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THE COMMITTEE ON FINANCIAL SERVICES THE SECURITIES INVESTOR PROTECTION CORPORATION: PAST, PRESENT, AND FUTURE

By Lawrence Velvel

THE COMMITTEE ON FINANCIAL SERVICES

THE SECURITIES INVESTOR PROTECTION CORPORATION: PAST, PRESENT, AND FUTURE
(PDF of transcript)

WEDNESDAY, MARCH 7, 2012

9:30 A.M.?
INDEX

EVENT PAGE

PANEL I 20
THE HONORABLE DAVID VITTER 20

PANEL II 28
MR. STEPHEN HARBECK 28
MS. SHARON BOWEN 35

PANEL III 110
MR. JOE BORG 110
MR. STEVEN CARUSO 119
MR. IRA HAMMERMAN 121
MR. RON STEIN 126

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[BEGINNING OF RECORDING]
Mr. Garrett: This hearing is entitled ?The Securities Investor Protection Corporation: the Past, the Present, and the Future?. This hearing will now come to order and I recognize myself for four minutes to give the opening statement.
So, with regard to today?s hearing, today?s hearing is fashioned, as I just mentioned, in a broader oversight hearing of the, of Securities Investor Protection Corporation, SIPC. And it?s not meant entirely to be focused solely on a particular aspect of SIPC?s work.

But, to me, the failure of SIPC in regards to the Madoff liquidation are so fundamental, relative to the protections that SIPC is supposed to provide to investors. And so, antithetical to the goals that SIPC and Congress set out to achieve at their beginning, that I would like to focus much of my time, and my thoughts, and my energy, and my comments on the circumstances surrounding that particular case.

I also think that it?s worthwhile to hear today about SIPC?s work in regard to the Lehman bankruptcy. And also, what we -- examining the long-awaited and recently-released report of SIPC?s Modernization Task Force as well. And going through that task force and looking at it, unfortunately, is that it?s somewhat of a missed opportunity, if you will, and it seriously studies some of the shortcomings of SIPC exposed by the recent failures of the broker-dealer.

So, let?s return now to the failure of the Madoff firm and let?s examine the facts of that case. As we?re all probably too familiar.

The Madoff firm was regulated by both FINRA and the SEC. And they repeated received government stamps of approval that it was operating basically legally. The firm proudly displayed the SIPC logo, which again implies government backing since SIPC is backed by the US Treasury. Madoff investors paid taxes to the IRS, US Government, for years. Again, another government agency saying that its investors and profits were, well, real.

Just around the same time SIPC was enacted, investors no longer held stock certificates. So, the only proof of ownership they have, or had, was the statement that they received from a government-regulated broker-dealer.
So, what does it mean? So, the Federal Government both provided a stamp of approval and relied upon that stamp of approval and yet, innocent private citizens now, as investors, are being held to a higher standard than them. So, instead of being provided protection by SIPC, as Congress did intend in order to increase confidence in investment in our markets, innocent investors in this case are being sued by the very same Trustee chosen by SIPC.

Now, am I the only one when you go down that whole litany of facts that are here to say that, ?Well, something is simply not right here?? Now, an additional irony is that if the Trustee is successful in suing individual investors, who will go to, who will the money go to? It will largely go to pay off institutional investors. Now, this is the same class of investors that the Trustee has repeatedly tried to sue because he believes, well, that they should have known better. But they?ll be paid.
It?s because of my concerns over these issues I?ve introduced H.R. 757, the Equitable Treatment of Investors Act. This legislation would reaffirm and clarify key protections for ordinary investors that were put in place when Congress passed and amended the SIPC.

In particular, the bill aims to shield innocent individual investors, who have already been defrauded and financially devastated by the Madoff situation, from further clawbacks by the SIPC Trustee. In addition, the bill clarifies that for purpose of SIPC protection, customers of registered brokers are legally entitled to rely on their broker statements as evidence of what their broker owes them. Indeed, in a world where customers do not any longer hold the physical stock certificates, how can it be done any other way? Finally, H.R. 757 would end an ongoing conflict of interest by having the SEC, rather than SIPC, select Trustees for the SIPC liquidation.

Now, several of my colleagues already joined me in cosponsoring this legislation and I encourage my other colleagues to look at it and consider it as well. So, I look forward to today?s testimony of our witness, and all the panels that we have, and a hearty discussion on SIPC activities and roles, those of the past, and the present, and the future as well.
And, with that, I yield back and I yield to the gentlelady from New York for three minutes.

Ms. Maloney: Okay. Thank you. Thank you, Mister Chairman. I thank you for your deep concern on this issue, which is a major concern for many of us on this committee. And, I welcome Senator Vitter. You honor us with your presence. We look forward to your testimony.

As a representative of New York City, the financial industry is a very important part of our economy. The massive fraud that was put forth by Bernard Madoff is very personal to me and it hurt many of my constituents and certainly violated the trust of the public for the industry. So, it was a tremendous blow to many people on an individual basis and to the industry at large.

My constituents, many of whom are victims of this fraud, from union workers who lost their pensions, to charities that lost their operating funds, to investors large and small who lost their life savings, literally lost their homes, lost absolutely everything, the experience has been absolutely devastating and they are devastated.

Even worse, the confidence of investors around the world in the system of regulation and law enforcement of our financial markets was visibly shaken by this scandal. Just yesterday, Mister Stanford, another perpetrator of a Ponzi scheme who cheated his investors out of over $7 billion was convicted on 13 out 14 counts that he faced. This should be some comfort for the people he defrauded, but we want to make sure that if this ever happens again, there are tools in place so that victims can be made whole and SIPC can do its job.

I believe that markets run as much on confidence as they do on capital. And this is a serious blow to investors? confidence at a critical time. We still see that many people are holding their money back from investing and going forward with our financial system.

The reason we are here today is to look at the Securities Investor Protection Corporation, SIPC, and to shed light on the reform proposals that are out there, including several pieces of legislation that are pending before the House. I know this committee is looking closely at the SIPC Modernization Task Force Report, which was released at the end of last month. So, this hearing is very timely.

I know that my colleague, Mister Ackerman, and the Chairman have put forth thoughtful bills. I?m interested in seeing how their bills coincide or reflect, go further, or not as far as the SIPC Modernization Task Force Report?s recommendations. And I look forward to working with them on these bills. I hope we can explore both of these legislative proposals and hear from the witnesses, what they believe is the right, is the better approach, or the right approach we should be taking.

I look forward to the hearing. It?s one that?s very important to our country. And I thank the Chairman for calling this important hearing and his work on his legislation. And also, I compliment Mister Ackerman for his hard work.
I reserve the balance of my time and turn it back to the Chairman.

Mr. Garrett: Okay. Gentlelady yields back. The gentleman from New York is recognized now for three minutes.

Mr. King: Thank you, Mister Chairman. Thank you for calling today?s hearing. It?s very timely for the representative from SIPC to come before the subcommittee. After several years, they?ve finally produced the recommendations of their Modernization Task Force and this hearing and report come against the backdrop of the Madoff liquidation, which you have referenced and which Miss Maloney has referenced.
This was unearthed three years ago and for the past three years that process run by SIPC has gone profoundly amuck. This is tragic, this is wrong. From my perspective, at least four takeaways from this liquidation.

One, the Trustee, Irving Picard, is out of control. He interprets SIPA as he desires, not as intended by the courts. And on several occasions, has been slapped down by the courts. He intimidates innocent victims, brings spurious clawback suits against them, maligning their reputations in the process, and leaking spuriously to the media. Even Chairman, Chairwoman Mary Schapiro expressed surprise as the initiation of the baseless lawsuit.

Just the other day, in an order dated March 5th in the Southern District of New York, Judge Rakoff in the case Irving Picard versus Saul Katz made a finding, ?The Court remains skeptical that the Trustee can ultimately rebut the Defendants? showing of good faith, let alone impute bad faith to the Defendants. More generally, the Court is concerned that much of ?the evidence? that the parties proffered on summary judgment did not comport with the Federal Rules of Evidence. Conclusions are no substitute for facts, and too much of what the parties characterized as bombshells proved to be nothing but bombast.? And that?s what that lawsuit has been from beginning to end, bombast.

Two, the victims are being treated unfairly. A very few victims have received the statutory mandated SIPC advances. The Trustee has hatched an accounting mechanism that disregards real-world, cuts reputations on broker-dealer protocol, it?s lawyer intensive, and it has run up the fees of $300 Million, paid to Mister Picard. $300 Million. He has an open piggybank here for himself.
It?s not an exaggeration to say the victims have been victimized twice, once by Bernie Madoff and now by Irving Picard.

Three, the Trustee is not being properly supervised. Where were the regulatory bodies tasked with oversight over this Trustee, SIPC directly and the SEC indirectly? Moreover, where was the Statutory Mandate Report on the liquidation required of the Trustee? The Trustee of the Lehman liquidation has completed and filed such a report. The broker-dealer failure is arguably much more complex and complicated than the Madoff debacle.

Lastly, this miscarriage of justice endured by the Madoff victims could happen to any investor if a broker-dealer fails for any reason.

We need to restore some reason and some rationality to the unwinding of failed brokerage firms, and that?s why I am proud to sponsor with Chairman Garrett H.R. 757, a proposal enjoying bipartisan support.

Chairman, thank you for your leadership on 757. Thank you for holding this hearing. I look forward to hearing from the witnesses.

I yield back.

Mr. Garrett: And again, I thank the gentleman from New York. Thank you for your work in this legislation as well and for this issue, leadership.

Mister Green is recognized for two minutes.

Mr. Green: Thank you, Mister Chairman. I?d like to thank my colleague and friend from Louisiana, my home state. While I represent Texas, I was born in Louisiana. So, I?m honored to have you with us today.

Mister Chairman, I, too, am concerned about investor confidence. I think it?s exceedingly important that investors understand that we desire to impose proper protection for their investments. As I weigh this issue of whether we are going to base our payments on account statements or actual net cash investments, my concern is the actual statements. Because as you know, in the Madoff case, his statements were misrepresentations and they were actually fraudulent in and of themselves. That causes a degree of concern. I?m eager to look at the legislation and make some decisions. My thoughts are rather ambivalent right now.

I do want the investors to be protected and I stand for investor protection. I would like to peruse legislation to ascertain how we manage these statements that are fraudulent, that themselves are misrepresentations. And, we are talking about tax dollars to a limited extent.

So, for this reason, I thank you and I look forward to hearing more so that I can come to a final conclusion.

Mr. Garrett: And thank you. The gentleman yields back.
Mister Dold for two minutes.

Mr. Dold: Thank you, Mister Chairman. Certainly appreciate you holding this hearing and for your leadership. I want to thank Senator Vitter for being here as well and our other witnesses.

We all have tremendous sympathy for all of the direct and indirect Madoff victims, and all other Ponzi scheme victims as well, which is why we?re all here, to see how we can improve available protections in a balanced way, without creating unsustainable, unfair, and otherwise negative, unintended consequences.

The fundamental reality of the Madoff Ponzi scheme, and every other Ponzi scheme, is that money is stolen from many innocent people and there isn't enough money to make everyone whole. That?s a difficult and complicated situation. And there aren?t any perfect answers or perfect solutions. People suffer in those circumstances and we need to find the most balanced way to minimize the losses and the suffering among a large group of innocent victims.

But all innocent victims aren?t in the same position. Many innocent victims have great conflicts of interest with many other innocent victims. Some victims ended up getting more money than they put in. In some cases, much more money than they put in. Their profits were, I would argue, all fake, were fraudulent, stolen by the Ponzi schemer from other innocent victims. Those other innocent victims received absolutely nothing and instead lose everything. And their stolen money has gone to pay for those fraudulent profits to others.

What do we do in that situation? There?s no perfect, or even good answer. But, historically, we?d recover the fake profits from the innocent victims who received them to partially repay the actual losses of other innocent victims. In that way, nobody gets to profit from the Ponzi scheme. There might be a better way, or more fair way, or a less unfair way to handle this difficult situation and I hope that we hear one today.

And if no investor should profit from a Ponzi scheme, the Federal Government should also never profit from the Ponzi scheme. For decades, innocent people paid very real taxes on totally fake profits. When the fraud is exposed, the IRS says that the innocent victims can only get refunds for the taxes paid during the last five years. So, ironically, the Federal Government benefits more and more from a long-term Ponzi scheme the longer it continues. Why shouldn?t the innocent investors be able to recover all taxes that were wrongly paid on totally fake or fraudulent profits?

I have a number of other questions and I see my time has expired, but I do hope we have an opportunity to ask them during the question and answer period.
I certainly want to thank those that are coming here today testifying. And again, Mister Chairman, I thank you for your work.

Mr. Garrett: Thank you. Thank you for your comments.
The gentlelady from California for the remaining time on her side at least.

Ms. Waters: Thank you very much, Mister Chairman. And thank you for holding this hearing on the Securities Investor Protection Corporation.

The past few years have been very challenging for SIPC. During the height of the financial crisis, the Corporation was forced to liquidate Lehman Brothers, one the world?s largest brokerage firms. Shortly thereafter, the Madoff Ponzi scheme was uncovered. In the years since Madoff, we?ve also seen the case of the Stanford Group Company and the failure of MF Global.

Following the liquidation of Lehman Brothers and the discovery of the Madoff Ponzi scheme in 2008, SIPC?s board of directors created the SIPC Modernization Task Force to review whether any changes to the law of the SIPC?s operations were needed.

Today, we?re considering the report published by this task force. Their recommendations include items that is requiring acts of Congress and items that can be pursued administratively. I?m interested to hear from the Corporation on the rationale behind these recommendations, as well as any areas where certain task force members may have alternatives to what was presented in the consensus report.

It?s also important to know how we can increase investor understanding of SIPC and make certain that investors realize that it does not offer the same protection as FDIC insurance.

I?m also interested in exploring how we can ensure the most equitable outcome for investors who put their savings into Madoff, Stanford, and MF Global.
I understand that Chairman Garrett and Representative Ackerman have legislation that would attempt to provide additional assistance to certain victims of the Madoff fraud. I?m very curious to hear more about this bill, but I?m also very mindful that Congress should be very careful in this area since any changes to how customers? claims are calculated will inevitably make certain investors winners and others losers.

Finally, I?m very curious to hear more about SIPC?s rationale for not paying out claims under the Stanford Group Company fraud and this issue that the SEC has contested. The timing of this hearing is all the more apt in light of Allan Stanford?s conviction yesterday on 13 counts related to his $7 billion Ponzi scheme.
Thank you, Mister Chairman. I yield back the balance of my time.

Mr. Garrett: Thank you, gentlelady. And that?s an interesting point on the last one you raised there.

And we have one other member who, Doctor Cassidy, who would, without objection, would like to serve, or sit on the panel later on today once we get into the panels, without objection.
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PANEL I
Mr. Garrett: So, we will now go to our, to our first panel. And we welcome the gentleman from the other side of the Capital. Welcome back to a former House Member, Senator Vitter. I know you serve on the Senate Banking Committee and I know also that coming from where you do, down south, that you have a number of your constituents who were more than adversely affected, not by the, well, some may by the Madoff case, but more often by the Stanford case, and that you have been a leader in trying to bring a equitable solution to that situation. So, we thank you to coming and joining us in this committee. Senator.

Mr. Vitter: Well, thank you very much, Chairman Garrett and Ranking Member Waters, and all of you for the invitation. I really appreciate it. And even more importantly, thank you for your important work and partnership on all sorts of issues, this, as well as a lot of challenges that have confronted Louisiana. Hurricane Katrina and Rita, the BP Oil Disaster, all of you have been wonderful and generous in terms of our working partnership. Thank you for that.

And it is great to be back on the House side. I remain a House Member in spirit. I brought a healthy House skepticism to the Senate, which I still don?t drink from the water fountains over there and that?s not going to change any time soon. So, it?s great to be here.

I am here, of course, because this is a very important issue and I have been particularly involved in the case that you mentioned, the Stanford case. I?ll submit my full comments for the record and I?ll summarize here. And because of that focus, of course, my comments are going to be very informed by the Stanford case in particular, although I certainly acknowledge the importance of many other cases and share all of your concerns, including, in particular, about the Madoff case.

I?m very involved in the Stanford case because, unfortunately, there are thousands of victims nationwide, and many of them, many retired oil and gas workers and executives are in Louisiana. So, I?m talking personally to dozens and dozens of them. Like in the Madoff situation, many lost their entire life savings. Many have literally had to sell their homes, go back to work well after normal retirement, things like that. They are real victims that have been taken advantage of.

In the Stanford case, as you know, SIPC has denied coverage completely. And that?s the fundamental problem. SIPC is basically taking the position, ?While these were valid CDs, that were lowered in value, lost value, and we don?t cover market losses.? Well, I think that position?s just flat-out wrong. And through the Stanford experience, I?ve come to the conclusion that there is a need for major SIPC reform.
It isn't to change their coverage. It isn't to change the parameters of the statute. I?m not here to argue that that should be broadened. Again, I think there is clearly coverage in the Stanford case under the present statute. And I don?t propose that SIPC should cover market losses or every evil or bad situation under the sun. Rather, I think reform is needed in a different way, and in some ways a much more fundamental one.

I reached the conclusion that SIPC, if it were a true regulator, would, in the [inaud.], is the, a situation of complete regulatory capture. I do not think SIPC is focused enough on following the law and executing the law. I think it?s far too focused on serving the industry and its member companies and looking after their interests. And my experience in the Stanford case in particular, has led me to that unfortunate conclusion.

First of all, let me talk briefly about why there is coverage. As was mentioned, Allen Stanford was found guilty just yesterday of 13 criminal counts. He was found guilty of basically fraud, stealing customer funds. Instead of purchasing Stanford International Bank CDs, the Stanford Group Company, which was a SIPC member, acquired control of its customer funds and the funds were stolen by Allen Stanford. The SEC and courts have taken the position in litigation that the Stanford companies operated a Ponzi scheme and ?a Ponzi scheme is, as a matter of law, insolvent from its inception.? So, it?s not a matter of real CDs losing value, it?s a matter of a Ponzi scheme, a fraud, and Allen Stanford stealing those funds.

There are several other precedents in law and other cases that back up this point of coverage that are in my written testimony. I won?t go into it exhaustively.
But, my first point is that there is coverage. Now, people can disagree about legal points, but what I?ve really been [inaud.] about isn?t simply that SIPC has disagreed, but the way they have acted again has led me to conclude that they?re not primarily focused in the right spirit on executing the law and protecting people properly covered under the law, but they?re really focused on protecting their fund and their member companies.

Let me give you some examples. The very first meeting I ever had with SIPC, the Chairman was there, top staff were there, the first concern mentioned about the Stanford case was the amount of money it would drain from the fund and the reaction of member companies to the need to replenish the fund through other assessments. That was the first thing that came out of their mouths, quite frankly, before we talked about, what?s the right thing to do, what the law says. Later, after they had dug in their heels for months and months denying all coverage, after the SEC finally acted and did the right thing, they entered into settlement negotiations and were willing to settle, albeit for far less than a hundred cents on the dollar. So, apparently, their view of the law changed if it was going to preserve more of their fund. When they couldn?t reach a settlement, they went back to court and are presently, in my opinion, dragging their feet and prolonging court action as much as possible. This includes spending $200,000 of what is there for ultimate recovery by the victims on certain discovery. This includes presently asking for more prolonged discovery, rather than getting to the heart of the issue in the legal proceeding.

You put all of that together, Mister Chairman, in my opinion, that is not a picture of an agency or an entity trying to meet its responsibility to covered victims under the law. It?s more of a picture of what would be akin to an industry trade group, or association, an active party litigant, if you will, just trying to preserve as much as they can of their resources and their fund. And I believe that?s the fundamental problem and that?s the most fundamental need for reform.

So, Mister Chairman, again, thank you for this hearing and calling attention to this important matter, including the Madoff case, including the Stanford case. I think this discussion will promote important reform. I hope, in the meantime, that SIPC still does the right thing in the Stanford case and that it doesn?t prolong the court activity and the litigation and we get to that bottom line as quickly as possible for the good of all of the victims. And I really appreciate the invitation to be here and all of your partnership on this important issue and other important issues. Thank you very much.

Mr. Garrett: Senator, I thank you for coming to join us today and speak on the first panel. I thank you also for your concern for your constituents and other constituents around the country as well for this matter. I appreciate also and thank you for your work and leadership in the Senate on this matter. As you see from the questions and by the opening statements, I think we, it is a bipartisan concern on this issue in general. And as you can see with the legislation that is here partly to be considered, you can also see that it is a bipartisan initiative as well. Still open questions as to the finality of some of these things, but I think we?re going to try to do it in a bipartisan manner.

I understand that we?re already at the top of the hour and I was told by staff that you have, as always for Senators, a commitment back on the other side of the House. So, I appreciate your coming over and appreciate accepting our invitation and look forward to working with you and the other side of the House as well on this issue.
Mr. Vitter: Thank you very much and appreciate it.?

PANEL II

Mr. Garrett: With that, then we will move on to Panel II. And they can come to the table.

At the table, we will have President and CEO of what we?ve just been talking about, the Securities Investor Protection Corporation, Mister Harbeck. And also, we have Miss Bowen, the Acting Chairman of the Board, Securities Investor Protection Corporation as well.

I?ll let you get situated there.

And welcome, again, to the committee hearing today. I appreciate both of you coming, joining us to talk about this very important topic. Your completed, written testimony, of course, as always, will be made part of the full record. We will recognize each of you on the stand for opening statements for five minutes each.
Mister Harbeck? Usually, we start from left to right.

Mr. Harbeck: If you wish, I?ll begin. Chairman Garrett, Ranking Member Waters, and members of the subcommittee, thank you this opportunity today. My name is Steve Harbeck, and I am the President and CEO of SIPC.

Since the collapse of Lehmen Brothers? entities, mentioned by Ranking Member Waters, in 2008, SIPC has been at the center of the financial crisis. I?d like to give you an overview of what SIPC has done between 2008 and the present day.

First, the guiding principle SIPC has used in this period is the greatest good for the greatest number consistent with the law. I?d like to briefly highlight some of the matters in both Madoff, Lehman, MF Global, and Stanford.

The Madoff case is the largest Ponzi scheme in history. The people who have not received funds from SIPC are those people who have either received a hundred percent of their investment back or people who must repay a portion of what they received before receiving funds. The courts have uniformly confirmed that SIPC?s method of computing what is owed to customers is, in fact, correct and in accordance with previous precedent.

I?m pleased to note that the GAO Report on Page 31 that was just issued within the last day indicates that the driver of administrative expenses in the Madoff case is asset collection for those people who have not received a hundred percent of their investment back. The Trustee has used the so-called ?avoiding powers? wisely, judiciously, and effectively. The avoiding powers are precisely what makes the Trustee?s distribution in that case among innocent investors truly an equitable one. The Task Force on SIPC Modernization agreed and Exhibit B to my written statement demonstrates that SIPC doesn?t benefit from the avoiding powers, but those people who are most damaged are the people who benefit.

The Trustee has also adopted a hardship program to discontinue any avoidance suit that should be dropped given the nature of a defendant?s circumstances. It?s very important to note that no customer money is used for administrative expenses. And there has been an incredible benefit to investors.

I first appeared before this body in January of 2009. And if I had told you then that the Trustee would recover $9-$10 billion for the Madoff investors, you would not have believed me. But that is already what?s been what has accomplished to date. And the driver of the $300 million of administrative expenses is the recovery of that $9 billion.
Those who would expand the distributions to net winners in the Madoff game should recall that the distribution in a Ponzi scheme is a zero sum game. And the Trustee?s plan distributes benefits to those who have been most damaged by Mister Madoff?s theft. If other victims, and they are victims, but people who are net winners, who have received a hundred percent of their assets back, share in that fund, it is mathematically ineluctable that the people who are most damaged will suffer on a dollar-for-dollar basis.

Turning to Lehman. Lehman is the largest bankruptcy in history. And in the early days of Lehman, or under SIPC?s initiation of the liquidation proceeding, 110,000 customers received $92 billion in ten days. Second, the Trustee in that case has been extremely successful in lawsuits. He?s won $2.3 billion from Barclays Bank, settled a suit for over $700 million with JP Morgan Chase, and lastly, the Trustee scored a major victory in the Supreme Court of the United Kingdom that will benefit American investors directly.

The impartial observer closest to the case, the bankruptcy judge, states that the case has been an extraordinary success and it is coming to a successful conclusion.
In the MF Global case, SIPC acted to protect investors and did so demonstrating that we can act quickly and decisively. SIPC placed a fiduciary in charge of the firm less than 12 hours after being notified that customer protection was warranted. As I outline in my written statement, significant distributions to both commodity investors and security investors have been made.

And that brings us to the most difficult subject. And that is the Stanford case. SIPC protects the ?custody? function that brokerage firms perform. Let me say that again. SIPC protects the ?custody? function that brokerage firms perform. The investors in the Stanford case, unlike the investors in the Madoff case, knowingly sent their money away from the brokerage firm to an offshore bank. They were specifically told, in writing, that SIPC does not protect their investments. They each opened a bank account in a bank of Antigua. And they now seek rescission of that investment and have SIPC pay the original purchase price of their investment using SIPC and, if necessary, taxpayer funds.

Simply put, Congress never intended, and the statute has never been held, to refund the purchase price of a bad investment. That is absolutely not what the law mandates. And while there are other legal reasons as well, that is why SIPC has not initiated the customer protection proceeding for the firm.
SIPC has acted to protect and benefit investors in those three cases, but SIPC?s protections are not available to restore the purchase price of a bad investment on a CD issued in an overseas bank.

Mister Chairman, if I could mention, or if I could respond to one of your comments at the beginning of this case, you mentioned that institutional investors would receive most of the money in the Madoff case. This is a point made by Mister Stein in his written communiqué. And I think we?re failing to connect some dots here that very, very much need to be connected. Mister Stein mentions that a number of investors received zero in the Madoff case and that is quite true. So, there are thousands of investors who did not receive money. But then, when you say 75 to 90 percent of the assets in Madoff are going to institutional investors, you must connect the dots by saying the thousands of people who did not receive anything are the people who own those institutions, and they will be satisfied by distribution to the institution.

So, I wanted to make that clear so that we realize that when the indirect claimants are not paid, they will receive their proportionate share of the distribution when the funds they own receive the distribution from the Trustee.

And another point made in the written comments concerning SIPC?s actions in this case, is that the distribution was not prompt. The Trustee stands ready to make a $9 billion distribution as soon as he can, but the people who have initiated litigation to allow net winners to share in that money, have delayed that distribution. And if you don?t connect those dots, you don?t get the complete picture.

SIPC?s done a great deal, we?ve advanced $800 million for the investors in Madoff. And we think, in that sense, the process is coming to a sound conclusion.

I?d be pleased to take any other questions you have. Thank you very much.

Mr. Garrett: And I thank you for your statement. Miss Bowen is recognized for five minutes and welcome to the panel.

Ms. Bowen: Thank you. Chairman Garrett, Ranking Member Waters, and members of the subcommittee, thank you for the opportunity to appear before you today to discuss the important work of the Securities Investor Protection Corporation. My name is Sharon Bowen, and I am the Acting Chair of SIPC. Because I also served as the Vice Chair of the SIPC Modernization Task Force, I will focus on the forward-looking issues raised by that report.

SIPC was created in 1970. With some narrow exceptions, every registered broker or dealer is a member of SIPC. Membership in SIPC is automatic upon registration as a broker or dealer. SIPC is not a government agency. Its policies are set by its seven-member Board of Directors, five of whom are appointed by the President and confirmed by the Senate.

SIPC administers a fund, which is comprised of assessments paid by its members. The fund is used to support SIPC?s mission of customer protection and to finance SIPC?s operations. Should the fund become inadequate for any purpose, SIPC may borrow against a $2.5 billion line of credit from the Treasury. In its nearly 40-year history, SIPC has never drawn on that line of credit.

Every customer at SIPC is protected up to $500,000 against lost or missing cash or securities deposited with the broker or dealer for that customer?s account. Of the $500,000, up to $250,000 may be used to satisfy claims for cash only.

To date, SIPC has overseen the administration of 324 customer protection proceedings, which have involved a distribution, through 2010, of roughly $109 billion of assets for those customers. Of that sum, $108 billion has come from the debtors? estates and $1.1 billion has come from the SIPC Fund.

Former SIPC Chairman, Orlan Johnson, promised Congress at his confirmation hearing that he would form a task force to conduct the first comprehensive review of the Securities Investor Protection Act and SIPC?s operations, since the amendments of 1978. The SIPC Modernization Task Force has completed its work, and the Report and Recommendations of the task force are attached.

The task force reached out to obtain a broad input. It conducted a live forum in New York City to receive the personal views of individual investors. It held an internet question and answer forum with investors as well. A website was also established to advise the public of the issues being considered and to solicit input from investors.
In particular, the task force reviewed issues raised by recent complex litigation. In some instances, the task force recommendations will require legislation. And others will require rule changes. And some of the recommendations can be implemented directly by SIPC. We also considered areas where we decided there should be no change.

Let me quickly cover some of the key recommendations. First, the task force concluded that SIPA should be amended to allow for inflation since 1980. In that year, the maximum SIPC advance was set at $500,000. In inflation-adjustment dollars today, that level of protection would be $1.3 million and the task force has concluded that sum should be used and should be adjusted for inflation periodically.

Second, the task force was presented with numerous cases where cash was being ?caught? at a moment just before a security is purchased, or subsequent to a security?s sale, and thus was subject to a lower protection. Because these results are somewhat arbitrary, the task force has recommended that we eliminated the treatment of cash for securities.

Third, since smaller investors often have so much of their wealth in pension plans, the task force has recommended that we extend ?pass-through? protection for pension plan participants that currently does not exist today.
Fourth, and what we believe was an unintentional consequence of an amendment to SIPA, some SIPC members actually had their assessments reduced. We recommend correcting this oversight.

Fifth, the task force recommended that SIPC assist in creating an international association of investor protection entities. While SIPC has memorandum of understanding with a number of these organizations, the Lehman and MF Global cases show that international issues will only increase in the future.
Finally, the task force allocated that SIPC continue to develop programs to fully educate investors about SIPC protections and limitations on those protections.
These are a few of the recommendations. I would like to take the opportunity to thank the members of the task force for their work. And I?d be happy to take any questions.

Mr. Garrett: And I thank you for your testimony. And so, I?ll recognize myself to begin with just a couple questions.

And maybe, I?ll throw it out to Mister Harbeck, but it certainly goes with the last comment that Miss Bowen was making as far as educating the investors and the like. So, Mister Harbeck, you made a comment, which was an interesting one, with regard, and I?ll bring this all around, with the Stanford case that, in that case that there was actually written notice -- well, your first comment was to the effect that the coverage and insurance, if you will, as protection is for the securities that are held by the broker. And you, in that particular case, I think you made comments just now saying the fact that actually written notice was made to the investors that they were investing and their money was going, as you put it, offshore. Correct?

Mr. Harbeck: In the Stanford case, as a part of the investor package that each investor received from the Stanford International Bank in Antigua, the investors, most of whom never gave money to the SIPC member firm at all, but some did, but all when they gave their money to the brokerage firm, the money went to the Stanford International Bank in Antigua, and that bank issued a statement saying that the brokerage firm is not liable and that SIPC does not protect the investment.
Mr. Garrett: Right. Okay. So that?s good to know on that particular case. In all other cases, or the average situation is when the investor goes into the broker?s office, there?s the SIPC logo there and the implication and whatever that comes with that as well. And I remember when we met for the first time, I guess, the comment was made is that there?s a perception that you are covered and insured, if you will, up to $500,000. I remember you saying at that time, ?No, not in all cases.? So, and I think that?s the message that you?re delivering today as well from your testimony.

No, you?re not covered in, for $500,000, in all cases.

So, I guess a very seminal question here is, should we go back to the days of allowing, or requiring that people actually have the stock certificate in their hand so that they can be guaranteed that this is actually what they have, if, and if without that, you?re not really sure what you have?

Mr. Harbeck: Congressman, that would solve the problem, but that?s just not going to happen. It?s not the way the world works. Transactions are done instantaneously at this juncture and in order to physical, take physical possession of securities, I think is an impractical --

Mr. Garrett: Right. So, if -- and I would agree with you. But, if that?s the case that we can?t really be sure of what I have in my hand, as I used to in the old days, then I have to be guaranteed of something, assured of something. And, in this case, the IRS was, or in certain of these cases, the IRS is ensured of something because they see the statement, I guess it?s a 1099 or what have you, that goes to them saying this is what the dividends or payments out, so they?re assured of it. I, as an investor, hypothetically, or an investor would say, ?I have the certificate? or ?I have the statement saying this.? If you can?t rely on, if the investor can?t rely on the statement, what should he rely upon then?

Mr. Harbeck: The, one of the problems here, of course, is that the investors in Madoff gave discretion as to what to buy to Mister Madoff.

Mr. Garrett: Well, in any case, in any case --

Mr. Harbeck: Yeah, but it --

Mr. Garrett: -- what can I rely -- if I can?t rely on the statement, what should I be able to rely on?
Mr. Harbeck: In the overwhelming majority of instances, you can. But what you cannot rely on is that when you give discretion to someone to buy securities and he backdates statement and generates fictitious profits again and again, month after month after month, it is --

Mr. Garrett: But the investor wouldn?t know about the backdating.
I only have a minute left already. As far as discretion, I mean, we can get right to the point on this one, the discretion right now as far as in this situation, when you have a situation like this and the appointing of a trustee, is the selection, the nomination of that process is by SIPC, correct?

Mr. Harbeck: Correct.

Mr. Garrett: Would it be a better process to take that step away from SIPC and have it to a so-called neutral party, which would be the SEC, let that, let them make at least the nomination of it, so you would avert any idea whatsoever, real or otherwise, of any conflict that SIPC would have? If not, why would that be bad?

Mr. Harbeck: Well, I think SIPC has an extended body of knowledge concerning who has expertise on this, number one. And number two, that knowledge and expertise has to be applied on about an hour?s notice. The MF Global case is a perfect example of that. I --

Mr. Garrett: So, if we could set up something within SEC that they would, A, get the knowledge, and, B, have a mechanism to be able to make these things quickly, could that address most of the situations?

Mr. Harbeck: I?m not sure it could, but there?s a further reason. And the further reason is that the people who are saying that these trustees are not comporting with the law are being unsuccessful in that position in courts. It would be different if these trustees were advancing positions in courts and the courts were saying, ?No, you are incorrect.? But, in Lehman, and in Madoff consistently, the trustee has upheld the law as Congress has written it. And the courts have said that that is the case. So, I don?t think there is anything broken about the process. Experts are being put in place and they are doing a good job.
Mr. Garrett: Well I -- my time has expired. I?m always mindful of my colleagues. I guess the question not necessarily is whether they are breaking the law, but whether they are, whether the intention of Congress is being fulfilled as far as how the trustee is managing the case. With that --
Mr. Harbeck: In 1978, Congressman, the Congress investigated that precise point and chose to strengthen SIPC?s ability to designate trustees.

Mr. Garrett: Thank you.
Gentlelady from California?s recognized.

Ms. Waters: Thank you very much, Mister Chairman. And let me thank our witnesses who have appeared here today to help us better understand some of the discussions about SIPC and these cases that have been mentioned here today that have played out in the press.

I want to understand -- can I get a summary of the areas where SIPC and the SEC disagree about how to resolve first the Robert Allan Stanford case?

Mr. Harbeck: Certainly. The essential dispute is that the SEC?s position is a change in the 40-year interpretation of the statute. For the first time, the SEC is saying that SIPC should pay rescission damages to people who are in physical possession of the security that they purchased. That?s never been the law, and it is not the law. And the reason that SIPC has not been involved for two years is because the SEC staff looked for instances where individuals left assets at the SIPC member brokerage firm and did not receive those assets. There is no such investor.
The investors who lost money knowingly and willingly sent their money to an offshore bank. And, saying that there is some vague connection between -- well, it?s not a vague connection. To say that there is, you can just sort of smush everything together and say therefore the brokerage firm must have had custody of the investors? assets is factually incorrect.

The fact is, the investors got what they paid for and they were defrauded. But, SIPC does not pay that as a damage claim. These are victims, but they are not covered by the statutory program.

Ms. Waters: Well, I must say, Mister Harbeck, you make a very good case. What is the current status of SEC?s effort to force SIPC to initiate a claims procedure for Stanford?s victims?

Mr. Harbeck: The SEC delivered a letter to SIPC on June 15th of last year. Our board examined the issue very, very carefully. The board did not take the staff?s recommendation without hiring outside counsel to make sure that the staff recommendation not to start a liquidation proceeding, under these circumstances, comported with law. We did attempt to resolve the problem. We were unsuccessful in resolving the problem with the SEC. And, as a result, the SEC filed suit to compel SIPC to take action.

But we have yet to have been presented with someone who left custody of their assets with the SIPC member brokerage firm, and that?s why we feel we must go forward with the lawsuit.

Ms. Waters: Thank you very much. Let me just ask about the Madoff case. How -- can you discuss how clawbacks have been treated by SIPC as it relates to Madoff?s scam?

Mr. Harbeck: Yes, I?d be happy to.

Ms. Waters: Fraud, I?m sorry.

Mr. Harbeck: Ever since Charles Ponzi enacted his own Ponzi scheme, there have been avoidance powers that allow a trustee to reach back to people who have already received assets out of the fraudulent scheme and bring them back into a common pool. That is exactly what the Trustee has done and that?s exactly what the task force has looked at with respect to whether that should continue under the Securities Investor Protection Act. And the task force concluded that if any bankruptcy trustee has that authority and right, then a SIPA trustee, under the Securities Investor Protection Act, should have that right. And the reason is, the common pool is expanded and it, we don?t let the luck of the draw, by getting out the day before, or withdrawing profits and even your principal just before the collapse of the scheme, gives you an advantage over people who are stuck.
And so, the trustee has used those avoiding powers and by starting one particular lawsuit, he?s brought back billions and billions of dollars into this estate for distribution to the people who need it the most.

Ms. Waters: Mister Chairman, I yield back.

Mr. Garrett: The gentlelady yields back.

Mister Dold, start please.

Mr. Dold: Thank you, Mister Chairman.
Miss Bowen, even though almost 11,000 indirect investors lost their money in the Madoff fraud, not one single indirect investor was invited to be on the Modernization Task Force. Why is that?

Ms. Bowen: The task force actually was comprised of a broad group of people with expertise including two lawyers who represent investors, such as the ones you?ve mentioned. So, we felt that their voice was being heard at the table. In addition, we created a website and we had the internet forum as well. And we had a live presentation where we had an open forum in New York City. I was there at that forum. Investors showed up and they did speak to the task force. And we heard their words and we took their comments to heart.

Mr. Dold: Mister Harbeck, do you believe that President Nixon, and Senator Muskie, and the other supporters that led the 1970 passage of SIPA to provide financial relief for all investors?

Mr. Harbeck: That?s a statement of extraordinary breadth. It -- the fact is the statute as originally drafted in 1970 was intended to protect the custody function performed by brokerage firms. And that is -- we?ve been following that mission for 40 years.
Mr. Dold: Do you believe that it?s fair and equitable to differentiate between direct and indirect investors?

Mr. Harbeck: The indirect investors that you?re referring to are people who I was referring to with respect to comments to Chairman Garrett. The Trustee did not pay them, but they -- the reason he did not pay them is he will pay the institution that they owned, the feeder funds that they owned. So, if five people own a feeder fund, they will each get whatever portion they get in terms of their ownership.
Mr. Dold: And that, will that be considered a single entity? Because I know we?re talking about each individual entity has certain abilities to receive resources back. Will that fund that has five individuals be counted as one or will that be counted as five?

Mr. Harbeck: It would be counted as one. And two points --

Mr. Dold: And you think that?s fair and equitable?

Mr. Harbeck: Yes, I do and here?s why. There?s two points on that. First of all, the task force considered that and considered the fact that small investors in pension funds might well be considered your small investors that are supposed to be protected by this statute. But moreover, the big protection is not the advance from SIPC. The big protection is the share of customer property. And in the Madoff case, this is precisely what Trustee Picard is trying to expand using the avoiding powers and those funds will, if numbers hold, will receive 50 cents on the dollar, which is, was an unthinkable result, an unthinkably positive result in 2008.

Mr. Dold: I just -- I understand what you?re talking about, but I think my concern is that the assumption is that these are going to be smaller investor. Could you not see a situation where actually a group actually with a large investor is coming in and will all be now be treated as one?

Mr. Harbeck: The size of the individual investor --

Mr. Dold: Obviously there is.

Mr. Harbeck: -- is not relevant. What is relevant is whether they had a direct relationship with the brokerage firm.

Mr. Dold: Are you saying --

Mr. Harbeck: And many of the indirect people had no direct investment.

Mr. Dold: Well, are you then trying to pick winners and losers in terms of who, in determining the direct or indirect?

Mr. Harbeck: Absolutely not.

Mr. Dold: You don?t believe that there?s any difference there?

Mr. Harbeck: No, if a large investor owns a share of a feeder fund, he will get a proportionate share.

Mr. Dold: Capped at what, $500,000, is that correct?

Mr. Harbeck: No, sir. The fund itself will get $500,000 plus a share of its prorated share of the fund. And the prorated share of the fund is the lion?s share of what any investor will receive.

Mr. Dold: Mister Harbeck, let me just move on then a little bit. How does the net equity of, or the cash in minus cash out computation protect all customers of a failed broker-dealer?

Mr. Harbeck: This is the methodology that?s been used in every single case under the Securities Investor Protection Act dating back to the ?70?s where fictional statements have been involved. S.J. Salmon in 1973, Adler Coleman in the ?90?s, many cases in between. These -- the money in, money out methodology is not new to Madoff. It is historically what has always been used when brokers enter fictional transactions to benefit customers.

Mr. Dold: Thank you. I realize my time has expired, Mister Chairman, but I do -- hopefully, we?ll have another round to talk about some clawbacks, which I think is important when you talk about some of these Ponzi schemes. I yield back.

Mr. Garrett: Gentlelady from New York is recognized for five minutes.

Ms. Maloney: First, I?d like to thank you for your testimony and voice my support for the task force?s recommendation that the 500 be raised to, with inflation, to $1.3 million and to provide pass-through protection to some indirect investors. I think that was a thoughtful recommendation and I support it.

I would like to ask a question on H.R. 757. It is one of the bills that we are debating and is before this committee. And, in that bill, the last statement would be used when determining a customer?s eligible claim. As was stated, the courts have recently ruled that this standard in a Ponzi scheme is not appropriate. And that the standard that SIPC is using, net investment money in, money out, is more appropriate. And I do think that there could be some problems with this and I ask you to comment on it. And one example that came into me was investors that most use in this case -- basically, the claim could be based on fraudulent information to begin with, so if you?re using, you know, the last statement, it could be based on fraudulent information and it could be a fraud in the first place. And, for example, if you invested $1 million ten years ago and your statement says you now have a fictitious earning and that you now have $10 million, you would be treated the same as someone who invested $10 million yesterday. So, the former has $9 million in fictitious earnings, the latter had no fictitious earnings, however both are treated the same. So, if the pot of money actually in a Ponzi scheme was $5 million, each would get $2.5 million and that doesn?t seem fair because it doesn?t reflect the reality of what is behind that. I ask you to comment on that and other ideas of why you think your recommendation of money in, money out is better and that that, of course, is what the courts are saying.

But, I also would like to ask, how do you and Trustee Picard determine when it would be a hardship to clawback funds?

Mr. Harbeck: I?d like to speak to your first issue first, if I may, Congresswoman. Exhibit D to my written testimony goes through the examples of why the avoidance powers resolve the problems and actually do equity. And that H.R. 757, while well intentioned, creates actually inequitable results.

Ms. Maloney: Thank you. And though we will read that, but now could you answer how do you and Trustee, or how does Trustee Picard determine when it would be a hardship to clawback funds?

Mr. Harbeck: The hardship program is one where anyone who has been sued, under the avoiding powers, can demonstrate financial hardship and there, those are as unique as the number of individuals involved. And I think the Trustee, first of all, made a decision not to sue certain of these, of the people who received relatively small amounts, although they?re, in absolute terms to me, they?re somewhat sizeable. But he didn?t sue everyone who received more than they put in.

But when he did, he was more than willing to listen and apply a rule of reason. That?s the only way you can really describe it to a situation. It makes no sense to sue someone when they have no assets or they?re extremely elderly.
Ms. Maloney: And my time is almost up. Can you discuss the task force?s recommendation to provide pass-through protection to indirect investors and certain ERISA qualified plans, but not investors in other funds?

Ms. Bowen: Making that determination, we start at least with the ERISA plans that those trustees have a fiduciary obligation. Those were retirement funds.
We also thought that, you know, the whole purpose of SIPC is to protect the small retail investor. And, given how people invest money today, most people?s savings are tied up, frankly, into their retirement accounts. And so, we were attempting to, to address that by really limiting it to that short list of people, frankly. And not to extend it to large institutional investors.

Ms. Maloney: Thank you. My time has expired.

Mr. Garrett: Thank you. The gentlelady yields back.
Mister Hurt is recognized for five minutes.

Mr. Hurt: Thank you, Mister Chairman. I want to thank you all for being here today as we try to understand and deal with these important issues.
I had three things I wanted to cover and maybe each of you could address it as appropriate. The first is, can you give us some concrete idea of what the financial solvency of the fund is, especially with the pressures that you face in wanting to raise the maximum reimbursement or the maximum claim amount, and, I hope, also considering the fact that you want to keep these assessments as low as possible?
The second question deals with the assessments themselves. How are you dealing with the fact that, you know, a lot of these broker-dealers are part of a small, smaller outfits, smaller firms? And how do you account for the pressures that they face as small business people?

And then finally, just a general question, is, are these reforms things that will require Congressional action or are these things that you all, from your standpoint, would prefer to be able to do from within?

Mr. Harbeck: Well, let me take a attempt to answer that. First of all, in terms of SIPC?s financial solvency, prior to the start of the Lehman Brothers case, SIPC had $1.7 billion. Even after paying $800 million to Madoff investors and paying administrative expenses of $300-$400 million that have brought in $9 billion for the Madoff estate. Because we, in effect, turned the spigot back on off assessments, we now have a fund of $1.5 billion. And that is adequate to perform the statutory functions that Congress has assigned to --

Mr. Hurt: Has anything been drawn down from the Treasury?

Mr. Harbeck: No, we have never used Treasury funds. But I hasten to add that if SIPC is to be tasked with some new and radically different level of protection or rescinding bad investments as in the Stanford case, I would anticipate that the Treasury line of credit may or may not be sufficient. And we would have to assess the industry.

To your second point about assessing the smaller, independent members, I have met and other SIPC staff members have met with the National Association of Independent Broker/Dealers to brief them on these issues. And we understand the nature of the problem. They are currently being assessed at one quarter of one percent of their net operating revenue.

Mr. Hurt: Well, and if I could just interrupt. Before, it was at $150 per member. $150 annually for each member, is that right?

Mr. Harbeck: We assessed on net operating revenues through the 1990?s when we reached a target of $1 billion, we cut back to a very nominal sum. But, with the onset of the Lehman and Madoff cases, we reestablished a higher target of $2.5 billion that we would like to have on hand.

Mr. Hurt: So, what does that mean? Is there a way to characterize that as it relates to the smaller firms?

Mr. Harbeck: Yes, if we were to continue --

Mr. Hurt: In a cash number?

Mr. Harbeck: On a cash number, it?s very difficult because the, frankly, the large brokers --

Mr. Hurt: Is it 500 bucks? $1000?

Mr. Harbeck: It varies dramatically and as Miss Bowen has said, some of the very smallest brokers have now actually, inadvertently, had their assessments reduced to zero.

Mr. Hurt: Okay.

Mr. Harbeck: But, and the basic point is that we will be assessing if we continued at the current rate of one quarter of one percent of net operating revenues, we would reach our target of $2.5 billion between the years 2015 and 2016.

Mr. Hurt: And then, the last question -- well, are -- well, the last question deals with Congressional action. Is it -- are these things -- is -- are these things that you all are inviting Congressional action or are these things that you feel like you can handle with in-house?

Mr. Harbeck: I think the task -- well, some of the things can be done in-house, but the most -- changes concerning the limits of protection require Congressional action and when Former Chairman Johnson issued the task force, he requested that, and raised at the board meetings, that we do some empirical studies as to the effect on the industry and on investors before we go to Congress and ask for those changes.

Mr. Hurt: Thank you. I don?t -- my time?s about to expire. Miss Bowen, do you have anything to add to that?
Ms. Bowen: The only other thing I would add with respect to the assessments is that obviously that number?s determined based on litigation when and if it happens in time. And so, we can?t predict necessarily if there?s going to be another big failure tomorrow. But so, the concept of assessments really depends on, you know, the likelihood of litigation, the outcome. Stanford obviously would definitely be a huge problem.

Mr. Hurt: Thank you.

Mr. Garrett: The gentleman yields back?

Mr. Hurt: Gentleman yields back. Thank you.

Mr. Garrett: Miste

Full post as published by Velvel on National Affairs on March 14, 2012 (boomark / email).