An introducing broker that has defrauded its customers can be liquidated under the Securities Investor Protection Act (SIPA), according to an opinion by District Judge Robert W. Sweet in Manhattan.
The opinion leaves open the question of whether an insolvent introducing broker is subject to a SIPA liquidation if customers have no claims against the firm.
An introducing broker maintains relationships with its customers and takes their orders for purchasing or selling securities. Another firm, in this case RBS Capital Markets LLC, executes the trades, holds the securities for customers, and sends them account statements under its name.
Judge Sweet held a hearing, took testimony from witnesses, and determined in his opinion on Feb. 11 that the introducing broker had been making unauthorized trades in customers’ accounts. Although customers complained, the introducing broker never reversed the trades.
The introducing broker withdrew its broker-dealer registration last year and went out of business. This year, the Securities Investor Protection Corp. (SIPC) initiated proceedings in Judge Sweet’s court to initiate a liquidation under SIPA, contending as it must that the customers were in need of the protection of SIPA.
The introducing broker argued it could not be the subject of a SIPA liquidation because it had no “customers,” a prerequisite to a liquidation conducted by SIPC, because the accounts were held by RBS.
Judge Sweet said that no court in his district has decided whether introducing brokers are subject to SIPA. Instead, he pointed to SIPA’s definition of a “customer” as meaning someone who has a claim “arising out of sales or conversion of securities.”
According to Judge Sweet, the unauthorized trades provided an independent basis for a SIPA liquidation because the customers have fraud claims arising from securities transactions. He therefore initiated the SIPA liquidation and referred the case to the bankruptcy court.
The initiation of a SIPA liquidation is significant for customers. If the firm instead were liquidated under the stockbroker provisions in chapter 7 of the Bankruptcy Code, there might be no assets to cover customers’ claims. Under SIPA, SIPC provides up to $500,000 in cash for each customer account. In addition, SIPC pays administration expenses, so costs of the liquidation do not decrease customers’ recoveries.