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Investors who were persuaded to convert securities into loans for use in a Ponzi scheme cannot recover their losses under a fund established by the Securities Investor Protection Act, the 2d U.S. Circuit Court of Appeals has ruled. In re New Times Securities Services v. Giddens, No. 05-5527 The court reversed a ruling by Judge Joanna Seybert of New York’s eastern district and reinstated the decision of a bankruptcy court judge who had ruled that the protections of the act do not apply to the plaintiffs because they were considered lenders and not customers. The bankruptcy of brokerage houses New Times Securities Services Inc. and New Age Financial Services prompted Maryann Stafford and Rheba and Joel Weine to seek recovery as “customers” from a reserve fund established pursuant to the Securities Investor Protection Act, 15 U.S.C. 78aaa, et seq. The brokerage houses were used by William Goren, who allegedly represented to the plaintiffs that they had substantial funds in their accounts when that was not the case. Stafford had invested $75,000 with Goren and the Weines had invested $35,000. Stafford and the Weines were persuaded to liquidate some or all of the illusory funds in their accounts to make loans to the brokerage houses and to Goren. In 1999, they authorized Goren to sell some or all of their securities and reinvest in interest-bearing promissory notes. Goren solicited clients, took their money and “invested” it in fictional money market funds. He also issued false promissory notes. Goren used some of the money to pay “dividends” on prior investments-a “Ponzi scheme” in which money contributed by later customers was paid out as dividends to the original investors. The U.S. Securities and Exchange Commission filed a complaint in 2000, seeking to freeze the brokerage houses’ assets and appoint a temporary receiver. The brokerage houses were then placed in liquidation under the act and a trustee was appointed to oversee the liquidation of assets pursuant to the orders of the bankruptcy court. Goren pleaded guilty in federal court in 2001 to securities fraud. The FBI claimed that he stole as much as $32 million from investors in the Ponzi scheme. The investors sought recovery as customers under the Securities Investor Protection Act (SIPA). The trustee denied the plaintiffs’ claims under the act, and the bankruptcy court affirmed on the ground that they were lenders, not customers. Seybert reversed, finding that the plaintiffs were customers within the meaning of the act. The 2d Circuit reversed. Writing on behalf of the panel, Judge Dennis Jacobs said that SIPA makes a “specific distinction” between “customers” and “lenders.” Whether an individual enjoys customer status turns on the “transactional relationship,” he said. “A loan transaction that is unrelated to trading activities in the securities market does not qualify for SIPA protection.” The act’s scheme for compensating wronged investors, Jacobs said, assumes that customers want to keep their investments despite the liquidation of the broker. “The promissory notes held by the plaintiffs on the filing date entitled them as holders to (i) a return of principal at a fixed time and (ii) interest at a fixed rate,” Jacobs said. “[T]hese are just the type of debt instruments whose possession brings claimants within the category of unprotected lenders.” Seybert, according to Cohen, had reasoned that the plaintiffs’ “legitimate expectations essentially froze at the moment they sold their securities, and they therefore retain customer claims for ‘cash.’ ” But unlike another case involving investors in New Times, in which “ customers” could recoup money given to a broker for investment in “wholly fictitious” securities, Jacobs said, “the plaintiffs here decided to swap their SIPA-protected securities investments for non-protected loan instruments.”

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