUSTOMERS IN A "PROTECTIVE PROCEEDING." SUCH PROTECTION CAN INCLUDE THE COURT ORDERED APPOINTMENT OF A TRUSTEE TO LIQUIDATE THE FIRM AND SATISFY CUSTOMER CLAIMS FROM THE PROCEEDS OF THE LIQUIDATION (15 USC §78FFF). SECOND, SIPC IS ENDOWED WITH FUNDS RAISED BY ASSESSMENTS ON ITS MEMBERS, WHO ARE ALL THE BROKERS REGISTERED UNDER EXCHANGE ACT SECTION 15(B). FROM THESE FUNDS, SIPC CAN ADVANCE MONIES TO THE TRUSTEE TO SETTLE CLAIMS
(15 USC §78FFF 3). AS A RESULT OF BDO'S ALLEGED MISSTATEMENTS, SIPC CLAIMS IT WAS REQUIRED TO SPEND OVER $2.5 MILLION SETTLING THE CLAIMS OF BARON'S CUSTOMERS AND $5.5 MILLION IN ADMINISTRATIVE FEES ASSOCIATED WITH BARON'S LIQUIDATION.
WHILE SIPC IS NOT AN AGENCY OF THE GOVERNMENT, THE SEC EXERCISES EXTENSIVE CONTROL OVER ITS BUSINESS AFFAIRS (SEE, 15 USC §78CCC). SIPC DOES NOT HAVE INDEPENDENT INVESTIGATORY POWERS TO CERTIFY THE FINANCIAL HEALTH OF ITS MEMBERS. IT DOES NOT RECEIVE FINANCIAL STATEMENTS FROM ITS MEMBERS, MUCH LESS AUDIT THEM. NO STATUTE OR RULE REQUIRES BROKERS TO SUBMIT THEIR AUDITED FINANCIAL STATEMENTS TO SIPC AS THEY ARE REQUIRED TO DO FOR THE SEC OR THE DESIGNATED SELF REGULATORY ORGANIZATION, HERE THE NASD.
IN ORDER TO COMMENCE A "PROTECTIVE" PROCEEDING, SIPC MUST FIRST BE AWARE THAT A BROKER IS IN FINANCIAL DIFFICULTY. NOTICE TO SIPC IS CONTEMPLATED IN SECTION 78EEE OF SIPA. UNDER THAT SECTION, THE SEC OR ONE OF THE SELF REGULATING ORGANIZATIONS, SUCH AS THE NASD, IS REQUIRED TO NOTIFY SIPC WHEN IT BECOMES "AWARE OF FACTS WHICH LEAD IT TO BELIEVE THAT ANY BROKER OR DEALER SUBJECT TO ITS REGULATION IS IN OR IS APPROACHING FINANCIAL DIFFICULTY" (15 USC §78EEE[A][1]). IN THE PRESENT CASE THE PLEADINGS DO NOT STATE HOW SIPC ULTIMATELY BECAME AWARE OF BARON'S FINANCIAL DIFFICULTIES IN 1996; HOWEVER, A PROTECTIVE PROCEEDING FOLLOWED AND JAMES GIDDENS WAS APPOINTED TRUSTEE FOR THE LIQUIDATION OF BARON.
BOTH GIDDENS AND SIPC COMMENCED THE PRESENT ACTION IN THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK. GIDDENS ASSERTED CLAIMS AGAINST BDO FOR NEGLIGENCE, FRAUD AND BREACH OF CONTRACT. SIPC ASSERTED CLAIMS FOR NEGLIGENCE AND FRAUD, BOTH AS SUBROGEE TO THE CLAIMS OF BARON'S CUSTOMERS AND ON ITS OWN BEHALF FOR THE ADMINISTRATIVE COSTS ASSOCIATED WITH THE LIQUIDATION. ON BDO'S MOTION, THE DISTRICT COURT DISMISSED THE COMPLAINT AS TO SIPC, CONCLUDING THAT SIPC DID NOT HAVE STANDING TO SUE ON ITS OWN BEHALF AND THAT THE ALLEGATIONS ON BEHALF OF BARON'S CUSTOMERS FAILED TO STATE CLAIMS FOR FRAUDULENT OR NEGLIGENT MISREPRESENTATION UNDER NEW YORK LAW. THE TRUSTEE'S CLAIMS WERE ALSO DISMISSED. THE UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT CONCLUDED THAT SIPC LACKED STANDING TO SUE ON BEHALF OF BARON'S CUSTOMERS BUT THAT IT COULD SUE ON