Brokerage insurance firm ailing

Upheavals of '08 leave $1.7b fund vulnerable

By Michael Kranish
Globe Staff / May 8, 2009
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WASHINGTON - Until recently, the little-known Securities Investor Protection Corp. was flying high, confident its $1.7 billion fund was more than enough to insure investors against brokerage failures and fraud for years to come.

For a decade, the agency did not raise how much it charged brokerage companies for insurance: only $150 a year to insure every account for up to $500,000 whether it was Merrill Lynch, a small-time broker, or admitted Ponzi scheme operator Bernard Madoff.

Then came the financial collapse of 2008, which included Madoff's $65 billion swindle. The cost of the claims in the Madoff case is expected to be in the hundreds of millions of dollars - and could wipe out the fund's assets. SIPC officials, who for years have said the fund could withstand the most severe economic shocks, now acknowledge that it is in danger of dropping far below adequate levels.

As a result, they have dramatically raised insurance rates on brokerage firms, increasing the annual fee from $150 to 0.25 percent of each brokerage's net operating revenues, which could cost millions of dollars a year at some firms. The agency, created by Congress but privately run, also has a $1 billion line of credit with the Treasury Department that it might have to tap for the first time in its history.

As a result, members of Congress including Barney Frank, chairman of the House Financial Services Committee, are now questioning whether the agency is too beholden to the securities industry that pays its bills. The Massachusetts Democrat, whose committee has jurisdiction over the agency, said that the financial collapse has exposed flaws that must be remedied, perhaps by changing the structure of the agency to diminish the influence of brokerage firms.

"We are going to have to increase investor protection," Frank said in an interview. "It clearly has not worked for level of the problem we've seen."

Stephen Harbeck, SIPC's president and CEO, said that his agency has followed the mandate of courts and Congress, and that it is up to lawmakers to make changes.

Established in 1970 in the aftermath of a series of financial problems in the industry where some securities firms went bankrupt and were unable to pay back account holders, SIPC calls itself "the investor's first line of defense." But that defense is only available in select cases.

On Wednesday, for example, Harbeck met with a group of investors who purchased certificates of deposit from the Stanford Group, which has been accused by the government of massive fraud. Harbeck said he told the investors they were not eligible for any payments even though some said they bought the certificates through a SIPC-backed brokerage.

Unlike the FDIC, which guarantees deposits in case a bank fails for any reason, SIPC says it only covers cases in which a brokerage firm fails to fulfill its duty as a "custodian" of a customer's account. That is why the SIPC does offer some coverage in the Madoff case - in which stock orders were never fulfilled and money was put into a Ponzi scheme - but not in the case where an investment was made and turned out to be worthless or depreciated.

But even in the Madoff case, the limited protection has stunned some investors. So far, only 51 Madoff claims have been approved, leading thousands of unpaid investors to question whether the agency is trying to limit its losses by unfairly denying payments

Moreover, although SIPC promises to protect "each customer" in the case, it says that a single customer actually could be a group of people. Thus, although 140 members of the Orthopedic Specialty Group in Fairfield, Conn., had their 401(k) retirement fund invested with Madoff, they may have to split a payment of $500,000 from SIPC, the agency says.

"We are saying there is one customer behind which there stands 140 people," Harbeck said in an interview. He said, however, a final decision has not been made because SIPC is still awaiting paperwork on the case.

Dr. Henry Backe, a representative of the orthopedic group, responded that detailed claims have been sent to SIPC and said every individual in the retirement plan should be covered.

"SIPC has a reputation of protecting the broker-dealers and their own entity, and not doing what it was set up by Congress to do," Backe said. He said his group - and a number of other retirement plans in the same position - are prepared to appeal if SIPC rules against them.

The agency has also indicated that it will take a tough stance against customers who took out more money than they put into the Madoff fund. Such customers may have to return the excess funds under a legal procedure known as "clawback." Those funds might be redistributed to other investors according to how much each lost.

Representative Ron Klein, a Florida Democrat who also sits on the House Financial Services Committee, wrote a letter earlier this week to Harbeck in which he criticized the agency's effort to "clawback" the funds of some investors. Such a move would "unfairly penalize Madoff's victims," Klein wrote. Harbeck responded that it would not be proper to let some investors keep "fictitious" profits.

Helen Davis Chaitman, a lawyer for 350 Madoff investors who also lost all of her savings in the case, is among those who believe they are being victimized twice - first by Madoff, and then by the SIPC.

She said in a recent letter to the government that the SIPC has "grossly misconstrued" the law and is acting "for the economic benefit of Wall Street and to the extreme detriment of investors."

Peter Moskowitz, another Madoff investor, said he wants SIPC "to do what it is supposed to do under the law and nothing more. The brokers have benefited from having insurance without having to pay the premium" other than $150 annual fee, he said.

Harbeck said his hands are tied by the laws under which his agency operates.

"I don't enjoy saying no to people," Harbeck said. "The fact of the matter is the law is what it is and until is it is changed, I am stuck with that result."

Michael Kranish can be reached at

"We are going to have to increase investor protection," US Representative Barney Frank said in an interview.

Concern in Congress