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SEC lawyers asked U.S. District Judge Robert Wilkins during a hearing today in Washington to require SIPC, a nonprofit corporation funded by the brokerage industry, to start a liquidation proceeding in federal court in Texas to handle more than $1 billion in possible claims related to the alleged Stanford fraud.

“Ultimately, what we’re seeking here is to provide a forum where claimants can seek judicial review of their claims,” Matthew Martens, the SEC’s chief litigator, told the judge during a three-hour hearing.

At issue is whether more than 7,000 brokerage customers who invested in the alleged $7 billion Ponzi scheme run by Stanford are entitled to have their losses covered by SIPC.

SIPC, a congressionally chartered group that insures customers against losses caused by broker theft, says the Stanford investments don’t fit into the confines of the federal law that governs who’s eligible for the payouts. Investors and their advocates in Congress say SIPC is deliberately taking a narrow view of the law to protect brokers from higher assessments.

‘Proof of Customers’

“There has to be proof of customers to start a liquidation,” Eugene Assaf, a lawyer for SIPC, argued today.

Assaf, of Kirkland & Ellis LLP in Washington, said the SEC was trying to open a liquidation proceeding in Texas without any judicial review of whether the Stanford investors are “customers” under the law. He asked Wilkins to require the SEC to refile its lawsuit, allow the parties to seek discovery and then decide whether the Stanford investors are covered by the Securities Investor Protection Act.

“This is our only opportunity to convince the court whether a liquidation should be ordered or not,” said Assaf, adding that a liquidation proceeding would cause significant expense for SIPC.

Martens told Wilkins that a SIPC-appointed trustee and the U.S. bankruptcy court in Texas would be responsible for reviewing whether individual claimants qualified for payouts.

‘Under Advisement’

Wilkins said he would take the matter “under advisement” and issue a ruling “as soon as I can.”

Stanford allegedly used his brokerage to entice investors to buy high-interest certificates of deposit through his private Stanford International Bank Ltd. in Antigua. Instead, according to prosecutors, much of the money was used to support Stanford’s businesses and lifestyle.

Opening statements in Stanford’s criminal trial began today in Houston.

Stanford, 61, was the ringleader of a $7 billion investment fraud, the U.S. said in a 14-count indictment accusing him of mail fraud and wire fraud, crimes that carry maximum sentences of 20 years in prison. He’s also charged with conspiracy to commit mail fraud and wire fraud and to obstruct an SEC probe.

“I plead not guilty to every count,” Stanford, wearing a light gray plaid suit and a white dress shirt and no necktie, told the jury today.

‘Lie After Lie’

Stanford stole from investors “so that he could live the lifestyle of a billionaire,” Assistant U.S. Attorney Gregg Costa said in his opening statement. “He told them lie after lie after lie.”

In the defense’s opening remarks, Robert Scardino, one of Stanford’s court-appointed lawyers, told the jury: “Mr. Stanford’s financial empire was real and did make a lot of money and did pay every penny of what was owed to depositors for 22 years.”

In June, the SEC ordered SIPC to start a process that could grant as much as $500,000 for each Stanford client -- the same maximum amount it offers in any case. After SIPC balked, the SEC for the first time sued the group in federal court in Washington.

SIPC is responsible for providing coverage for individual investors who lose money or securities held by insolvent or failing member brokerage firms. It has agreed to cover losses sustained by victims of Bernard Madoff’s multibillion-dollar Ponzi scheme and investors who may have lost money in the October collapse of commodities broker MF Global Holdings Ltd. (MFGLQ)

SIPC may be best known for its logo, which dues-paying brokerage firms put on their marketing materials to show customers they’re protected. Unlike the protection that the Federal Deposit Insurance Corp. gives to bank accounts, SIPC doesn’t run a general insurance fund or cover investment losses. Under the Securities Investor Protection Act, it’s supposed to aid investors when their securities or cash are stolen or go missing.

Offshore Banks

SIPC doesn’t guarantee an investment’s value or protect against fraud, the agency said in court papers. It also doesn’t cover investments with offshore banks or non-member firms.

Stephen Harbeck, SIPC’s president, has said that SIPC shouldn’t get involved because investors received actual CDs after the brokerage passed their money to a bank. What happened after that isn’t under SIPC’s purview because the Stanford account holders have possession of their securities, he told a court-appointed receiver in 2009.

The SEC eventually decided that there was no true separation between Stanford’s bank and the brokerage firm. Customers who made investments with the bank were effectively depositing money with the brokerage and should get SIPC coverage, the SEC said.

Martens told Wilkins today that the SEC has full authority over SIPC, which is why the judge should enforce the SEC’s order to begin the liquidation proceeding.

U.S. Senator David Vitter, a Louisiana Republican whose state is home to many Stanford investors, asked SEC Chairman Mary Schapiro in a Capitol hearing last month to sue SIPC.

The case is Securities and Exchange Commission v. Securities Investor Protection Corp., 11-mc-00678, U.S. District Court, District of Columbia (Washington).

To contact the reporter on this story: Tom Schoenberg in Washington at tschoenberg@bloomberg.net.

To contact the editor responsible for this story: Michael Hytha at mhytha@bloomberg.net.