A federal judge has said that the US Securities and Exchange Commission (SEC) got it very wrong when it issued an order earlier this year that froze more than $88 million in assets belonging to two financial institutions suspected of securities fraud that led to the collapse of Caledonian Bank in Grand Cayman. Although the SEC recently authorized a settlement with Caledonian Bank that is awaiting approval by Cayman Island authorities, it comes too late to rectify the mistakes that brought the forty-five 45-year-old bank to its knees.
In a ruling dismissing a pre-trial motion in the bankruptcy case, Manhattan District Court Judge William H. Pauley said blunders by the SEC triggered the collapse of the bank and other “collateral damage” in a case involving an alleged penny stock scheme, according to US press reports.
“This case offers fertile ground for agency self-examination,” the judge said, adding that the SEC was mistaken and its key allegations were wrong when it issued the order to freeze assets that closed one of Cayman’s oldest financial institutions.
In February SEC lawyers asked the court to approve its decision to freeze assets of Caledonian as well as three offshore brokerages. They claimed the financial institutions had illegally sold “large swathes” of worthless, unregistered penny stocks to investors as part of a “pump and dump” fraud and were holding millions of dollars in proceeds from those transactions in their company accounts.
Caledonian Bank Ltd and its related financial entities collapsed and filed for bankruptcy after a depositors’ run on the bank. But the SEC later revealed that they got it wrong and that Caledonian’s role in the alleged fraud was far more limited than the agency had first claimed. The firms were not directly selling the penny stocks but trading them on some customers’ behalf.
“For an enforcement agency with vast investigative powers, the SEC’s disclosure was chillingly casual,” Judge Pauley wrote in his ruling.
“Bureaucratic siloing and missed opportunities” ensured the failure of Caledonian but the judge also blamed the bank for agreeing to the regulator’s freeze on $76 million, which was more than three times its capital. “This case reveals the dire consequences that flow when the SEC fails to live up to its mandate and litigants yield to the government’s onslaught,” stated Pauley, the judge who had agreed to freeze the assets.
“The bank collapsed because of your actions, didn’t it?” Pauley asked Richard Simpson, a SEC lawyer, during a May hearing and Simpson agreed.
“It’s stunning,” Pauley said, according to Bloomberg reports at the time. “It’s incredible government overreach.”