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Rabbi Mark Kunis agreed he was maybe a bit rash when back in June 1994, he invested a few thousand dollars with a cold-calling broker from Hanover Sterling, a Manhattan brokerage specializing in penny stocks. But his investment did very well, so he kept investing. He even took out a loan of $100,000 on his Atlanta, Ga., home to purchase more stocks recommended by his broker, John Lembo. Then in January 1995, Kunis recalls, he saw a report on CNBC questioning the value of the Hanover Sterling stocks he owned, known as house stocks because they were controlled by the brokerage. “I panicked,” said Kunis, who by that point had invested his life savings. “I called my broker and told him to sell the stocks and put me in something safe.” Over the next few weeks, Kunis called repeatedly to find out if the stocks had been sold. Not yet, Lembo told him. But don’t worry, I’ll get you out. Finally, on Feb. 24, 1995, the day Hanover Sterling went under, Lembo called Kunis. “You’re very lucky,” the rabbi was told, “I got you out.” Shortly after, Kunis received written confirmation that he had sold the penny stocks and purchased 4,660 shares of Dell Computer. So despite Hanover Sterling’s demise, Kunis thought he was OK. He had his money in a blue chip stock. And if worse came to worse, he reasoned, the Securities Investor Protection Corporation (SIPC), the quasi-governmental, industry-financed agency that insures brokerage accounts, would cover his loss. After six years of fighting, he now knows he was mistaken. “I was foolish,” he said, “I thought it was a security investor protection corporation.” Instead, he said, “they did everything in their power to get rid of me.” SIPC FACES CRITICISM The plight of investors like Kunis has provoked criticism of the SIPC by lawyers for investors and securities experts. They claim that the agency, created by Congress in 1970, has defined its mandate so narrowly that it does not do nearly as much as it could to help victims of broker fraud. Instead, it pays back investors in only the most clear-cut cases, they say. Critics also contend that the SIPC dictates the stances taken by the trustees who oversee the liquidation of failed brokerages, an assignment that can be worth millions of dollars. SIPC chooses the trustees and pays them, explained Jed Horwitt, the lawyer who represents Kunis. “That’s a huge conflict,” he added. “I challenge anyone to show me a case where the trustee took a position adverse to the SIPC,” he said. SIPC trustees contest these charges. They say they are helping investors to the best of their ability, but that they are constrained by the statute, which does not cover losses stemming from broker fraud, something that was not a widespread concern 30 years ago when the statute was passed. “It tugs at your heart strings,” said Irving Picard, a partner in the New York office of Gibbons, Del Deo, Dolan, Griffinger & Vecchione who is the trustee in several SIPC liquidations, including Hanover Sterling. “You want to do something for these people but you can’t.” He dismissed arguments about conflicts of interest: “One can always punch holes.” He said he gets “letters of accolades from claimants for what I’ve done for them.” But that did not happen for Kunis: The trustee in his case, Edwin Mishkin, of New York’s Cleary, Gottlieb, Steen & Hamilton, denied his claim. The story of Hanover Sterling’s demise was a sordid one, and ultimately may have tainted the claims of innocent investors like Kunis. As chronicled in a famous 1996 Business Week cover story, “The Mob on Wall Street,” Hanover Sterling was a classic “pump and dump” operation, aggressively marketing flimsy house stocks to retail customers, running up the price to profit Hanover’s alleged backers, the Genovese organized crime family. The mob was also the reported cause of the brokerage’s collapse: While the Genoveses were profiting from the inflated price of Hanover stocks, other mobsters were shorting them, pushing their price downward. Ultimately, they sent Hanover Sterling over the brink, hoping to profit when prices crashed as a result. When Hanover Sterling collapsed, it also brought down Adler, Coleman Clearing Corp., a major clearinghouse that guaranteed and processed trades for Hanover Sterling and 41 other small brokerages. The clearinghouse found itself on the hook for Hanover trades that exceeded its own resources. Three days after Hanover Sterling shut its doors, Adler Coleman was forced into bankruptcy. In the final frantic week of Hanover Sterling’s existence, the brokers tried to protect friends, family and certain clients with sizable investments by selling house stock from their accounts to buy blue chip stocks such as Dell, Microsoft, Cisco and IBM. Eighty percent of these purchases were made on Feb. 24, the same day the NASD shut Hanover Sterling down. The trustee Mishkin denied claims based on these 11th-hour trades, about 400 out of a total of 5,900 customers. He said these blue chip trades, which included Kunis’ purchase of Dell, were invalid because the claimants did not authorize them, lacked the funds to pay for them, and did not receive trade confirmations on Feb. 24. U.S. Bankruptcy Judge James Garrity Jr. sided with the trustee. In a 200-page decision, Mishkin v. Ensminger ( In re Adler, Coleman Clearing Corp.), 247 B.R. 51 (Bankr. S.D.N.Y. 1999), he ruled that the 100 or so claimants who challenged Mishkin were not entitled to the proceeds of the disputed trades. DISTRICT COURT AFFIRMS Nine of the claimants, including Kunis, appealed to the U.S. District Court for the Southern District of New York. But they fared no better: Last month, in another 200-page decision, In re Adler, Coleman Clearing Corp., 00 Civ. 4216 (June 11, 2001), that court affirmed the bankruptcy court. Since the Hanover brokers acted as the customers’ agents when making the fraudulent trades, the court reasoned, the customers are responsible for those acts, even absent their knowledge of fraud. The trades were fraudulent, the court said, because they were not backed by sufficient funds. Horwitt, who represents the claimants, found this incredible. “It’s remarkable that people like my clients whose only relationship with Hanover was calling to make a trade would be considered responsible for market manipulation.” He contended it was the judges’ attempt to fit the law to a predetermined conclusion. “The court was looking for a way not to pay these customers,” he said, because of all the others who didn’t get their trades executed. Indeed, the Southern District pointedly noted that “in the final week, only 9 percent of Hanover’s 5,900 customers were able to sell their house stocks, while many more attempted unsuccessfully to do so.” That is wrong too, Horwitt said, but two wrongs do not make a right. Mitchell Lowenthal, a partner with Cleary Gottlieb who represents Mishkin, defended the courts’ decisions. Over 98 percent of Adler Coleman’s customers have been paid in full, he said, and the SIPC guaranteed tens of millions of dollars. The trustee denied claims made by a select group of investors who tried to take advantage of the brokers’ fraudulent trades, he added. “These people were given benefits that others were not,” he said. “A lot of them were the brokers’ girlfriends or parents or people who had done a significant amount of business with the firm.” Horwitt challenged Lowenthal’s description of the claimants as a group of select investors. He pointed out that his clients included Kunis, a retired bank president from Oklahoma and a former Navy fighter pilot. All of the nine who appealed the bankruptcy judge’s ruling, he said, expressly ordered the trades that the trustee ultimately voided. PUSH FOR REFORM The Adler, Coleman decisions highlight a major failing of the SIPC, said Thomas Joo, a professor at University of California, Davis School of Law. “It shows that brokerage collapses tend to be related to fraud that isn’t really part and parcel of the SIPC.” It might be time for Congress to take a fresh look at an act that is out of sync with the industry it regulates, he said. Even the SIPC’s defenders agree with this assessment. “The business is different today,” said Hanover Sterling trustee Picard, pointing to the increase in broker fraud and advent of electronic trading. “It wouldn’t be an inappropriate exercise for Congress to look at changes in the industry and whether it should do something” to update the statute, he said. The SIPC and its problems have attracted the attention of at least one person on the Hill. In late 1999, Michigan Congressman John Dingell, the ranking Democrat on the House Commerce Committee, asked the General Accounting Office to investigate and report on the SIPC’s policies and practices. The report, released late last month, “found significant deficiencies on the part of the SIPC � that appear to have operated to the detriment of investors,” Congressman Dingell stated in a letter to the agencies. Steven Caruso, of the New York office of Maddox Koeller Hargett & Caruso, who represents investors, said the report “screams out for Congressional hearings to be held and people to ask what the purpose of the SIPC is.” “It’s an outdated, ill-served piece of legislation that no longer serves its original purpose- to provide protection for investors,” he said. Whether such hearings will take place remains to be seen but in any event it will be too little too late for Kunis. Although his Dell stock would be worth around $7 million today, he has received nothing. He said he thought he would still win on appeal, but he could no longer afford to continue the litigation. “I’m a man of faith,” and God will provide, Kunis said. “But I’m very disappointed and hurt by the government.”

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