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Friday, October 1, 2010

Securities Investor Protection Corporation

Gary Shorter
Specialist in Financial Economics

The Securities Investor Protection Corporation (SIPC) is a nonprofit, quasi-public, quasi-industry, nongovernmental corporation that was established in 1970 through the Securities Investor Protection Act (SIPA), which amended the Securities and Exchange Act of 1934. Overseen by the Securities and Exchange Commission (SEC), SIPC reimburses customers of failed SIPC member broker-dealers for remaining losses beyond the recovered assets that are returned to them by a court-appointed trustee who presides over the firm’s liquidation. With the broad goal of helping to maintain investor confidence in the securities markets, SIPC has historically provided valid customer claims up to $500,000 per customer, of which up to $100,000 can be in claims for cash, and the rest in claims for securities. Signed into law on July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act expands SIPC protection available for cash claims up to $250,000 out of the total maximum per customer claims of $500,000.

The SIPC funds that are used for such customer claims derive from the SIPC Fund. The fund’s assets come largely from annual assessments on SIPC broker-dealer members, at a rate that has been periodically adjusted by SIPC. From 1997 to 2009, SIPC charged a flat rate of $150 per member. In the event that the SIPC Fund became insufficient for carrying out SIPA’s mission, SIPC had the authority to borrow up to $1 billion from the U.S. Treasury.

Following large liquidations at firms like Lehman Brothers and Bernard Madoff’s operation, Investment Securities LLC, the SIPC Fund fell to $1 billion in 2009, a recent historical low. In response, SIPC decided to provide for a SIPC fund level target of $2.5 billion, and increased annual member assessments to 0.25% of each member’s net operating revenue. The Dodd-Frank Act increases the amount that SIPC could borrow from the Treasury Department to $2.5 billion and imposes a minimum assessment on SIPC members of 0.02% of the gross revenues from the securities business of each SIPC member. Arguing that the present system effectively subsidizes and thus encourages potentially high-risk firms, some observers have urged SIPC to shift to a risk-based pricing system for member assessments. Others, however, question the cost-benefit calculus of risk-based pricing.

The Madoff case drew the public’s attention to a number of public policy concerns. One involves the use by the trustee in the Madoff case of a “cash-in-minus-cash-withdrawn” approach to calculating the value of a customer’s account. By contrast, many of Madoff’s victims advocate a calculation based on the “last-statement method,” which relies on the value of a customer’s account according to their last statement. In March 2010, a bankruptcy judge from the United States Bankruptcy Court for the Southern District of New York ruled in support of the Madoff trustee, a ruling that received SEC support. A second issue involves the large number of Madoff’s investors who were indirect investors, investors invested through third party investment vehicles like pension funds and mutual funds. According to SIPC officials, SIPA limits each of their protections to a prorated portion of the up to $500,000 in cash and securities that the vehicle that they were invested in would receive from SIPC. Many of the indirect investors, however, say that being the recipients of such a diluted, prorated form of distribution is unfair. H.R. 5032 (Ackerman) would require SIPC to provide up to $100,000 worth of protection to indirect investors in Ponzi schemes, and it would retroactively apply to the Madoff liquidation. Other pending legislation that involves SIPC include S. 3166 (Schumer), S. 3258 (Reed), H.R. 1159 (Meeks), H.R. 1389 (Ackerman), and H.R. 2798 (Arcuri). In 2010, SIPC formed a Modernization Task Force, whose mission is to conduct a major review of the corporation and then report to the SIPC board.

Date of Report: September 21, 2010
Number of Pages: 13
Order Number: RS21741
Price: $29.95

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