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Monday, January 24, 2011

Securities Investor Protection Corporation (SIPC): Basic Functions and Fairness and Adequacy Issues

Gary Shorter
Specialist in Financial Economics

The Securities Investor Protection Corporation (SIPC) is a nonprofit, nongovernmental corporation that was established in 1970 through the Securities Investor Protection Act (SIPA) to protect securities investors in the event of a broker-dealer failure. Except as otherwise provided in SIPA, the provisions of the Securities Exchange Act of 1934 (1934 act) apply as if SIPA were an amendment to, and included as a section of, the 1934 act.

A court-appointed trustee generally presides over a SIPC member broker’s liquidation and returns the remaining cash and securities to the firm’s former customers. If the returned customer assets do not make customers whole, SIPC advances additional cash and securities to the customers. With the broad goal of helping to maintain investor confidence in the securities markets, SIPC has historically provided up to $500,000 per customer, of which up to $100,000 could be in satisfaction of claims for cash only (as opposed to claims for recovered securities). Signed into law on July 21, 2010, and in effect the next day, the Dodd-Frank Wall Street Reform and Consumer Protection Act (P.L. 111-203) expanded SIPC protection available for cash claims up to $250,000 of the maximum customer protection of $500,000.

The SIPC funds that are used for such customers 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 adjusted by SIPC. From 1997 to 2009, SIPC charged a flat rate of $150 per member.

In September 2008, immediately before the start of the Lehman Brothers liquidation, the size of the SIPC Fund was $1.5 billion. Beginning in April 2009, following the commencement of large liquidations of firms like Lehman Brothers and Bernard L. Madoff Investment Securities LLC, SIPC re-instituted assessments on a percentage basis. At that time, the Fund stood at $1.6 billion. SIPC increased the SIPC Fund level target from $1 billion to $2.5 billion, and increased annual member assessments from $150 to 0.25% of each member’s net operating revenue. On January 31, 2010, the size of the Fund reached a low point of $1.07 billion. As of August 31, 2010, the Fund stood at $1.31 billion. The Dodd-Frank Act increases from $1 billion to $2.5 billion the amount that SIPC can borrow from the Treasury Department if the SIPC Fund is insufficient, and it imposes a minimum assessment on SIPC members not to exceed 0.02% of the gross revenues from the securities business of each SIPC member.

The Madoff case drew public attention to a number of public policy concerns. One concern is that SIPA does not cover so-called indirect investors, individuals invested in investment pools such as family partnerships or pension plans (also known as “feeder funds”), who have SIPA coverage as single entities. Under SIPA, each feeder fund is treated as an individual investor whose maximum SIPC protection is $500,000. Investors in feeder funds are thus entitled to a prorated and hence diluted portion of the payment to such a fund. Various observers say this is unfair. H.R. 5032 (Ackerman, 111
th Congress), which could be reintroduced in the 112th Congress, would have required SIPC to provide up to $100,000 worth of protection to indirect investors in Ponzi schemes, including those involving Madoff. In addition, under H.R. 6531 (Garrett, 111th Congress), which also could be reintroduced in the 112th Congress, a victim’s losses would be determined by the last amount on the individual’s account statement. Currently, trustees use the last statement minus any amounts that have already been withdrawn by a customer, which is another concern.

Date of Report: January 20, 2011
Number of Pages: 13
Order Number: R41599
Price: $29.95

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