Decision by U.S. Bankruptcy Court Supports SIPC in Action Related to 1995 Failure of Hanover Sterling & Co.

NEW YORK--(BUSINESS WIRE)--Dec. 22, 1999

Court Rules That Hanover Investments Were Fraudulent,

SIPC Should Not Pay Claims

The U.S. Bankruptcy Court for the Southern District of New York has ruled that the Securities Investor Protection Corporation (SIPC), and Edwin B. Mishkin, the trustee for the bankrupt brokerage firm Adler, Coleman Clearing Corp., were correct in asserting that SIPC should not pay certain customer claims because the claims were based on securities transactions that were fraudulent, SIPC announced today. The customer claims were related to the failures of New York-based Hanover Sterling & Co., and its clearing firm Adler, Coleman, and the liquidation of those firms pursuant to the Securities Investor Protection Act (SIPA).

In a ruling dated December 15, 1999, Bankruptcy Judge James L. Garrity agreed with SIPC that Hanover Sterling engaged in a series of fraudulent stock transactions designed to benefit its preferred customers in the face of the firm's inevitable failure. Hanover Sterling employees realized that the brokerage firm was collapsing, and that stocks in customer accounts could not actually be sold for the prices Hanover Sterling quoted for those securities. The employees then entered fictional, fraudulent transactions in preferred customers' accounts which made it appear that the preferred customers had sold their portfolios at high prices. Because these sales never actually took place, no cash was ever actually received for the preferred customers. Hanover Sterling employees then used the fictional "sales proceeds" to enter orders for "blue chip" stocks.

The claimants will receive their original securities portfolios. Had the customer claimants been successful, they would have had claims for the cash or the "blue chip" stocks which were never actually contained in their accounts. SIPC, a nonprofit, membership corporation created by SIPA in 1970 to provide certain protection against loss to investors in the event of a brokerage firm's failure, provides up to $500,000 for claims for securities, including $100,000 for cash claims. SIPC provides such protection when a member firm fails financially and is unable to meet its obligations to customers.

The Bankruptcy Court rebuffed the customer claims, determining that the securities transactions in question were fraudulent on numerous levels, and therefore not eligible for SIPC protection. The Court held that the transactions had occurred without customer knowledge or had never actually been executed at all. As the Court stated: "While SIPC was clearly designed to protect customers of failed broker-dealers, it was not intended to be a vehicle for shifting investor accounts from worthless securities to cash or securities with value by means of fraudulent manipulation."

According to Michael E. Don, SIPC's president, SIPC would have faced a liability of as much as $80 million if the claims had been found to be legitimate. "SIPC's primary mission is to safeguard the interests of brokerage customers with legitimate claims. SIPC has already expended $8 million to satisfy valid claims in the Adler Coleman liquidation. But the claimants before Judge Garrity were actually seeking to benefit from a fraudulent act. SIPC was never intended to protect those transactions," said Mr. Don.

"With this decision, the Court has helped SIPC protect the integrity of the securities markets and the SIPC Fund, to the benefit of all brokerage customers who may legitimately need SIPC protection," he said.

Since SIPC's founding in 1970, SIPC has satisfied (as of December 31, 1998) more than 426,500 claims in completed or substantially completed cases, distributing cash and securities totaling $2.87 billion ($194.4 million from the SIPC Fund and $2.67 billion from debtors' estates).