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THE SECURITIES INVESTOR PROTECTION 

CORPORATION: PAST, PRESENT, AND FUTURE 

HEARING 

BEFORE THE

SUBCOMMITTEE ON CAPITAL MARKETS AND 

GOVERNMENT SPONSORED ENTERPRISES 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

MARCH 7, 2012 

Printed for the use of the Committee on Financial Services 

Serial No. 112–105 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

SPENCER BACHUS, Alabama, Chairman 

JEB HENSARLING, Texas, Vice Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

NAN A. S. HAYWORTH, New York 

JAMES B. RENACCI, Ohio 

ROBERT HURT, Virginia 

ROBERT J. DOLD, Illinois 

DAVID SCHWEIKERT, Arizona 

MICHAEL G. GRIMM, New York 

FRANCISCO ‘‘QUICO’’ CANSECO, Texas 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

BARNEY FRANK, Massachusetts, Ranking 

Member 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

ANDRE ́ CARSON, Indiana 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

JAMES H. CLINGER, Staff Director and Chief Counsel 

(III) 

SUBCOMMITTEE ON CAPITAL MARKETS AND GOVERNMENT SPONSORED ENTERPRISES

SCOTT GARRETT, New Jersey, Chairman 

DAVID SCHWEIKERT, Arizona, Vice 

Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

DONALD A. MANZULLO, Illinois 

JUDY BIGGERT, Illinois 

JEB HENSARLING, Texas 

RANDY NEUGEBAUER, Texas 

JOHN CAMPBELL, California 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

NAN A. S. HAYWORTH, New York 

ROBERT HURT, Virginia 

MICHAEL G. GRIMM, New York 

STEVE STIVERS, Ohio 

ROBERT J. DOLD, Illinois 

MAXINE WATERS, California, Ranking 

Member 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

RUBE ́ N HINOJOSA, Texas 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

CAROLYN B. MALONEY, New York 

GWEN MOORE, Wisconsin 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

ANDRE ́ CARSON, Indiana 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

AL GREEN, Texas 

KEITH ELLISON, Minnesota 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

March 7, 2012 ................................................................................................... 1 

Appendix: 

March 7, 2012 ................................................................................................... 57 

WITNESSES 

WEDNESDAY, MARCH 7, 2012 

Borg, Joseph P., Director, Alabama Securities Commission ................................ 39 

Bowen, Sharon Y., Acting Chair, Securities Investor Protection Corporation 

(SIPC) .................................................................................................................... 12 

Caruso, Steven B., Partner, Maddox Hargett & Caruso, P.C. ............................. 42 

Hammerman, Ira, Senior Managing Director and General Counsel, Securities 

Industry and Financial Markets Association (SIFMA) ..................................... 43 

Harbeck, Stephen P., President and Chief Executive Officer, the Securities 

Investor Protection Corporation (SIPC) ............................................................. 10 

Stein, Ron, CFP, President, The Network for Investor Action and Protection 

(NIAP) ................................................................................................................... 45 

Vitter, Hon. David, a United States Senator from the State of Louisiana ......... 7 

APPENDIX 

Prepared statements: 

Borg, Joseph P. ................................................................................................. 58 

Bowen, Sharon Y. ............................................................................................. 87 

Caruso, Steven B. ............................................................................................. 160 

Hammerman, Ira .............................................................................................. 165 

Harbeck, Stephen P. ......................................................................................... 172 

Stein, Ron .......................................................................................................... 211 

Vitter, Hon. David ............................................................................................ 225 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Garrett, Hon. Scott: 

Written statement of the Bond Dealers of America (BDA) ........................... 229 

Written statement of the Financial Services Institute .................................. 232 

Perlmutter, Hon. Ed: 

Written statement of Peter J. Leveton, Co-Chairman, Agile Funds Investor Committee ............................................................................................... 237 

(1) 

THE SECURITIES INVESTOR PROTECTION 

CORPORATION: PAST, PRESENT, AND FUTURE 

Wednesday, March 7, 2012 

U.S. HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON CAPITAL MARKETS AND

GOVERNMENT SPONSORED ENTERPRISES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The subcommittee met, pursuant to notice, at 9:37 a.m., in room 

2128, Rayburn House Office Building, Hon. Scott Garrett [chairman of the subcommittee] presiding. 

Members present: Representatives Garrett, King, Royce, Pearce, 

Fitzpatrick, Hayworth, Hurt, Grimm, Stivers, Dold; Waters, Sherman, Maloney, Perlmutter, Donnelly, Peters, and Green. 

Also present: Representative Cassidy. 

Chairman GARRETT. Good morning. The Subcommittee on Capital Markets and Government Sponsored Enterprises is called to 

order. Today’s hearing is entitled, ‘‘The Securities Investor Protection Corporation: Past, Present, and Future.’’ This hearing will now 

come to order, and I recognize myself for 4 minutes to give an 

opening statement. 

Today’s hearing is a broad oversight hearing on the Securities Investor Protection Corporation (SIPC.) It is not meant entirely to be 

focused solely on the particular aspects of SIPC’s work. But to me, 

the failure of SIPC in relation to the Madoff liquidation is 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 the very 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 is worthwhile to hear today about SIPC’s 

work in regard to the Lehman bankruptcy, and also to examine the 

long-awaited and recently-released report of SIPC’s Modernization 

Task Force, as well. In going through that Task Force and looking 

at it, unfortunately, is that it is somewhat of a missed opportunity, 

if you will, to seriously study some of the shortcomings of SIPC exposed by the recent failures of the broker-dealers. 

So let us return now to the failures of the Madoff firm. Once examined, the facts of that case—as we are all probably too familiar—the Madoff firm was regulated by both FINRA and the SEC. 

And it repeatedly 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 U.S. Treasury. 

2 

Madoff investors paid taxes to the IRS, the U.S. Government, for 

years. Again, another government agency saying that its investments and profits were, well, real. 

Since around the same time that SIPC was enacted, investors no 

longer held stock certificates, so the only proof of ownership they 

have, or had, was a statement that they received from a government-regulated broker-dealer. So what does this mean? 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 and 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 here—to say that something is 

simply not right here. 

An additional irony is that if the trustee is successful in suing 

individual investors, 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 that they should have known better. But they will be paid. 

It is because of my concerns over these issues that I have 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 purposes of SIPC protection, 

customers of registered brokers are legally entitled to rely on their 

broker’s statements as evidence of what the broker owes them. Indeed, in a world where customers no 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 have already joined me in 

co-sponsoring this legislation, and I encourage my other colleagues 

to look at it and consider it, as well. 

I look forward to today’s testimony from our witnesses on all the 

panels that we have, and a hearty discussion on SIPC activities 

and roles in the past, in the present, and in the future. 

With that, I yield back, and I yield to the gentlelady from New 

York for 3 minutes. 

Mrs. MALONEY. Okay. thank you. Thank you, Mr. 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, and 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. 

3 

So it was a tremendous blow to many people on an individual 

basis, and to the industry at large. For 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, and 

the system of regulation and law enforcement of our financial markets, was visibility shaken by this scandal. Just yesterday, Mr. 

Stanford, another perpetrator of a Ponzi scheme who cheated his 

investors out of over $7 billion, was convicted on 13 out of 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, 

Mr. Ackerman, and the chairman, have put forward thoughtful 

bills. I am 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 better approach, or the right 

approach we should be taking. I look forward to the hearing. It is 

one that is very important to our country. 

And I thank the chairman for calling this important hearing, and 

for his work on his legislation. I also compliment Mr. Ackerman for 

his hard work. 

I yield back the balance of my time. 

Chairman GARRETT. Okay. The gentlelady yields back. 

The gentleman from New York is recognized now for 3 minutes. 

Mr. KING. Thank you, Mr. Chairman. Thank you for calling today’s hearing. It is very timely for the representatives from SIPC 

to come before the subcommittee. After several years, they 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 Ms. 

Maloney has referenced. This was unearthed 3 years ago, and during the last 3 years that process, run by SIPC, has gone profoundly 

amok. 

This is tragic, this is wrong. From my perspective, there are at 

least four takeaways from this liquidation. One, the trustee, Irving 

4 

Picard, is out of control. He interprets SIPC 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 furiously to the media. 

Even Chairwoman Mary Shapiro expressed surprise at the initiation of the baseless lawsuits. Just the other day, in an order dated 

March 5th, in the southern district of New York, Judge Rakoff, in 

the case Irving H. Picard v Saul B. Katz et al. made a finding: ‘‘The 

court remains skeptical that the trustee can ultimately rebut the 

defendant’s 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 party’s profit 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 characterize as bombshells 

proved to be nothing but bombast.’’ And that is what that lawsuit 

has been from beginning to end—bombast. 

Two, the victims are being treated unfairly. Very few victims 

have received the statutory-mandated SIPC advances. The trustee 

has hatched an accounting mechanism that disregards real-world 

customer expectations and broker-dealer protocol, it is lawyer-intensive, and it has run up the fees of $300 million paid to Mr. 

McCarter—$300 million. He has an open piggybank here for himself. It is 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 the trustee, SIPC 

directly, and the SEC indirectly? Moreover, where is the statutorymandated report on the liquidation required of the trustee? The 

trustee in 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. 

And four, this miscarriage of justice endured by the Madoff victims could happen to any investor whose broker deal fails for any 

reason. We need to restore some reason and some rationality to the 

unwinding of failed brokerage firms, and that is why I am proud 

to sponsor, with Chairman Garrett, H.R. 757, a proposal that enjoys bipartisan support. 

Mr. Chairman, thank you for you leadership on H.R. 757, and 

thank you for holding this hearing. I look forward to hearing from 

the witnesses. I yield back. 

Chairman GARRETT. And again, I thank the gentleman from New 

York. Thank you for your work on this legislation, as well, and for 

your leadership on this issue. 

Mr. Green is recognized for 2 minutes. 

Mr. GREEN. Thank you, Mr. Chairman. I would like to thank my 

colleague and friend from Louisiana, my home State. While I represent Texas, I was born in Louisiana. It is an honor to have you 

with us today. 

Mr. Chairman, I, too, am concerned about investor confidence. I 

think it is 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 

5 

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. So that causes a degree of concern. I am 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 the 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. 

Chairman GARRETT. And thank you. The gentleman yields back. 

Mr. Dold, for 2 minutes. 

Mr. DOLD. Thank you, Mr. Chairman. I certainly appreciate you 

holding this hearing, and for your leadership. And I want to thank 

Senator Vitter for being here, as well, and the 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 are 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 

is 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 lost everything. And their 

stolen money has gone to pay for those fraudulent profits to others. 

What do we do in that situation? There is no perfect or even good 

answer. But historically, we 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 a 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 5 years. 

So ironically, the Federal Government benefits more and more from 

6 

a long-term Ponzi scheme the longer it continues. Why shouldn’t 

the innocent investors be able to recover all the 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 

who are coming here today to testify. 

And again, Mr. Chairman, I thank you for your work. 

Chairman GARRETT. Thank you. Thank you for your comments. 

The gentlelady from California for the remaining time on her 

side, I believe? 

Ms. WATERS. Thank you very much, Mr. 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 of the world’s largest brokerage 

firms. Shortly thereafter, the Madoff Ponzi scheme was uncovered. 

In the years since Madoff, we have 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 or to SIPC’s operations were needed. Today, we 

are considering the report published by this Task Force. 

Their recommendations include both items that require an Act of 

Congress, and items that can be pursued administratively. I am 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 is 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 am also interested in exploring how we can ensure the most equitable outcomes for investors who have 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 am very curious 

to hear more about these bills, while also being mindful that Congress should be very careful in this area since any changes to how 

customer claims are calculated will inevitably make certain investors winners, and others losers. 

Finally, I am very curious to hear more about SIPC’s rationale 

for not paying out claims under the Stanford Group company fraud, 

a decision that the SEC has contested. The timing of this hearing 

is all the more apt in light of Allen Stanford’s conviction yesterday 

on 13 counts related to his $7 billion Ponzi scheme. 

Thank you, Mr. Chairman, and I yield back the balance of my 

time. 

Chairman GARRETT. I thank the gentlelady. And that is an interesting point, the last one you raised there. 

7 

And we have one other member, Dr. Cassidy, who, without objection, would like to sit on the panel later on today, once we get into 

the panels. Without objection, it is so ordered. 

So we will now go to our first panel, and we welcome a gentleman from the other side of the Capitol, 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, a number of your constituents were more than adversely affected by the—some maybe by the Madoff case, but more by the 

Stanford case, and that you have been a leader in trying to bring 

an equitable solution to that situation. 

So we thank you to coming and joining us, and commenting. Senator? 

STATEMENT OF THE HONORABLE DAVID VITTER, A UNITED 

STATES SENATOR FROM THE STATE OF LOUISIANA 

Senator VITTER. Thank you very much, Chairman Garrett, 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—Hurricanes 

Katrina and Rita, and 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. In fact, I still don’t drink 

from the water fountains over there, and that is not going to 

change any time soon. 

So it is 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 you mentioned, the Stanford case. I will submit my full comments for the record, and I will 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 am 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 am 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, and things like that. 

There are real victims who have been taken advantage of. In the 

Stanford case, as you know, SIPC has denied coverage completely. 

And that is the fundamental problem. SIPC has basically taken the 

position that these were valid CDs that were lowered in value, lost 

value, and we don’t cover market losses. 

I think that position is just flat-out wrong. And through the 

Stanford experience, I have 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 am not here to 

argue that should be broadened. 

8 

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 way. 

I have reached the conclusion that SIPC, if it were a true regulator, would—in the parlance that is used—be 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 is far too focused on serving the industry and its member companies, and looking after their interests. 

And my experience in the Stanford 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 the courts have taken a 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 is not a matter of real CDs losing value. It is 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. They are in my written testimony, 

so 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 have really been crestfallen 

about isn’t simply that SIPC has disagreed, but the way they have 

acted again has led me to conclude that they are not primarily focused in the right spirit on executing the law and protecting people 

properly covered under the law. But they are 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, the 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 is 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 100 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, presVerDate Nov 24 2008 15:08 Dec 12, 2012 Jkt 075077 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 K:\DOCS\75077.TXT TERRI
9 

ently, asking for more prolonged discovery rather than getting to 

the heart of the issue in the legal proceeding. 

You put all of that together, Mr. Chairman, and 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 is 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. 

I believe that is the fundamental problem, and that is the most 

fundamental need for reform. So, Mr. Chairman, again thank you 

for this hearing, and for 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, 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. 

[The prepared statement of Senator Vitter can be found on page 

225 of the appendix.] 

Chairman 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, with this matter. I appreciate also, and thank you for 

you work and leadership in the Senate on this matter. 

As you see from the questions in 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 we—that is here partly to be considered—you also see that it is a bipartisan initiative, as well. 

There are still open questions as to the finality of some of these 

things, but I think we are going to try to do it in a bipartisan manner. I understand that we are 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 Capitol. 

So I would just say I appreciate your coming over, and I appreciate your accepting our invitation, and I look forward to working 

with you and the other side of the house, as well, on this issue. 

Senator VITTER. Thank you very much. 

Chairman GARRETT. Thank you, Senator. 

Senator VITTER. I appreciate it. 

Chairman GARRETT. With that, then, we will move on to panel 

two, and they can come to the table. At the table, we will have the 

president and CEO of what we have just been talking about, the 

Securities Investor Protection Corporation, Mr. Harbeck. And we 

also have Ms. Bowen, the acting chairman of the board of the Securities Investor Protection Corporation, as well. 

I will let you get situated there. And welcome, again, to the committee hearing today. I appreciate both of you coming and joining 

us to talk about this very important topic. Your complete written 

testimony, of course, as always, will be made a part of the record. 

But we will recognize each of you, I understand, for opening statements for 5 minutes each. 

10 

Mr. Harbeck, we usually go from left to right. 

STATEMENT OF STEPHEN P. HARBECK, PRESIDENT AND 

CHIEF EXECUTIVE OFFICER, THE SECURITIES INVESTOR 

PROTECTION CORPORATION (SIPC) 

Mr. HARBECK. If you wish, I will begin. Chairman Garrett, Ranking Member Waters, members of the subcommittee, thank you for 

this opportunity today. My name is Steve Harbeck, and I am the 

president and CEO of SIPC. 

Since the collapse of Lehman Brothers Entities—as mentioned by 

Ranking Member Waters—in 2008, SIPC has been at the center of 

the financial crisis. I would 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 

would like to briefly highlight some of the matters in 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 100 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 am pleased to note that the GAO 

report that was just issued within the last day, indicates on page 

31 that the driver of administrative expenses in the Madoff case is 

asset collection for those people who have not received 100 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 D 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 is 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 billion to $10 billion for the Madoff investors, you would not have believed me. But 

that is already what has been 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 Mr. Madoff’s theft. 

If other victims, and they are victims, but people who are net 

winners, who have received 100 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. 

11 

Turning to Lehman, Lehman is the largest bankruptcy in history. And in the early days of Lehman, under SIPC’s initiation of 

a liquidation proceeding, 110,000 customers received $92 billion in 

10 days. The trustee in that case has been extremely successful in 

lawsuits. He has won $2.3 billion from Barclays Bank, and settled 

a suit for over $700 million with JP Morgan Chase. 

And last week, 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 securities 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 see recision of that investment and to have 

SIPC pay the original purchase price of their investments 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 were 

other legal reasons as well, that is why SIPC has not initiated a 

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. 

Mr. Chairman, if I could respond to one of your comments, at the 

beginning of the case you mentioned that institutional investors 

would receive most of the money in the Madoff case. This is a point 

made by Mr. Stein in his written communique, and I think we are 

failing to connect some dots here that very, very much need to be 

connected. 

Mr. 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 

percent 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 distributions to the 

institutions. 

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 owned receive 

12 

a 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 has done a great deal. We have advanced $800 million for 

the investors in Madoff. And we think, in that sense, the process 

is coming to a sound conclusion. I would be pleased to take any 

other questions you have. 

Thank you very much. 

[The prepared statement of Mr. Harbeck can be found on page 

172 of the appendix.] 

Chairman GARRETT. I thank you for your statement. 

Ms. Bowen is recognized for 5 minutes. And welcome to the 

panel. 

STATEMENT OF SHARON Y. BOWEN, ACTING CHAIR, 

SECURITIES INVESTOR PROTECTION CORPORATION (SIPC) 

Ms. BOWEN. Thank you. 

Chairman GARRETT. Thank you. 

Ms. BOWEN. 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 Vice 

Chair of the SIPC Modernization Task Force, I will focus on the 

four 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 a 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 of SIPC is protected up to $500,000 

against loss or missing cash or securities deposited with the 

broker-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 the distribution, 

through 2010, of roughly $109 billion of assets for those customers. 

Of that sum, $108 billion has come from the debtors estate, 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 

13 

Act and SIPC’s operation 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 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 Web site was 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 SIPC should be amended to 

allow for inflation since 1980. In that year, the maximum 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 securities 

purchase or subsequent to a securities sale. And that was subject 

to a lower protection. Because these results are somewhat arbitrary, the Task Force has recommended that we eliminate the 

treatment of cash and 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, in 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 a 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. 

And finally, the Task Force advocated that SIPC could change 

the developed 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 would be happy to take any questions. 

[The prepared statement of Ms. Bowen can be found on page 87 

of the appendix.] 

Chairman GARRETT. And I thank you for your testimony. I will 

now recognize myself to begin with just a couple of questions. 

And maybe I will throw it out to Mr. Harbeck, but it sort of goes 

with the last comment that Ms. Bowen was making as far as educating the investors and the like. So Mr. Harbeck, you made a comment which was an interesting one with regard—and I will bring 

14 

this all around—to the Stanford case; that in that case, there was 

actually written notice. 

Your first comment was to the effect that the coverage and insurance, if you will, is—protection is for the securities that are held 

by the broker. And you—in that particular case, I think you made 

a comment just now saying that actually written notice was made 

to the investors that they were investing and the 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—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. 

Chairman GARRETT. Right. Okay. That is good to know, on that 

particular case. In all other cases, the average situation is, when 

the investor goes into the broker’s office, there is the SIPC logo 

there. And the implication comes with that, as well. I remember 

when we met for the first time, I guess, the comment was made 

is that there is a perception that you were covered, or insured if 

you will, up to $500,000. 

I remember you saying at that time no, not in all cases. And I 

think that is the message that you are delivering today, as well, 

from your testimony. No, you are not covered 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, without that, you are not 

really sure what you have? 

Mr. HARBECK. Congressman, that would solve the problem. That 

is just not going to happen. It is not the way the world works. 

Transactions are done instantaneously at this juncture. And to 

take physical possession of securities, I think is an impractical— 

Chairman GARRETT. Right. I would agree with you. But if that 

is 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 insured of something because they 

see the statement—I guess it is a 1099 or what have you—that 

goes to them saying this is what the dividends, or payments out. 

So they are 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 the investor can’t rely on the statement, what should 

he rely upon then? 

Mr. HARBECK. One of the problems here, of course, is that the 

investors in Madoff gave discretion as to what to buy to Mr. 

Madoff. 

Chairman GARRETT. In any case, 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 a statement and 

15 

generates fictitious profits again and again, month after month 

after month, it is— 

Chairman GARRETT. Yes, but the investor wouldn’t know about 

the backdating. I only have a minute left already. As far as discretion—I am going to get right to the point on this one—the discretion right now, as far as the situation when you have a situation 

like this in the appointing of a trustee, that selection or the nomination of that process is by SIPC. Correct? 

Mr. HARBECK. Correct. 

Chairman GARRETT. Would it be a better process to take that 

step away from SIPC, and give it to a so-called neutral party, 

which would be the SEC? Let them make 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. 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 

received— 

Chairman GARRETT. So if we could set up something within SEC 

that they would: one, get the knowledge; and two, have a mechanism to be able to make these things quickly, could that address 

both of the situations? 

Mr. HARBECK. I am not sure it could, but there is 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 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. 

Chairman GARRETT. My time has expired. I am always mindful 

of my colleagues. I guess the question is not necessarily whether 

they are breaking the law, but whether the intention of Congress 

is being fulfilled as far as how the trustees are 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. 

Chairman GARRETT. Thank you. 

The gentlelady from California is recognized. 

Ms. WATERS. Thank you very much, Mr. 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 SEC disagree about how to resolve, first, the Robert 

Allen 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. 

16 

For the first time, the SEC is saying that SIPC should pay recision 

damages to people who are in physical possession of the security 

that they purchased. 

That has never been the law, and it is not the law. And the reason that SIPC has not been involved for 2 years is because the SEC 

staff looked for instances where individuals left assets at the SIPCmember 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—it is not a vague connection. To say that 

there—you can just sort of smush everything together, and say 

therefore the brokerage firm must have had custody of the investor’s 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. I must say, Mr. 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 is why we feel we must go 

forward with the lawsuit. 

Ms. WATERS. Thank you very much. Let me just ask about the 

Madoff case. Can you discuss how clawbacks have been treated by 

SIPC as it relates to Madoff’s fraud? 

Mr. HARBECK. Yes, I would be happy to. 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 it is exactly what 

the Task Force has looked at with respect to 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 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 has brought back billions and billions of dollars into this estate for distribution to the 

people who need it the most. 

17 

Ms. WATERS. Mr. Chairman, I yield back. 

Chairman GARRETT. The gentlelady yields back. 

Mr. Dold is recognized. 

Mr. DOLD. Thank you, Mr. Chairman. 

Ms. 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 of expertise, including two lawyers who represent 

investors such as the ones that you have mentioned. So we felt that 

their voice was being heard at the table. In addition, we created 

a Web site and we had the Internet forum, if you will. 

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. Mr. Harbeck, do you believe that President Nixon and 

Senator Muskie and the other supporters led the 1970 passage of 

SIPA to provide financial relief for all investors? 

Mr. HARBECK. That is a statement of extraordinary breadth. The 

fact is, the statute, as originally drafted in 1970, was intended to 

protect the custody function performed by brokerage firms. And we 

have been following that mission for 40 years. 

Mr. DOLD. Do you believe that it is fair and equitable to differentiate between direct and indirect investors? 

Mr. HARBECK. The indirect investors that you are referring to are 

people to whom I was referring with respect to comments to Chairman Garrett. The trustee did not pay them, but the reason he did 

not pay them is he will pay the institution that they own, the feeder funds that they own. 

So if five people own a feeder fund, they will each get whatever 

portion they get in terms of their ownership. 

Mr. DOLD. And will that be considered a single entity? Because 

I know we are 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 2-point— 

Mr. DOLD. Do you think that is fair and equitable? 

Mr. HARBECK. Yes I do, and here is why. There are 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 the small investors who 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, if numbers hold, 

will receive 50 cents on the dollar, which was an unthinkable result, an unthinkably positive result, in 2008. 

Mr. DOLD. I understand what you are talking about. But I think 

my concern is that the assumption is that these are going to be 

smaller investors. Could you not see a situation where a group actually were the large investors coming in, and would not be treated 

as one? 

18 

Mr. HARBECK. The size of the individual investor— 

Mr. DOLD. Obviously varies. 

Mr. HARBECK. —is not relevant. What is relevant is whether 

they had a direct relationship with the brokerage firm. 

Mr. DOLD. Are you then taking— 

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

Mr. DOLD. Are you then trying to pick winners and losers in 

terms of determining direct or indirect? 

Mr. HARBECK. Absolutely not. 

Mr. DOLD. You don’t believe that there is any difference there? 

Mr. HARBECK. No. 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 its 

pro rata share of the fund. And the pro rata share of the fund is 

the lion’s share of what any investor will receive. 

Mr. DOLD. Mr. Harbeck, let me just move on then a little bit. 

How does the net equity, or the cash-in minus cash-out computation, protect all customers of a failed broker-dealer? 

Mr. HARBECK. This is the methodology that has been used in 

every single case under the Securities Investor Protection Act dating back to the 1970s where fictional statements have been involved; S.J. Salmon in 1973, Adler Coleman in the 1990s, and 

many cases in between. 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, Mr. Chairman. But I do—hopefully, we will have another round to talk about 

some clawbacks, which I think is important when we talk about 

some of these Ponzi schemes. 

And I yield back. 

Chairman GARRETT. The gentlelady from New York is recognized 

for 5 minutes. 

Mrs. MALONEY. First, I would like to thank you for your testimony, and voice my support for the Task Force’s recommendation 

that the $500,000 be raised, 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, 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. 

I do see that there could be some problems with this, and I ask 

you to comment on it. And one example that came in to me was, 

investors that most used—in this case, basically, the claim could be 

based on fraudulent information to begin with. 

So if you are using 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 10 years ago, and your statement says you now have a fictitious earning and that you now have 

19 

$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 the 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, 

of course, is what the courts are saying. But I also would like to 

ask, how do you or Trustee Picard determine when it would be a 

hardship to claw back funds? 

Mr. HARBECK. I would like to speak to your first issue first, if 

I may, Congresswoman. Exhibit D to my written testimony goes 

through examples of why the avoidance powers resolved the problems and actually do equity, and that H.R. 757, while well-intentioned, actually creates inequitable results. 

Mrs. MALONEY. Thank you, we will read that. But for now, could 

you answer how do you and Trustee—or how does Trustee Picard 

determine when it would be a hardship to claw back funds? 

Mr. HARBECK. The hardship program is one where anyone who 

has been sued under the avoiding powers can demonstrate financial hardship. And 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 the people who received relatively small 

amounts, although they are, in absolute terms to me, somewhat 

sizeable. 

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 is 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 are extremely— 

Mrs. MALONEY. And my time is almost up. Can you discuss the 

Task Force’s recommendation to provide pass-through protection to 

indirect investors in certain ERISA-qualified plans but not investors in other funds? 

Ms. BOWEN. Oh, sure. Making that determination, we thought at 

least with the ERISA plans that those trustees have a fiduciary obligation to those retirement funds. We also thought that 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, in their retirement accounts. 

So we were attempting to address that by really limiting it to 

that circle of people, frankly, and not to extend it to large institutional investors. 

Mrs. MALONEY. Okay, thank you. My time has expired. 

Chairman GARRETT. Thank you. The gentlelady yields back. 

Mr. Hurt is recognized for 5 minutes. 

Mr. HURT. Thank you, Mr. 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 is of the fund? Especially with the pressures that 

20 

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 a lot of these broker-dealers are 

a part of smaller outfits, smaller firms? And how do you account 

for the pressures that they face as small businesspeople? 

And then finally, just a general question. 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. Let me make an 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 million to $400 million that have brought in $9 billion for the Madoff estate, because we, in effect, turned the spigot 

back on of assessments we now have a fund of $1.5 billion. 

And that is adequate to perform the statutory functions that 

Congress has assigned— 

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 for 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 1 percent of their net operating revenues. 

Mr. HURT. 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 1990s. 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, with 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. Oh, in a cash number? It is very difficult because, 

frankly, the large brokers— 

Mr. HURT. Is it $500, $1,000? 

Mr. HARBECK. Oh, it varies dramatically. And as Ms. Bowen has 

said, some of the very smallest brokers have now actually, inadvertently, had their assessments reduced to zero. 

Mr. HURT. Okay. All right, go ahead. 

Mr. HARBECK. But the basic point is that we will be assessing, 

if we continued at the current rate of one-quarter of 1 percent of 

21 

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 deals with congressional 

action. Are these things that you all are inviting congressional action, or are these things that you feel like you can handle in-house? 

Mr. HARBECK. I think some of the things can be done in-house. 

But most changes concerning the limits of protection require congressional action. And when former Chairman Johnson issued the 

Task Force Report, he requested—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. my time is about to expire. 

Ms. 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 is determined based on 

litigation, when and if it happens, at the time. And so we can’t predict, necessarily, if there is going to be another big failure tomorrow. 

So the concept of assessments really depends on the likelihood of 

litigation, the outcome. Stanford, obviously, would definitely be a 

huge problem. 

Mr. HURT. Thank you. 

Chairman GARRETT. The gentleman yields back? 

Mr. HURT. Thank you. 

Chairman GARRETT. Mr. Green is recognized. I think you are 

next. 

Mr. GREEN. Thank you, Mr. Chairman. I thank these witnesses 

for appearing, as well. And I do concur and believe that we should 

raise the amounts to investors that they may acquire if there is 

some scheme that is uncovered. 

Now, let us focus specifically on Mr. Madoff. And I would like to 

speak to you, if I may, Mr. Harbeck. Sir, is it true that Mr. Madoff 

had, with malice aforethought, statements issued that were misrepresentations? 

Mr. HARBECK. Absolutely. 

Mr. GREEN. And is it true that these statements—and I am not 

sure that you have added them up, but if you did add them up, 

that they would total probably billions and billions more than you 

are capable of paying if you pay based upon the statements? 

Mr. HARBECK. On a money-in, money-out basis, the customers of 

the Madoff brokerage firm deposited between $17 billion and $20 

billion. The final statements totaled about $63 billion. He had on 

hand virtually nothing. 

Mr. GREEN. Before going on, let me make it very clear that I 

really am in sympathy with people who have been defrauded. This 

is a dastardly deed perpetrated by a criminal mind, without question. The question, however, becomes how do you compensate these 

victims? 

And this is why I have said my thoughts are somewhat ambivalent. Because I am trying to do equity. I want to make sure that 

people can have some confidence in capital markets and confidence 

that when they go to these brokers, they are going to get some degree of equity. 

22 

Just address it, please, given the wide chasm between the statements and the money-in, money-out methodology. 

Mr. HARBECK. The difficult answer, but the correct answer which 

the courts came to, is that to base the payments on the last statement is to allow the fraudulent actor—the dastardly criminal who 

you correctly characterized—the final say as to who wins and who 

loses. 

And further, if you go by the last statement, the unintended consequence of that is you make Ponzi scheme participation a good 

thing. You make it profitable. So in one of the comments that I 

made to one of the bills, it was to create a dialogue between a 

fraudulent salesman and someone who was questioning, ‘‘Well, if 

this is a fraud, will I get money back?’’ 

And the answer was, ‘‘Don’t worry about that. SIPC will pay for 

it even if it goes down, even if it’s fraudulent.’’ So it is a difficult 

question. But the courts that considered it—the trial court, the 

bankruptcy court and the 2nd Circuit Court of Appeals—came to 

the conclusion—and these are not my words, these are the words 

of the four judges who have considered this—that it would be absurd to let the thief determine who wins and who loses. 

And consequently, you can’t use the last statement. 

Mr. GREEN. Now, I concur with the chairman with reference to 

the statement. And to this extent, I want the person receiving a 

statement, the investor, to have some belief in that statement and 

to rely on that statement. Is there any means by which we can use 

technology, or somehow cross-reference, or give that person receiving the statement the opportunity to—as an aside, are all or most 

of these persons sophisticated investors? 

Mr. HARBECK. We make the assumption that they are not. 

Mr. GREEN. Okay. Now, they are not sophisticated investors. 

How can we, perhaps with technology or some other means, give 

them a greater degree of confidence in that statement? Because the 

chairman makes a good point. I have my statement, I am relying 

on my statement. To a certain extent, there are other entities that 

rely on the statement. 

How can we strengthen the statement? 

Mr. HARBECK. I think you have put your finger on it. I think 

technology is the answer. In this case, Bernard Madoff, acting as 

an investment advisor, used his own firm as the custodian of the 

securities supposedly held for his clients. If you divorce the custody 

function from the investment advisor function, as is done by most 

investment advisors, then the problem solves itself. 

Then the brokerage firm with custody has the securities. It is a 

check on the system. And I think the SEC has located that as one 

of the problems in the Madoff case. 

Mr. GREEN. Thank you, Mr. Chairman. I yield back. 

Chairman GARRETT. And I thank you. 

The gentleman from New Mexico is recognized for 5 minutes. 

Mr. PEARCE. Thank you, Mr. Chairman. 

Ms. Bowen, as I am reading through Senator Vitter’s testimony, 

he alleges that SIPC is dragging its feet on solving the cases. Do 

you have a rebuttal to his testimony? 

Ms. BOWEN. Obviously, I think you are referring to the Stanford 

case. 

23 

Mr. PEARCE. He is talking also, saying—he says you are dragging 

your feet on the Madoff case also. 

Ms. BOWEN. I would say, just given the outcome with the Madoff 

case, that we haven’t been dragging our feet, and we have been 

maximizing the return to the investing public. With respect to 

Stanford, it is a really complicated issue. We decided that we did 

not have the authority to change the law, to change the statute. 

And our reading of the statute is such that we felt we had to go 

to court. I believe the court has decided to be as expeditious as possible in reaching a resolution. And actually, we will follow the law. 

Mr. PEARCE. Does the SEC agree with your position, or does the 

SEC oppose your position? 

Ms. BOWEN. It opposes our position as to whether or not they 

are— 

Mr. PEARCE. So they feel like it is not required to change any 

law? 

Ms. BOWEN. I believe—again, I haven’t really read their filings. 

But I believe they think that there is, there may be a customer 

who is entitled to recovery. We don’t see a customer at a brokerdealer. 

Mr. PEARCE. Do you all get involved at all in the notifications up 

front that investors are worried about their investment? Are you 

all notified at all? You just come in later as the insurers? 

Mr. HARBECK. First of all, we are not a regulator in any way, 

shape, or form. And unlike the FDIC—one of the questions earlier 

concerned the FDIC. We are not an insurer, and that is not in our 

name. We do come in—and you are correct—only after the firm has 

failed. 

Mr. PEARCE. So are you involved in the MF Global case at all? 

Mr. HARBECK. Yes, sir. I was notified at 5:20 a.m. on Halloween 

day that MF Global’s customers were in need of protection. And 

one of the gentleman in this room, who is on the legal staff of 

SIPC, was in court and had a trustee appointed that afternoon. 

Mr. PEARCE. Who notified you at 5:20 a.m.? 

Mr. HARBECK. A member of the trading and market staff of the 

Securities and Exchange Commission. 

Mr. PEARCE. Do you remember the name? 

Mr. HARBECK. Yes. His name was Mike Macchiaroli. 

Mr. PEARCE. You received the SEC’s e-mail at 7:29 on October 

31st, and that e-mail set forth the basis that they thought that a 

settlement was going to be reached? Is that correct? 

Mr. HARBECK. I think you are conflating two cases, sir. Oh, a settlement in the MF Global case. 

Mr. PEARCE. Okay. 

Mr. HARBECK. Yes, yes. At 7:29 on October 31st of last year, that 

was a written confirmation that MF Global had failed and was in 

need of protection. 

Mr. PEARCE. Okay. 

Mr. HARBECK. Subsequent to my—the 5:20 call from the Securities and Exchange Commission, Mr. Macchiaroli in New York, we 

put an attorney on a plane that day. And that day, we took over 

the firm and placed a trustee in position. 

I think that demonstrates that we don’t drag our feet. We had 

no idea whether we had billions of dollars worth of exposure in 

24 

that situation, and we did it because that was the right thing to 

do. 

Mr. PEARCE. You are discussing, in another circumstance, about 

the professionals that you all contacted. Who are the professionals 

that you all contacted? Can you get us a list of that, and what were 

their positions? 

Mr. HARBECK. We contacted attorneys from Weil, Gotshal & 

Manges, we contacted attorneys from several other law firms, the 

name of which escapes me. Several of them had conflicts of interest. And we felt that, as it turned out that MF Global was the 8th 

largest bankruptcy of any kind in history, it would be a poor time 

to put in someone who had no previous experience in this case. 

Mr. PEARCE. Let me get one question in before my time is up. 

I am sorry to interrupt, but you talked about going and getting settlements from—say people had received a payment, they had 

cashed in their account. And you go back, and you are not going 

to let them succeed just because they got paid out the day before 

the bankruptcy. 

Do you ever go after the personal assets of the people, the principles, involved in these decisions? In other words, Mr. Corzine? 

Mr. HARBECK. Since no lawsuit has been started against Mr. 

Corzine, I would rather speak to either past cases or— 

Mr. PEARCE. That was an example. 

Mr. HARBECK. —or theoretically. 

Mr. PEARCE. You do go after— 

Mr. HARBECK. We go—the SIPC trustees are financed by SIPC 

to take every—we think it is a good lesson for people who steal 

money to be held accountable for it. And we will finance litigation 

to do that, and take those people down to their last cent. 

Mr. PEARCE. All right. Thank you, Mr. Chairman. I appreciate it. 

Mr. HARBECK. Thank you. 

Chairman GARRETT. Mr. Royce? You are recognized. 

Mr. ROYCE. Thank you, Mr. Chairman. I guess what has caught 

our attention, among other things, is the report of the Office of Inspector General Office of Audits, where they have some very pointed things to say about the oversight. They say, ‘‘We found that significant criticism and concern have been expressed about the 

amount of trustee fees awarded in the two largest liquidations in 

SIPC’s history, Lehman and Madoff.’’ 

And here is what they say about that. We will have a comparison 

up on the board in terms of the way Lehman, in the U.K., has been 

handled versus the U.S. up there. But here is the observation from 

the report: ‘‘For the Lehman liquidation, SIPC’s trustee fee chart 

combined both the trustees and the council’s time, and the hourly 

rate ranged from $437 to $527 an hour.’’ 

‘‘Moreover, the fees paid to date for both the Lehman and Madoff 

liquidations are a mere fraction of the amounts that will be eventually sought.’’ The fees paid to date I think are in the order of $600 

million. And I guess my question is the same question that the Office of Inspector General is getting to, and that is, do you believe 

the $600 million-plus in legal fees is reasonable? 

Mr. HARBECK. Yes, sir, I do. 

Mr. ROYCE. Then let me ask you, if this is reasonable, what 

would you deem reasonable for a completed Lehman liquidation? 

25 

Because as they point out, again, ‘‘It is a mere fraction of the 

amounts that will eventually be sought. Significant work relating 

to customer claims with pending litigation remains to be done.’’ 

Now, this is after 3-plus years. And, of course, they point out 

that they would like additional oversight, that they would like 

SIPC to negotiate with outside court-appointed trustees more vigorously to retain a reduction in these fees. So they have a little different take on this than you do. 

What do you think the final cost will be? 

Mr. HARBECK. The cost estimation for the Madoff case in the administrative expenses is $1 billion. To date, I believe somewhere in 

the vicinity of $400 million has been expended of legal fees. Two 

important things to note. One, not one penny of that came from 

customers, or diminished customer assets. SIPC paid for it all. 

So SIPC paid for the litigation, which the GAO report which was 

issued yesterday, or today, indicates brought in billions and billions 

of dollars in the Madoff case. Customers haven’t been diminished 

in any way, shape or form by that. 

Mr. ROYCE. I understand. 

Mr. HARBECK. As to the Lehman Brothers case, this is the largest bankruptcy of any kind in history. And what I would refer you 

to in terms of the person closest to the facts on the legal fees is 

Bankruptcy Judge Peck in New York. 

And I have included in my written statement his comments at 

the Chapter 11 confirmation hearings, where he says the case is 

coming to an unbelievably successful conclusion and that he congratulates all of the professionals involved. So my God, the hourly 

rates these people charge are staggering. Everybody knows that. 

But in that one instance, and I am familiar with that, the SIPA 

trustee did an outstanding job, and I think the fees are reasonable. 

Mr. ROYCE. But one of the unique situations here is that we can 

compare and contrast with the situation in the U.K. And in terms 

of return of customer assets, you have a situation in the U.K. 

where of the $21.8 billion of client assets, $20 billion was returned. 

In terms of settlements with foreign affiliates, in terms of the U.K., 

you have a situation where they have settled with U.S. affiliates, 

with Lehman Hong Kong, with affiliates around the world. 

That process hasn’t gotten under way here. In terms of general 

unsecured estate, in the U.K., they have resolved the majority of 

its unsecured claims, whereas in the United States, they have yet 

to review unsecured claims. But most importantly is the fees. 

Look at the difference, and you look at the timeframe—3-plus 

years versus what has occurred in the U.K.—and it truly grabs 

one’s attention in terms of the cost, but also the criticism of the Office of Inspector General brought to the process about the oversight 

and the way in which we are conducting this. 

And especially the way in which you are down to two firms doing 

some pretty major work. or one firm handling MF Global and Lehman simultaneously. Reportedly, in the financial press, that is 

causing some backlog in terms of the ability to push this through. 

If I get your response. 

Mr. HARBECK. [Off mike.]. 

Mr. ROYCE. Yes. 

26 

Mr. HARBECK. If I could respond, actually, the fact that the trustee in the Lehman Brothers case and the MF Global case has leveraged their work incredibly well. The Lehman Brothers trustee just 

won a case for American investors over Lehman Brothers, Inc. Europe before the Supreme Court of the United Kingdom last week. 

And the exact same issue arises in the MF Global case. This is 

an example of picking a veteran staff and a veteran trustee who 

knows what they are doing and does it well. 

Mr. ROYCE. I will close with this. Reportedly, part of the problem 

in terms of making progress is that you have people pulled off of 

one case to work on the other case because you have one firm. But 

my time has expired. 

Mr. HARBECK. I can speak to that. I asked that exact same question on the morning of October 31st to make sure that the trustee 

staff would not affect either case. I was assured that it would not, 

and our supervision of the case indicates that it has not. 

Chairman GARRETT. Thank you. 

The gentleman from Colorado? 

Mr. PERLMUTTER. [Off mike.] 

Chairman GARRETT. And then you will—would like to come back 

to you? Sure. 

Then, the gentlelady from New York. 

Dr. HAYWORTH. Thank you, Mr. Chairman. If we can just leave 

that slide up for a moment, Mr. Harbeck or Ms. Bowen, I am intrigued by the difference between the two columns. 

To what do you attribute—is there a matter of the laws being different in the U.K., or they— 

Mr. HARBECK. It is apples and artichokes. They are just not comparable. The size and scope of the operations aren’t comparable, 

the laws are different, the administration of bankruptcies are different. The fact that they both have the name Lehman Brothers is 

the reason they are both on the same chart. 

Dr. HAYWORTH. Understood. Is there something that we can use 

from the U.K.—although two different entities, obviously the Lehman Brothers applies to two different entities. But is there something we can take home from that as legislators in terms of our approach to these kinds of problems? 

Mr. HARBECK. Let us think about Lehman Brothers and MF 

Global, and the Dodd-Frank Act. I think the 8th largest bankruptcy 

in history was not a Dodd-Frank event. And that is a good thing. 

So the fact is, I think the system works. It is an expensive system. 

Bankruptcy is an expensive process in financial institutions. 

But by and large, the system is working in the United States. 

Again, the Lehman Brothers Holding bankruptcy judge comments 

on this case really do strike home for those of us who have been 

living with that situation for several years. 

Dr. HAYWORTH. In terms of Madoff, I have met a couple of folks 

who have been directly affected by the Madoff situation. Is there 

any shred of hope we can offer people who trusted their Madoff accounts, and— 

Mr. HARBECK. One thing that the trustee has run across when 

he has sued financial institutions—saying that those financial institutions knew, or should have known, of Madoff’s problems—he 

27 

has been running into a defense that he does not stand in the 

shoes of all of the individual customers. 

I think he does. Under the law, some courts have held to the contrary. If we get some clarity on that, then SIPC could use its funds 

to prosecute lawsuits against entities that should be held financially responsible. And that would benefit customers at no expense 

to them. 

So if the courts do not see it our way, perhaps legislation to give 

the trustee an overruling of an old, old case called Kaplan v Marine 

Midland would be a tool in the trustee’s quiver that he could use 

to benefit investors. 

Dr. HAYWORTH. Okay. 

Ms. Bowen, any— 

Ms. BOWEN. No, nothing to add to that. No. 

Dr. HAYWORTH. Thank you. 

Mr. Chairman, I yield back. 

Chairman GARRETT. If the gentlelady will yield to me, just a couple of quick points. 

On the point that Mr. Royce and Dr. Hayworth were raising as 

far as the two entities, the United Kingdom and the United States. 

If you convert these to dollars, are the size of the assets of the book 

of these companies apples and artichokes? What are the relative 

sizes? 

Mr. HARBECK. I think the answer to your question is, the overwhelming majority of assets were in the United States. For example, SIPC—the trustee—transferred $92 billion in the first week. 

And the wind-down of the other assets, the non-liquid assets, is 

being conducted in the Chapter 11 proceeding of Lehman Brothers 

Holding. 

Chairman GARRETT. I understand that. 

Mr. HARBECK. Not the liquidation of the SIPC-member firm. 

Chairman GARRETT. Yes, but— 

Mr. HARBECK. But I think the American entity is larger by a factor. I don’t know the factor sitting here, no. 

Chairman GARRETT. All right. And as long as we have the time, 

part of your position is that SIPC has done such a tremendous 

job—your point of saying, well, $9 trillion now, I guess, at about 

a cost of a billion dollars in fees in this particular case, ballpark 

figures. But— 

Mr. HARBECK. That is projected out into the future, sure. 

Chairman GARRETT. Right. 

Mr. HARBECK. Yes. 

Chairman GARRETT. But out of that $9 billion, isn’t the bulk of 

that just through one case? It is a very great case—the Jeff Picower 

matter—there was net equity in that case, if I—my understanding, 

on Madoff’s books, basically saying, hey, you really owe this money 

back to us, meaning Madoff from Picower. 

So 99 percent of that net equity in the book was from the 

Picower case. And that was around, a little over $7 billion. Is that 

right? 

Mr. HARBECK. The overwhelming majority of it was, absolutely. 

Chairman GARRETT. So— 

Mr. HARBECK. But the trustee is not done yet, sir. 

28 

Chairman GARRETT. Right. But when you—yes, you add $200 

million on top of that, I guess, from the kids of the Picower family, 

which is all good, but to come and say, we spent a billion bucks— 

which, as you agree, is amazing fees, $500 or so an hour—that is 

good work if you can get it. 

I used to be an attorney. I billed out, I guess, a tenth of that or so, or a little more than that. But, yes, out of the $9 billion when 

you came here, first I thought that is great. But $7 billion-plus of 

that is one case, and the other—so a little over a billion dollars 

comes from all the rest. 

So I guess you really have to put that into perspective as to exactly what the trustee has accomplished. But for that case, you 

would be spending $1 billion to get about $2 billion. 

Mr. HARBECK. And the answer to your point is, we are not done 

yet. The trustee— 

Chairman GARRETT. I guess that is part of the— 

Mr. HARBECK. The trustee hopes to get back 100 cents on the 

dollar. Will he do that? I don’t know. 

Chairman GARRETT. And that is the concern. 

Mr. HARBECK. But if you say—I think if you said to anyone from 

any source that you were going to get back $9 billion— 

Chairman GARRETT. Right. We keep going back to that. Yes, but 

we never knew the Picowers were out there, and the negative equity out there the one individual had. But when you say they are 

not done yet—and there is the rub, or there is the concern, is that 

they are not done yet—there are probably not that many more 

Picowers, if I am saying the names correctly, out there anymore. 

So the rest are going to be the smaller ones. The rest are going 

to be people that we are concerned about in this panel—or some 

of us concerned on this panel—of going back to those people who, 

as Mr. Green was saying and shares with me the concern, all they 

did was rely upon what was sent to them. 

And to your comment that it makes Ponzi schemes a good thing, 

only if there is the intention, or knowing that it is a Ponzi scheme. 

But I am going over my time. 

If the gentleman from Colorado is not ready yet, then Mr. Stivers 

is recognized for 5 minutes. 

Mr. STIVERS. Thank you, Mr. Chairman. 

My first question is for—I think it is probably for Mr. Harbeck, 

although maybe both of you can answer this one. What would the 

impact on the SIPC fund be if every indirect investor expected to 

receive SIPA coverage? 

Mr. HARBECK. At the start of the Madoff case, we made an effort 

to tell every person who thought they even remotely were damaged 

by the Madoff case to file a claim. Thousands of people did so who 

didn’t even know that they were invested in Madoff. 

Some of the people who have testified in front of this body 

bought a feeder fund that bought a feeder fund that bought a feeder fund that bought Madoff, and said that they were an indirect investor. So that is like throwing a ping pong ball into a bunch of 

mouse traps loaded with ping pong balls. 

I couldn’t possibly tell you what the cost would be because the cost would be capped at the net equity of $17 billion, assuming that 

they were all owed by feeder funds. But the relationship between 

29 

broker and customer, that is the one part about this that isn’t rocket science. 

Did you open an account? Yes? Okay. If you didn’t open an account, you are not going to be a customer. 

Mr. STIVERS. Ms. Bowen, do you have anything to add to that? 

Ms. BOWEN. No, I don’t. 

Mr. STIVERS. Do either of you think that SIPC has a responsibility to warn customers about possible signs of fraud, or conduct 

that might indicate fraud? 

Mr. HARBECK. Whether we have an obligation to do so or not, it 

is a good thing to do. Ms. Bowen has recommended, and championed on the Task Force, an investor education program. I have 

been doing what I would call ‘‘dog and pony shows’’ with members 

of the North American Securities Administrators Association on 

fraud. 

And I have, in the back of my mind, a program that I want to 

use at Walter Reed Hospital. Because you would be surprised at 

the fact that people will steal money from amputees. And I have 

seen enough different kinds of these schemes. 

I have been doing this for 35 years, and I have seen enough of 

these things to put together a program where we could say these 

are some red flags that you should have. And actually, I enjoy 

doing that. 

Mr. STIVERS. Great. 

Ms. BOWEN. I would add to that, too, that with the Task Force, 

we did have some securities regulators who were part of our Task 

Force. And we talked about— 

Mr. STIVERS. Was that the SEC or FINRA? Or who was that? 

Ms. BOWEN. Mr. Borg is here from Alabama. 

Mr. STIVERS. Oh, some State regulators. Sorry. Thank you, great. 

Ms. BOWEN. Yes, State regulators. And so we talked about having forums maybe throughout the country, to get the word out. And 

also, frankly, if there is a way for us to work with the SEC and 

FINRA to maybe change the language that is in the broker’s statement; although we know, frankly, that may not solve the problem 

in terms of education. 

And then I think, following the Task Force, to recommend that 

we have a person dedicated to investor education who would work 

with us to get the word out much more effectively. 

Mr. STIVERS. Great. Do either of you think that SIPC should be 

empowered to conduct spot audits to ensure that cash and securities are really in the custody of broker-dealers? 

Mr. HARBECK. The one-word answer is no, but I would really like 

to explain why. 

Mr. STIVERS. You have 1 minute and 6 seconds. 

Mr. HARBECK. There are five levels of review of that issue. The 

internal auditor of the brokerage firm, let us assume he is corrupt. 

The outside auditor, let us assume that auditor is either corrupt or 

incompetent. A State audit, a self-regulatory organization audit, 

and the SEC. If you added SIPC as a sixth, SIPC would have to 

hire the experts who are already doing it. 

And I am not sure that we— 

Mr. STIVERS. Can I do a quick follow up on that? Like in Madoff’s 

case, he was not covered by FINRA so he wouldn’t have had an 

30 

SRO. He would have only had an SEC, and they actually do it once 

every 10 years for firms of his size? 

Mr. HARBECK. I don’t believe you are correct, sir. 

Mr. STIVERS. Okay. 

Mr. HARBECK. I believe he was—every brokerage firm is a member of a self-regulatory organization. It is required. 

Mr. STIVERS. Okay. 

Mr. HARBECK. So, yes, FINRA did not find this, nor did the SEC. 

Mr. STIVERS. I yield back the balance of my time, Mr. Chairman. 

Thank you. 

Chairman GARRETT. The gentleman yields back. 

The gentleman from Colorado is ready and recognized. 

Mr. PERLMUTTER. Thanks, Mr. Chairman, and thanks to the 

panel. 

I guess let us just sort of—and I know you have broken it down 

into two categories. You have the situation where it is a fraud from 

the outset, or more or less a fraud. It is insolvent is a result of just 

being a fraud, and then it is insolvent as a result of things falling 

apart. It wasn’t a sham to begin with. 

So let us deal with the fraud one first—the Madoff, the Stanford, 

the Peters or Peder, whatever they are called. In Colorado, we had 

a number of investors who invested in ‘‘company A’’ that invested 

in ‘‘company B’’ that then invested in Madoff or Stanford or some 

other Ponzi artist. 

As I am looking at the recommendations of the Task Force, 

those—everybody calls them indirect investors—are sort of out of 

luck, based on the law today, the SIPC law today, or the Task 

Force recommendations, except for those that might be pension 

plans. Am I right? Wrong? 

Ms. BOWEN. No, that— 

Mr. PERLMUTTER. And I am asking both of you, so— 

Ms. BOWEN. No, that is correct. That is the recommendation. 

Mr. HARBECK. Sir, if I could elaborate, though. The indirect investors will share—and I believe in my written comments I speak 

to this specifically because I know this is of particular concern to 

you. If you take a look at exhibit B to my written comments, it is 

a letter that I wrote to you and to Congressman Ackerman to make 

sure that when we settle with one of those feeder funds on a preference or a fraudulent transfer, that the money flows directly 

through to the indirect holders. 

Mr. PERLMUTTER. Okay. But I guess I am just trying, from a policy standpoint, to understand why the pensioners—and they are 

obviously a sympathetic group. I think the firefighters lost some 

money, or their pension initially was in the Madoff mess. 

So why—the pensioners, I guess I am happy if they get it. But 

I would like to see others, indirect investors, be entitled to some 

recovery directly from the fund. What is the policy distinction you 

all make? 

Ms. BOWEN. I think one of the things we considered is the fact 

that, with the pension plans that we suggested with the passthrough, there is already a level of fiduciary obligation under 

ERISA, so we felt that level of protection, if you will, gave us some 

comfort. 

31 

If we are talking about people who may invest in a hedge fund, 

for example, we wouldn’t be privy to what their arrangement is in 

terms of, they may have invested in a huge fund in Connecticut. 

Mr. PERLMUTTER. And I guess what I am saying—and Mr. 

Harbeck, I understand your sort of black-and-white position that 

you know who has opened an account with Madoff—you can go 

back, so-and-so, so-and-so, and so-and-so. But the reality of how the 

system works these days is that you are going to have—or at least 

in that instance, and I think in many you have—a number of different investors who invest in ‘‘company A’’ who then conglomerate 

into ‘‘company B,’’ and then ‘‘company B’’ invests with the Madoff— 

with the broker-dealer. 

So I understand your wanting to have a black-and-white line 

there, but that is not how it works. And the guys who are really 

getting clobbered are the little investors back here in the indirect 

investors. 

Mr. HARBECK. Again, if you focus on the common pool of assets 

known statutorily as ‘‘customer property,’’ that is where the lion’s 

share of any customer’s assets are typically restored, not the advances from SIPC. So typically, the person who is an indirect holder will not be clobbered because the entity that has the account will 

get, typically—not in Madoff, granted, but typically—will get a 

large share of its assets. 

Because typically—and here I find myself reluctantly, very reluctantly, defending the SEC—they usually find these things at a 

point where the amount of missing assets is small. And that means 

that the common pool of assets is in the 95 percent, 98 percent 

range. 

In Madoff, there was an egregious failure that proves that rule. 

So ordinarily, the entity would receive a substantial portion. There 

have only been, prior to Madoff, somewhere in the vicinity of 350 

customers—entities, or any kind—whose claims were not 100 percent satisfied; individuals, entities, whatever. 

And the total amount that those claimants did not receive— 

again, this is prior to Madoff—was somewhere in the vicinity of 

only $47 million. So I am not sure that pounding the Madoff issue 

is the reality for most people who get caught in one of these unfortunate situations. 

Mr. PERLMUTTER. Thank you. 

And, Mr. Chairman, if I could ask unanimous consent to insert 

into the record a letter dated March 2, 2012, from the Agile Funds 

Investor Committee? 

Chairman GARRETT. Without objection, it is so ordered. 

Mr. PERLMUTTER. Thank you. I yield— 

Chairman GARRETT. The gentleman yields back. 

Dr. Cassidy? 

Dr. CASSIDY. I want to first thank the chairman and the ranking 

member for allowing me to ask questions. 

Mr. Harbeck, I am not a securities attorney. I am a doctor, so 

your knowledge greatly exceeds mine, and if I say something stupid, it won’t be the first time, and it won’t be the last, so please 

forgive me. 

That said, let me first ask, was there a settlement offered by 

SIPC to the SEC on behalf of the Stanford victims? 

32 

Mr. HARBECK. Yes, there were settlement discussions. 

Dr. CASSIDY. And was one offered? 

Mr. HARBECK. We made an offer. But I would hasten to add that 

I won’t go into the details on that because— 

Dr. CASSIDY. That is fine. But the fact that you offered, even 

though you categorically deny the rationale for it in your testimony, gives me a little bit of pause regarding your testimony. 

Secondly, let me ask you this. It seems as if you have two objections to SIPC expanding coverage: one, that SIPC does not cover 

losses of an investment; and two, the custody issue. So let me take 

the first. You quoted a court case earlier, in your reply to Mr. 

Green—clearly, you are an attorney, you defer to court—do you disagree with the Fifth Circuit Court, which found that a Ponzi 

scheme is, as of a matter of law, insolvent from the inception? That 

the value is fictitious; there is no value to lose because the value 

is not there at its inception. Do you disagree with the 5th Circuit? 

Mr. HARBECK. The fact that it is insolvent from the initial moment does not detract from the fact that the instrument received 

by the Stanford people was a real certificate of deposit issued by 

a real bank in a real country that is in a real receivership— 

Dr. CASSIDY. It is a piece of paper, I will agree with that. But 

whether or not the value is real or fictitious seems to be the point. 

And the fact that it is insolvent at inception suggests that the 

value is fictitious. I would just make that point, and you can hash 

that out in court. But I— 

Mr. HARBECK. The other thing I would like to say is that this 

matter is in litigation. 

Dr. CASSIDY. I understand that. But on the other hand, I think— 

Mr. HARBECK. And I— 

Dr. CASSIDY. —your— 

Mr. HARBECK. —am constrained by that. 

Dr. CASSIDY. Your testimony, written and spoken, really went 

after this case as if it were in case. And I think it is important on 

behalf of the victims to make the counterargument, if you will. So 

if the first point is that, indeed, the value is fictitious and there 

may not have been value to lose, let us move to the second, regarding custody. 

Again, knowing that you are an attorney and that you have previously quoted court cases in reply to Mr. Green, you spoke earlier 

about how you would have to fold in these different entities in the 

Stanford Financial Group to, if you will, give the Stanford victims 

standing. 

And yet there is a U.S. District Court for North Texas that says 

that the Stanford International Bank and Stanford Financial 

should be collapsed together; that, indeed, they should be folded 

and it is, again, a fiction to pretend that they are different. 

Now that effect—and my understanding, again I am a gastroenterologist, what do I know, although I feel like I am kind of in 

the sweet right now—that would not give them standing as a customer? 

Mr. HARBECK. For a wide variety of legal reasons, the answer is 

no. 

Dr. CASSIDY. Okay. 

33 

Mr. HARBECK. Among other things, the independence of the entity in Aruba has been recognized in several other countries, separate, who have not turned over assets to the receiver in Texas. 

Dr. CASSIDY. Let me just point out, though, that the Stanford 

Group company was a broker-dealer registered with the commission, and it is a big member. That both that, and the Stanford 

International Bank, Ltd. were wholly owned and directed by Stanford. That the Stanford Financial Group was a brand name, under 

which SGC, SIBL, and others operated, to give credibility to SIBL. 

And that domestic clients purchasing Stanford International 

Bank limited CDs dealt substantially, if not exclusively, with Stanford Group company brokers. And that some SGCs—if you will, account holders—received consolidated statements from SGC regarding their Stanford International Bank loan investment. 

I could go on, but I think I am making the point. It does seem 

as if there is a case for them to be folded together, as the North 

Texas District Court suggests. This would be the one to do so. Let 

me just kind of go on for a couple of other things because I am almost out of time, I apologize. 

I have to admit, you give the hypothetical of, we have a salesman 

who says go ahead and invest in the Ponzi scheme and you will be 

covered. And I have to say that there isn’t a victim yet who I 

learned would have invested in this Ponzi scheme should they have 

known it was a Ponzi scheme. 

Now, I will just frankly dispute that. And the idea that somehow, don’t worry, you give your $500,000 to us and we will cover it on 

the backside—forget the fact that you have lost the investment 

value over the period of time it is with them—I will just make that 

point. 

But one last thing. Since there was a settlement offer, and since 

there has been discussion as to the amount of money it would cost 

for such a settlement, can you give us the cash figure that SIPC 

thought would be involved in such a settlement? 

Mr. HARBECK. No, sir, I will not. 

Dr. CASSIDY. I appreciate that. 

Mr. HARBECK. That is a matter in litigation. 

Dr. CASSIDY. But I will presume, because you are fiduciary 

agents, it would not have been one that would have broken the 

bank. And I think that point needs to be made. 

You have been generous with your time. I yield back, thank you. 

Chairman GARRETT. I thank the gentleman. 

All Members have had the opportunity to ask questions, but a 

couple of members have asked for follow-up questions. So what we 

thought we would do is just split 5 minutes on either side, to split 

however the Members want to on either side. 

And, oops. I reclaim that whole statement, and we will start with 

the gentleman from California for his 5 minutes. 

Mr. SHERMAN. Last, and probably in this case least, what is the 

financial position of SIPC, and how is that affected by how you determine whether the Madoff investor, when pooled, is eligible for 

one $500,000 limit, or several? 

Mr. HARBECK. We didn’t take SIPC’s financial situation into consideration in the slightest in making those determinations. Those 

determinations are made by the law. 

34 

Mr. SHERMAN. No, I am asking a financial question. I am not 

asking for a legal defense. What is your financial position, assuming your position on the Madoff claims is upheld by the courts, as 

I am sure you think it will be? 

Mr. HARBECK. Our financial position would be that we have already paid all of the customers who are entitled to protection. We 

have paid— 

Mr. SHERMAN. So what is the net worth of SIPC right now? 

Mr. HARBECK. One-point-five billion dollars. 

Mr. SHERMAN. And that is after paying all of the Madoff claims? 

Mr. HARBECK. Correct. 

Mr. SHERMAN. And if you were to lose on the arguments that 

have been raised for Madoff, how far underwater would you be? 

Mr. HARBECK. Which arguments, sir? There are several. 

Mr. SHERMAN. The argument that each participant in a pool is 

a separate investor. 

Mr. HARBECK. I will preface this by saying we have never lost 

that issue. 

Mr. SHERMAN. Right. 

Mr. HARBECK. And I believe the outside is $17 billion because 

that would—I assume that all of— 

Mr. SHERMAN. That would be the full— 

Mr. HARBECK. —everybody would get paid 100 cents on the dollar. 

Mr. SHERMAN. Okay. Do you have different rates for, in effect, 

what is insurance, based upon whether the securities are being 

held in one of the generally accepted depository houses, or whether 

the member of SIPC just says, ‘‘Hey, I have a safe in the back 

room?’’ 

Mr. HARBECK. First of all, since it is almost all done electronically now, almost all securities positions are held at a common facility, such as the Depository Trust Corporation, or something like 

that. But we have tried—and many members have proffered the 

fact—that our kind of brokerage firm poses less risk. 

And every time a group of brokers says that, I can come up with 

an example of large— 

Mr. SHERMAN. So you charge the same amount for everybody. 

Mr. HARBECK. We charge the same amount for everybody. It 

doesn’t work for— 

Mr. SHERMAN. What portion of your members do the, ‘‘We have 

our own safe’’ approach, rather than using one of the established 

depository— 

Mr. HARBECK. I don’t think it is possible to go back to the days, 

in the 1960s, where— 

Mr. SHERMAN. Madoff did it. 

Mr. HARBECK. Oh, I see your point. 

Mr. SHERMAN. Yes. 

Mr. HARBECK. I— 

Mr. SHERMAN. If Madoff had had all his securities in— 

Mr. HARBECK. No. Many brokerage firms—self-custody positions. 

But in turn, the positions should be reflected at the Depository 

Trust Company, DTC. And in Madoff’s case, if any examiner had 

bothered to check between the positions shown on Madoff’s records 

and what was in DTC, they would have dropped dead on the spot. 

35 

Mr. SHERMAN. If anybody had bothered to notice that he had an audit letter from a one-person CPA firm on a $17 billion balance 

sheet, that would have been caught, too. 

But I yield back. 

Chairman GARRETT. The gentleman yields back, and seeing no 

one else coming in at the last mimute, we will then just close with 

5 minutes, if there are 5 minutes of questions on either side to be 

split up. 

I will begin with the gentlelady from New York, then Mr. Pearce, 

and then Mr. Stivers. 

Mr. PEARCE. Thank you, Mr. Chairman. 

You have brought almost 1,000 clawback suits. How many of 

those were against institutional investors? 

Mr. HARBECK. I don’t know the answer to your question of percentage. It was done strictly— 

Mr. PEARCE. Do you ever bring clawbacks against hedge funds, 

or the big guys? 

Mr. HARBECK. Oh, absolutely. And, in fact, if I could speak to 

your question and simultaneously to a point made by the chairman, 

many of the clawback suits are in sums in the hundreds of millions 

of dollars that have been settled. 

Mr. PEARCE. The one speculation is that the trustee has said that 

75 percent of the property is going to be distributed to institutional 

investors in the Madoff case. What happens to all the little guys? 

Mr. HARBECK. That statement was made by, I believe, Mr. Stein 

in his written statement. The trustee is going to distribute the 

money pro rata to each customer. 

Mr. PEARCE. No. I said, what happens to the little guys? 

Mr. HARBECK. If there is a claimant who is, regardless of the nature of— 

Mr. PEARCE. So the big guys get protected, and the lawyers get 

500 bucks an hour, and we spend about a billion bucks. 

Mr. HARBECK. No, sir. Everyone gets the same pro rata share. 

Mr. PEARCE. If you give 75 percent to the big guys, it looks like 

the little guys are going to be left out. I suspect I have used my 

minute there, Mr. Chairman. 

Mr. HARBECK. No, sir. I would like to respond, if I may. 

Chairman GARRETT. Let me— 

Mr. HARBECK. Every customer— 

Mr. PEARCE. The chairman owns the time, sir. 

Chairman GARRETT. Yes. Let me go to the gentlelady from New 

York for a bit of—do you have any other questions? 

Then Mr. Stivers is— 

Mr. STIVERS. Thank you. I have one quick follow up. Because 

when I was talking to Mr. Harbeck about the Madoff portion, I believe Mr. Madoff had two sides of his business. He had a brokerdealer side and an investment advisor side. And most of the problems were in the investment advisor side. 

But that is the side that is not regulated by FINRA. You indicated that his entire business was regulated by FINRA, or at least 

gave that impression. And I just wanted to make sure everybody 

in the room and everybody who might see this understands that 

the investment advisor side was not regulated by FINRA, and that 

is where most of the losses were. 

36 

Is that correct? 

Mr. HARBECK. No, sir. Because the— 

Mr. STIVERS. Okay. 

Mr. HARBECK. —custody of the assets would have been at the 

brokerage firm, and that should have been discovered. 

Mr. STIVERS. The brokerage firm had the custody of the assets, 

but it may or may not have had the custody of the assets. 

Mr. HARBECK. It did not. That is the entire problem. 

Mr. STIVERS. But that is the point. It may or may not have, in 

the first place— 

Mr. HARBECK. But FINRA— 

Mr. STIVERS. There was no requirement that the investment advisor firm keep all of its assets at that broker-dealer firm, was 

there? 

Mr. HARBECK. No, but they did. 

Mr. STIVERS. Okay, but there was no requirement. So therefore 

they could say they are—we have them somewhere else. And 

FINRA doesn’t—you have to—there is too much coordination requiring, and FINRA doesn’t have the ability to look at everything. 

So they are looking at the broker-dealer side of the business, and 

maybe they missed some stuff. 

But the whole point is, there is not really an SRO on all of the 

Madoff business, is there? 

Mr. HARBECK. No. 

Mr. STIVERS. Thank you. 

Mr. HARBECK. Okay. 

Mr. STIVERS. I yield back my time. 

Chairman GARRETT. Mr. Green? 

Mr. GREEN. Thank you, Mr. Chairman. 

When the individual investor makes an investment through an 

institution, and that institution benefits from the common pool of 

assets, does the institution that benefits from the common pool of 

assets receive instructions as to how it is to distribute the funds 

to the individual investor? 

Mr. HARBECK. That is done by contract between the individual 

investor and the fund. But in response to Congressman 

Perlmutter’s concerns, when we have settled—when the trustee, 

rather, has settled with a fund, perhaps on a fraudulent transfer 

of preference, thus allowing the fund to share in the pool, one of 

the things that we, the trustee, has done is, as part of the settlement, get an agreement from the fund that the money flows 

straight through to the individual investors. 

Mr. GREEN. Thank you. 

I yield back, Mr. Chairman. 

Mr. PERLMUTTER. Thank you. And sort of going back to the preference-fraudulent transfer piece of all this, the question is, let us 

say I put $100 in. I get to a fraud. I get 50 bucks back, so I have 

still lost 50 bucks. Somebody else puts $100 in, and they get nothing back because they are the last guys in the game. 

The question is, I am out $50, but I got $50 more than the other 

guy who got robbed. So the question is, should we all get robbed 

equally? And I think that is where this clawback stuff comes in, 

and the policy behind the clawback. As we do these preferences, as 

37 

say Tremont settles with the trustee, recovers all sorts of money, 

goes to Tremont. 

When I am looking at your letter—and I thank you for your letter of September 11th, actually, or September 30th—how will all 

of these investors from Colorado know that they are going to get 

treated proportionately as to Tremont’s share? 

Mr. HARBECK. We don’t. 

Mr. PERLMUTTER. In terms of the preferential or fraudulent 

transfer of recoveries— 

Mr. HARBECK. The way it works is, Tremont would have returned a preference of fraudulent transfer to the trustee, thus enabling them—freeing up, if you will—the entire amount of their 

valid claim. In the settlement of that preference, the trustee said 

that he would only enter into the settlement if Tremont or the 

other entities similarly situated would agree that regardless of any 

contractual commitments between the individual investors and the 

fund that they would pass the money straight through. 

You have demonstrated one of the hard problems of what happens when somebody pulls out of the fund itself, not out of the 

Madoff case. And all of that has to be done at the level where the 

books and records are for that particular fund. 

Mr. PERLMUTTER. Okay, thank you. 

Chairman GARRETT. The gentlewoman from California? 

Ms. WATERS. Thank you very much. 

Ms. Bowen, I see that you have described to us your work with 

the Task Force. And I am looking at recommendation number 

three—‘‘protect participants in pension funds on a pass-through 

basis.’’ And I happen to have a communication here from Colorado, 

from one of our constituents. 

Let me just read it to you: ‘‘My name is Peter J. Leveton. I live 

in Lakewood, Colorado, a Denver suburb in Congressman Ed 

Perlmutter’s 7th District. I am an indirect investor victim of the 

Bernard L. Madoff Investment Securities, LLC (‘Madoff’ or 

‘BLMIS’) Ponzi scheme, and a Co-Chairman of the Agile Funds Investor Committee of the Agile Group, LLC, Boulder, Colorado 

(‘Agile’ or ‘Agile Group’). In December 2008, Agile had 205 investors and managed three primary hedge funds. The Group and its 

funds are currently in liquidation.’’ 

Now listen to this: ‘‘A large portion of Agile’s funds under management were invested by Agile in the Rye Select Broad Market 

Prime Fund (the ‘Prime Fund’) managed by Tremont Group Holdings, Inc. (‘Tremont’ or ‘Tremont Group’), and invested by Tremont 

with Madoff/BLMIS. Tremont is a subsidiary of Oppenheimer 

Funds, itself a subsidiary of Massachusetts Mutual Life Insurance 

Company.’’ 

I am trying to read this so I can get it all in very fast. Is this 

what you are referring to when you are rejecting the idea of passthrough to all who would claim that they should be considered for 

protection? 

Ms. BOWEN. Yes. You mean outside of the pension, we would say 

other indirects would not be entitled? There would not be any direct customer relationship, in that case? 

Ms. WATERS. What moves me about this is, he goes on to say, 

‘‘Many of us placed a lifetime of savings in what we believed were 

38 

safe investments but which were ultimately invested with BLMIS, 

often without our knowledge.’’ 

‘‘Many of us are now devastated, financially and psychologically.’’ 

‘‘Many of us have sold or are trying to sell our homes just to obtain money to live on without becoming wards of the state.’’ 

‘‘Many of us in our 60s, 70s and 80s have been retired but have 

had to, or are attempting to, go back to work,’’ and on and on and 

on. 

The pension funds where you have the protection, they are more 

sophisticated. And, of course, they should have a lot more knowledge about investments. 

But these people, who appear to have invested in some small entities who were managed by other entities that were managed by 

other entities, had no idea this was going on. So do you feel that 

they have no right to some kind of protection? 

Ms. BOWEN. I do empathize with them. They obviously have recourse against the funds in this instance. But SIPC was not really 

created to reimburse victims such as those, who unfortunately suffered because they put money in the wrong place. It is really unfortunate, but that is not what we were entitled to do. 

Ms. WATERS. All right. Given that, I understand exactly what 

you are saying. But for those who are members of SIPC, are they 

advised or told, or any regulation or rule, about who they represent 

and how many they represent and who these people are? What is 

the responsibility of SIPC to the members who are covered? 

Mr. HARBECK. I am not certain I know what you mean, unless 

you are talking about the Agile to Rye to Tremont situation, something like that. 

Ms. WATERS. Yes, I am talking about this situation. 

Mr. HARBECK. The fact of the matter is, there would be no way 

for SIPC to know those relationships. 

Ms. WATERS. I know, and that is my question. In your Task 

Force review, did you consider this aspect of it? That you have your 

members who don’t—SIPC would not know the relationship of the 

members that are protected to all of these other entities that are 

involved with them. 

Ms. BOWEN. Yes. 

Ms. WATERS. Was that considered? 

Ms. BOWEN. It was considered by the Task Force. And we did 

hear from investors such as the one that you mentioned. We also, 

with some of our participants on the Task Force, particularly the 

State securities regulator—it was rightly pointed out that there are 

Ponzi schemes and frauds that occur throughout their State all the 

time. And those folks are not entitled to SIPC protection because 

it is not a broker-dealer. 

So unfortunately, we do have really bad people who are taking 

money from other people. But that is not really what SIPC is supposed to be protecting. 

Ms. WATERS. So SIPC has no responsibility in this whatsoever in 

terms of educating? 

Ms. BOWEN. Yes. 

Ms. WATERS. The kinds of forms that you are talking about— 

Ms. BOWEN. Yes. No, and that is something we did spend a lot 

of time talking about. Because there is a misperception as to what 

39 

SIPC is and what SIPC is not. And so one of the recommendations 

is that we work with the SEC, with FINRA, and with the State 

regulatory agencies to try to broaden the educational pool; to, in 

fact, hire someone whose job is to work with these entities to better 

get the word out to the investing public as to what it is that SIPC 

does protect as well as what it does not protect. 

Ms. WATERS. Does the broker-dealer have any responsibility to 

tell them that? 

Mr. HARBECK. The only responsibility is to display the symbol. 

We, at one point many, many years ago, tried to expand the investor education levels by the SEC. And we were not met with very 

enthusiastic results. 

Ms. WATERS. So you need some congressional help. 

Mr. HARBECK. Let us see what we can do on our own first, and 

then we will try. Thank you. 

Ms. WATERS. Thank you. 

Chairman GARRETT. I thank the gentlelady. 

I thank the panel for your testimony, and for answering the 

questions today. Thank you. 

Ms. BOWEN. Thank you. 

Chairman GARRETT. The panel is dismissed. 

Mr. HARBECK. Thank you, sir. 

Chairman GARRETT. And then we, following that, move on to our 

third and final panel for the day. And as you are getting ready, we 

have four members of the panel: Joe Borg, director, Alabama Securities Commission; Steven Caruso, partner, Maddox Hargett & Caruso; Ira Hammerman, senior managing director and general counsel, Securities Industry and Financial Markets Association; and 

Ron Stein, president, Network for Investor Actions and Protection. 

I assume that gave you all enough time, as I read that, to get 

your papers organized. I thank the members of the panel for coming forward today, and we look forward to your statements. As you 

know, your complete written statement will be made a part of the 

record, and you will now be recognized for 5 minutes. 

Mr. Borg? 

STATEMENT OF JOSEPH P. BORG, DIRECTOR, ALABAMA 

SECURITIES COMMISSION 

Mr. BORG. Good morning, Mr. Chairman, Ranking Member Waters, and members of the subcommittee. Thank you for the invitation. I am honored to be back before the subcommittee in these 

hearings. 

I am Joe Borg, the State securities regulator for the State of Alabama. Our office has administrative, civil, and criminal authority 

under the Securities Act. And in addition to the examinations of 

audits of broker-dealers and investment advisors, we do quite a bit 

of investigation on Ponzi, pyramids, illegal blind pools, offshore and 

tax scams, fraudulent private placements under Reg D, oil and gas 

and everything. 

I have filed my written testimony with the committee, and I will 

briefly go over some of the points in that. And I will try and skip 

over some of the points that were discussed in the earlier panel. 

Direct equity investments, retirement plans, mutual funds, and 

similar investment vehicles have become the primary method by 

40 

which Americans save for their future, accumulate wealth, and 

plan for a secure retirement. 

Financial fraud in any form threatens the future security and 

well-being of our citizens, destroys the hopes and dreams of families, and destroys what should be the golden years of our life-experienced seniors. As I previously testified back in September, the 

Task Force was charged to look at 12 particular areas. 

And out of that, we have a report covering 15 specific recommendations. The Task Force was split into two working groups. 

My particular subgroup covered recommendations 1 through 4, 14, 

and 15. So I will briefly talk about those particular points. 

The $1.3 million reflects my original opinion of an increase to $1 

million, plus an adjustment for indexing to inflation. Americans are 

looking to the markets and investments to secure their long-term 

future goals. The days of realizing the American dream of a secure 

future by saving only in a bank account or a certificate of deposit 

are long gone, especially with current rates below 40 basis points. 

Interestingly enough, in meeting with the Federal banking authorities, they had concerns about SIPC diverging from the historical relationship between FDIC and SIPC protection levels. In my 

opinion, the historical tie between SIPC and FDIC levels have contributed to the lack of understanding of the differences of FDIC 

and SIPC coverage. 

The insurance of FDIC to bank accounts, and the coverage noninsurance of SIPC to securities, is fundamentally different both in 

statutory application and practical application, at least under existing law. The reality is that my future security in retirement is not 

going to come from my savings and checking account, but from my 

investment accounts. 

Recommendation number two had to do with eliminating the distinction for cash and securities. This outdates—it is meaningless in 

today’s markets. Consider that money market accounts were relatively small in 1978. Now, they are $2.7 trillion. Brokerage cash 

sweeps into money market accounts or bank accounts overnight 

and back and forth, with substantial investor cash routinely held 

in brokerage accounts. 

Those funds deserve the full amount of SIPC protection. This distinction has caused inconsistent court decisions, investor confusion, 

and, in some cases, lost customer funds. Interestingly enough, the 

Canadian counterpart to SIPC did away with the distinction back 

in 1998. 

Again, banking authorities express concerns that SIPC will offer 

greater protection against cash losses than FDIC. This is an artificial connection. And again, maintaining parity does not benefit investors. The recommendation allows the realities of today’s markets to determine the actual and appropriate need for the benefit 

of all investors. 

Recommendation three had to do with the pension funds on a 

pass-through basis. There are a lot of Americans whose investments are not, right now, covered by SIPC protection. They should 

not be discriminated against because they have some generally 

small accounts, they are part of a defined benefit, defined contribution, or a deferred profit sharing plan. 

41 

The recommendations made comports with the trusted fiduciary 

provisions under ERISA. And we also took into consideration certain pension plans and employee benefit plans have been covered 

by FDIC and NCUA on a pass-through basis since 1978. On minimum assessments, according to the staff at SIPC, 25 percent of 

the membership paid a flat $150, based on net operating revenues. 

After Dodd-Frank, the 0.2 percent of gross revenues, many of the same members are actually going to pay less than $150. I think 

this has to do with accounting issues. If members are utilizing 

SIPC in marketing materials and benefiting from the SIPC program, they should pay some minimum amount. 

I personally thought the thousand was a little low, but the general consensus was a thousand would be reasonable in the current 

environment. The Task Force also discussed whether mutual fund 

dealers and assessments on mutual fund reserves should be included. 

SIPC currently exempts mutual fund revenues. Representatives 

of the mutual fund industry made a case that there was no significant history of losses to investors. I did not agree with the majority 

of the Task Force not to assess mutual fund revenues because the 

mutual fund industry utilizes the SIPC logo, touts specific coverage, and billions of dollars of mutual fund shares are held in 

street name. 

However, the fact is there is a history of minimal losses, and that 

was persuasive to the majority of the Task Force. And I respect the 

decision. Concerning international relations, it is a global economy. 

Geographical boundaries have no meaning. Cross-border effects of 

a failure like a Lehman or an MF Global have local, national, and 

international implications. 

The resolution depends on the respective national jurisdictions. 

That just doesn’t work. The Task Force recommendation encourages SIPC to elevate the program in taking the lead in developing 

a new international association. I think investor education has already been covered. 

I proposed a suggestion with regard to adding information into 

brokerage accounts. The Task Force considered that recommendation, but were unable to determine the costs. The issue is left with 

a SIPC board. The invitation also asked for views on pending legislation. I will try and cover that very quickly. 

The purpose of fraud is simple; deprive honest people of their 

funds to benefit the crooks. Look, in a perfect world, we want anyone so injured to get back what they lost. The question is, is it the 

actual investment that was stolen and distributed as profits to 

other victims, less the amount taken by the crook, or what was 

promised—that is, the representations of potential profit. 

Our office investigates numerous Ponzi pyramids and other 

scams. I currently have 48 defendants awaiting trial for various 

forms of survey fraud right now, mostly Ponzis and pyramids and 

that type. In the past year, we have convicted 16. The problem is 

also the same: limited assets to distribute. 

And while the intent of H.R. 757 is noble, I think it is not equitable, and it confirms an unequal benefit to some victims over others. And unfortunately, earlier investors may benefit at the expense of later investments, and may receive distributions in excess. 

42 

So with a limited amount of assets to distribute, we must find 

a way to treat every investor equitably by first attempting to make 

everyone whole on their initial investment. That is the amount invested minus amount received equals actual cash lost. Unless there 

is an endless supply of funds to pay promised returns, it becomes 

impossible from assets available to cover all promises. 

The fundamental problem with the last-statement approach is 

that when thievery is involved, the statements will match the 

fraudulent misrepresentations, historical or otherwise, regardless 

of reasonableness, market conditions, or reality. And H.R. 757 attempts to fix a terrible problem. 

I have a suggestion with part of it. During the September 23, 

2010, hearings, Professor Coffee and I—and I will give most of the 

credit for this to Coffee, it was his idea—here is a signage to consider the creation of a de minimis exception instructing a specific 

trustee not to bring a suit against persons whose withdrawals exceeded their investment by a set amount, a given amount. 

This would give peace of mind to many, but would not impede 

the trustee in his pursuit of the very large net winners. Another 

possible exemption is giving early investors credit for the imputed 

interest on their investments. Such amounts should not be regarded as fictitious profits. 

Congress could immunize some minimum amount of rate of return from the concept of fictitious profits. I don’t know what that 

rate would be: 5 percent; 7 percent; 2 percent; or adjusted to some 

sort of standardized index. But whatever the basis is used, it 

should maintain equitable balance between the victims of a Ponzi 

scheme. 

H.R. 1987 contains similar concepts to H.R. 757. My commentary 

would be the same. I would say, again, there is no real profits in 

a Ponzi scheme, and payments to early investors are proceeds of 

a crime, unbeknownst to both the earlier and later investors. 

For a second, let me discuss indirect— 

Chairman GARRETT. Before we do that, since you are 4 minutes 

over time, let us allow the other members of the panel to testify, 

and we will come back to that thought. 

Mr. BORG. That would be fine, sir. 

[The prepared statement of Mr. Borg can be found on page 58 of 

the appendix.] 

Chairman GARRETT. Thank you. 

Mr. Caruso? 

STATEMENT OF STEVEN B. CARUSO, PARTNER, MADDOX 

HARGETT & CARUSO, P.C. 

Mr. CARUSO. Thank you, Mr. Chairman, and Ranking Member 

Waters. My name is Steven Caruso. I am with the law firm of Maddox Hargett & Caruso in New York City. And as you may recall 

from our last appearance before this committee, our representation 

is of investors; people who have been defrauded, whether it is 

through some of the examples that we have discussed today—what 

I am going to call the ‘‘trifecta of criminality,’’ the Madoffs, the 

Stanfords, the MF Globals—but we see this every day. 

And in serving on the SIPC Task Force, one of the overriding 

considerations is, what are we going to do the next time one of 

43 

these blows up? We have already today discussed the finances of 

SIPC. And if the Stanford case alone goes against the SIPC fund, 

that fund is gone. That fund is gone, the Federal Government 

backup of the SIPC fund is gone, and I would submit to you that 

investor confidence in our entire capital market system is going to 

be gone. 

So one of the primary things I think that needs to be looked at 

is, how do we pay for what needs to be done? And clearly, there 

are victims of Madoff, there are victims of Stanford. But the time, 

I would suggest, has come for this committee to consider requiring 

brokers and investment advisors to have insurance. 

It is too easy today to become a stock broker, it is too easy to 

become a registered investment advisor. But none of those folks are 

required to have insurance. So when we are entrusting them with 

millions of dollars, in some cases hundreds of millions of dollars, 

there is no requirement for any insurance whatsoever. 

And I think that as part of any legislation, insurance is something that needs to be considered. There is no free lunch in this 

world, and asking for insurance when we have to have insurance 

to drive a car, when we have to have insurance to rent an apartment, I think when we have a fiduciary who is out there as an investment advisor and an investment professional, requiring insurance will go a long way towards helping potential victims. 

I will yield back the rest of my time, given Commissioner Borg 

running over. And I thank you for the opportunity to appear here 

today. 

[The prepared statement of Mr. Caruso can be found on page 160 

of the appendix.] 

Chairman GARRETT. There you go. Thank you, Mr. Caruso. 

Mr. Hammerman, please? 

STATEMENT OF IRA HAMMERMAN, SENIOR MANAGING DIRECTOR AND GENERAL COUNSEL, THE SECURITIES INDUSTRY 

AND FINANCIAL MARKETS ASSOCIATION (SIFMA) 

Mr. HAMMERMAN. Thank you for the opportunity to testify as a 

member of the SIPC Modernization Task Force. I am appearing 

here today in my individual capacity, and not speaking on behalf 

of my fellow Task Force members. 

I would like to highlight some of the important pro-investor 

changes recommended by the Task Force, namely expanding and 

increasing the protection available to customers in three important 

ways. 

First, when a brokerage is liquidate and the customer property 

marshaled by the trustee is inadequate to return all customer fund 

and securities, SIPC makes advances from its own funds to assure 

the return of the customer’s property. For over 30 years, these advances have been capped at $500,000 per customer. The Task Force 

recommends increasing the maximum advance to $1.3 million to 

adjust the limit to reflect inflation since 1980. 

Second, SIPA currently distinguishes between claims for cash 

and securities, setting a lower $250,000 limit on claims for cash entrusted to the broker-dealer. The Task Force recommends eliminating this distinction, which has been a subject of controversy and 

unproductive litigation. 

44 

And third, the Task Force recommends a limited pass-through of 

SIPC protection to make individual pension plan participants eligible for advances with respect to their share of the plan’s accounts 

at a failed broker-dealer. 

While I support these recommendations, I wish to note that they 

were made without any real consideration of their cost. This cost 

will be funded by the members of SIPC and, ultimately, by the investing public. Before implementing these recommendations, I suggest Congress obtain a reasonable estimate of the cost of that expanded protection, and consider whether these costs would be justified by the increased investor confidence. 

I am disappointed by the Task Force’s failure to take action with 

respect to several critical areas previously identified by SIFMA. It 

is essential to ensure consistency between SIPA and the SEC’s 

rules that determine the property a broker is required to reserve 

or segregate for its customers. 

Inconsistencies between the two may result in an insolvant brokerage holding an inadequate customer property to satisfy all the 

customers’ claims for the property entrusted to it. To take just one 

example, discrepancies in the treatment of the proprietary accounts 

of broker-dealers may result in a multi-billion dollar shortfall in 

the property available for distributions to customers of Lehman 

Brothers, as we have heard earlier today. 

The current discrepancies were briefly addressed by the Task 

Force’s report, which recommended further study. The Task Force 

missed an opportunity to recommend a solution to a problem that 

is only going to become more urgent as the SEC promulgates rules 

for the protection of securities-based swap customers. 

Although the Dodd-Frank Act addressed the treatment of these 

customers in a liquidation under the bankruptcy code, it did not 

address their status under SIPA, where their status is highly uncertain. If they are not protected as customers under SIPA, securities-based swap customer protection rules may be futile. 

On the other hand, if they are protected as customers under 

SIPA, regular securities customers may be exposed to risks arising 

out of the swap business. The SEC should be authorized to make 

rules under SIPA so that it can promulgate harmonious rules addressing both the requirements for brokers to set aside property for 

customers, and also the distribution of that property in a liquidation. 

The SEC should consider tailoring the customer protection and 

distributive schemes so that customers with simple securities accounts are not unduly exposed to the risks of newer and more complex types of transactions. Finally, to the question of fraud committed by a broker-dealer, I would like to note, as intended by Congress, SIPC’s funds are available only to replace missing customer 

property that was in the custody of a failed broker-dealer. 

I share in the sympathy with, and outrage on behalf of, the many 

innocent victims of massive fraud by the likes of Madoff and Stanford. Financial fraud undermines confidence in our markets and 

our regulatory system. However, SIPA is not intended to protect investors against losses on their investments, only against losses of 

their investments in the event of a broker-dealer failure. 

45 

Investors who lose money because of a decline in the value of the 

securities are not protected by SIPA against such losses, whether 

the decline is due to market forces or even due to fraud. 

In conclusion. SIFMA appreciates the opportunity to participate 

in the work of the Task Force, and is committed to working constructively to modernize SIPA to better protect investors, and 

thereby increase confidence in the final markets. We look forward 

to continuing to work with the subcommittee on these important 

investor protection issues. Thank you. 

[The prepared statement of Mr. Hammerman can be found on 

page 165 of the appendix.] 

Chairman GARRETT. Thank you, Mr. Hammerman. 

Mr. Stein? 

STATEMENT OF RON STEIN, CFP, PRESIDENT, THE NETWORK 

FOR INVESTOR ACTION AND PROTECTION (NIAP) 

Mr. STEIN. Thank you, Chairman Garrett, Ranking Member Waters, and members of the subcommittee. My name is Ron Stein, 

and I am president of the Network for Investor Action and Protection, NIAP, a national nonprofit organization comprised of small investors dedicated to improving our Nation’s investor protection regime. 

I am also a registered investment advisor, certified financial 

planner, and a member of the financial services community. NIAP’s 

primary constituents are individual, noninstitutional investors who 

are often the least equipped to deal with the fallout arising from 

Madoff-like catastrophes, but include an increasing number of regular investors concerned about protecting their assets. 

To supplement my written testimony, which goes into great detail about the Madoff liquidation and the urgent need for H.R. 757, 

I wish to emphasize the following points. First, a majority of the 

Madoff victims have not and will not receive any of the SIPC advance guaranteed by Congress under the SIPA statute due to the 

misguided and inequitable methodology adopted by SIPC and the 

trustee, which minimizes investor protection and the amount that 

SIPC needs to pay to defrauded investors. 

Despite assertions to the contrary, the payment of SIPC advances has nothing to do with investor-to-investor fairness or parity, nor does it reduce the amount of a customer fund available for 

distribution to customers. SIPC advances come from the SIPC 

fund, not from the customer property. 

Over 3 years into the fraud, it appears as though the Madoff liquidation has protected SIPC and enriched the trustee and the 

trustee’s law firm at the expense of the customers. The trustee has 

acknowledged in court filings that his method for calculating net 

equity has saved SIPC over a billion dollars, money that should be 

paid to the victims. 

At the same time, the cost of the liquidation has exceeded $450 

million, and this committee has been told to expect that an additional billion dollars will be spent before the process is complete. 

Ironically, it would have cost approximately the same amount to 

pay each Madoff victim the full measure of SIPC advances guaranteed by Congress when it enacted SIPA. 

46 

SIPC and its trustee have fashioned a net equity methodology 

which consciously ignores reasonable customer expectations as reflected in customer account statements, destroys the certainty Congress intended under SIPA law, and virtually ensures that no rational investor can have confidence in our capital markets or in the 

protections that SIPC promises but fails to deliver. 

These core principles of basic investor protections were the fundamental reasons—indeed, the stated purpose—of enacting SIPA, 

despite an explicit congressional prohibition to the contrary. And in 

the Madoff liquidation, the trustee has been given carte blanche to 

create whatever definition he wants of net equity, including the one 

which favors SIPC over customers. 

As a result, customers can never be sure until long after the fact 

what protections they have if their brokerage firm fails. Moreover, 

in light of the clawback cases the trustee has brought, no investor 

will be able to safely withdraw funds from their brokerage account 

for fear that years later, some SIPC trustee will sue to recover 

those monies under the rationale that it was other people’s money. 

Victims who have lost everything are now forced to defend 

against lawsuits that treat them as thieves, and victimizes them 

yet a second time. How can investors be asked to rely on a system 

which leaves wide open whether, and to what extent, SIPC will 

provide coverage, and which investors remain subject to clawback 

in perpetuity, even though they withdrew funds from their own accounts, in good faith, under the reasonable assumption that it was 

their own money. 

Simply put, as of now, no investor can have confidence in the validity of their statements. Enactment of H.R. 757 is a crucial step 

in restoring sanity to the SIPA process. It will make clear that account statements which reflect positions in real securities will be 

honored in the event of a brokerage firm failure. 

It will end the use of clawbacks against innocent victims. And it 

will end the cozy relationship between SIPC and their short list of 

trustees. I also commend Congressman Ackerman for his legislation which, among other things, would aid indirect investors who 

are often just as damaged, both financially and emotionally, from 

an event like Madoff. 

Thank you for allowing me to testify. I would now be pleased to 

respond to any questions. Thank you. 

[The prepared statement of Mr. Stein can be found on page 211 

of the appendix.] 

Chairman GARRETT. Thank you. I thank the panel. I recognize 

myself, since—I was going to say because—I will begin on this 

point. We are all in agreement that there is an untold number of 

victims who are out there. 

But some of the beginning comments from this panel just lead 

me to a different set of—and I don’t use the word lightly—‘‘victims.’’ That is, the conversations with regard to what happens as 

far as the fees, if you will, or the costs to the broker-dealers because of the money that is being paid out now and trying to build 

up the fund going forward, and what have you. 

It is interesting to hear, first of all, as far as the previous figure, about $150. And that may actually be less, in certain circumstances. But we have also heard from certain broker-dealers 

47 

that the assessment figure could be substantially higher. And these 

are, usually, still the smaller guys who did absolutely nothing 

wrong in this situation and did nothing wrong in any other situations. 

But you might say, from their perspective and ours, as well, perhaps, that they are now being penalized for the errors of others. 

So I guess I will throw that out to Mr. Caruso, because I believe 

you were talking about the idea of mandating insurance. Is this a 

different, another class, of ‘‘victims’’ that we have to consider because of the ills and the bad behavior of others? 

Mr. CARUSO. Chairman Garrett, one of the ways I would respond 

to your question is, I have never had a car accident in 35 years of 

driving. And yet through my insurance coverage, I am certainly 

paying for the ills of others. Again, looking at our financial system, 

somebody is going to need to focus on how we finance what we are 

discussing in this hearing and in similar hearings. 

Whether we provide restitution, the money is not endless. Although I guess in this City, sometimes people think it is endless. 

But if you look at the SIPC fund, there is not enough money to accomplish, I would submit, what needs to be accomplished. The 

Madoff investors are victims because quite honestly, the government let them down. 

The SEC did not pick up on what was going on. I think they deserve to be treated differently than the Stanford investors or the 

ML Global investors. But clearly, where the government is at fault, 

and allowed certain things to go on longer than they clearly should 

have, those people are indeed being victimized twice. 

Chairman GARRETT. Thank you. 

Along another note, the whole panel was here, obviously, all day 

listening to the previous panel. Mr. Stein, you heard Mr. Harbeck 

discuss several reasons why—three or four reasons why—he had 

concerns with, or opposed H.R. 757. Would you like to run down 

some of those, his position versus whether he is correct in his oppositions? 

Mr. STEIN. I think Mr. Harbeck has a slightly different 

worldview than we do at NIAP. I think what we have all clearly 

heard from Mr. Harbeck today is that the SIPC fund, instead of 

perhaps saying, how can we help, says, how can we not help. I 

think, in Mr. Harbeck’s worldview, there is equitability in denying 

SIPC protection for 75 percent of the victims, of the innocent victims of a fraud. 

I think, in Mr. Harbeck’s worldview, suing a thousand innocent 

victims on a clawback claim is an equitable solution. I think in Mr. 

Harbeck’s world, making sure that close to 90 percent of the recoveries of customer property go to the highest, most wealthy institutions and institutional investors is equitable. 

I think what Mr. Harbeck is missing is the point that there are 

basically two pots from which to provide restitution for victims or 

benefits to victims. You have the SIPC fund, which has a responsibility to pay victims based upon their final account statements, or 

the reasonable expectations of those final account statements. 

And I would say that is a very, very core principle underlying the 

creation of SIPA, and that is step one. Step two is finding and 

seeking some equitable solution to dealing with the distribution of 

48 

money from the recovery of customer property. But to focus on customer property, we believe is a red herring. 

Second of all, Mr. Harbeck seems to feel that in some way, paying SIPC benefits in a Ponzi scheme empowers the fraudsters; it 

legitimizes the fraudsters. I would suggest to you that the only 

thing that legitimizes the fraudster is the failure of the regulatory 

apparatus to catch the fraudster. 

And to say that the protection of—that giving funds to a customer or a victim of a fraud in a situation like this enables the 

fraudster is akin to saying a fire truck and a fireman putting out 

a fire that was caused by an arsonist in some way legitimizes the 

arsonist. It is an absolute absurd twisting of the concept. 

At the core, we are talking about protecting customers. We are 

protecting small customers, people who are at the core of our financial system. And it doesn’t sound to me like Mr. Harbeck has really 

addressed those core principles. Because that, in fact, is what is 

needed for Madoff victims now. 

Chairman GARRETT. Thank you. And I have a few more questions. 

But Mr. Hurt? Thank you, Mr. Stein. 

Mr. HURT. Just following up with Mr. Stein, what I thought I 

heard Mr. Harbeck talking about, though, was that, in his opinion, 

the SIPC was not designed financially, in a fiscal way, to be able 

to address all of the inequities that could possibly occur. And that 

with respect to the Stanford case, if you follow the rules as he interprets them, it was not designed to do that. 

Now, if Congress or SIPC wants to expand that authority, then 

suddenly you are going to have to build a different model and there 

is going to have to be more capital involved. I think what he said 

was you would end up having to draw down on the equity line with 

the Treasury in order to be able to guarantee that. 

I think that is what he was saying. Can you talk about it in 

terms of that? Because I think that is what he was saying. 

Mr. STEIN. Yes. Let me speak to that briefly, Congressman. I 

think, first of all, we are in great sympathy with a vast majority 

of the victims of the Stanford fraud. The vast majority of them had 

no knowledge that they were investing in something that was not 

going to be protected, that they were investing through a brokerdealer that was not going to property manage their funds. 

They are truly victims. And what I think is important for SIPC 

to do in a situation like this is to address the situation in a way 

that says, what can we do to help, and what do we need to do in 

the future to prevent these sorts of calamities from happening 

again? And frankly, that is something that requires all parts of the 

regulatory apparatus to work together. 

The fact of the matter is, Mr. Harbeck was correct. There were 

major failures of regulatory oversight that allowed the Stanford 

fraud to continue. And that is something that we have to pay very, 

very significant attention to. That said, I think we also have to find 

a way to think about how we can help the Stanford victims rather 

than do them further damage. 

Mr. HURT. Another question that I would like to address, or have 

addressed, is a question that I asked the previous panel. And that 

is, when you look at the broker-dealers that are paying for this proVerDate Nov 24 2008 15:08 Dec 12, 2012 Jkt 075077 PO 00000 Frm 00054 Fmt 6633 Sfmt 6633 K:\DOCS\75077.TXT TERRI
49 

tection for the public—which I think everybody understands and 

agrees is appropriate—at some point, it seems to me, you have to 

be concerned about how much you are asking those to contribute. 

Because at the end of the day, that comes out of their bottom 

line. It makes them either more profitable or less profitable, allows 

them to stay in business and provide that protection. 

But it is something that I am aware of because as I travel across 

my district, I hear from people in every line of work who say, ‘‘You 

know, these little fees, they sound good when you are talking about 

them in a committee meeting in Washington. But once they all pile 

up on us, they have a devastating effect on our ability to be competitive.’’ 

And I was wondering if maybe each of you could just speak to 

that topic. What is the appropriate level of assessment, and does 

that assessment take into account the size and relative risk that 

perhaps each dealer-broker exposes the fund to? 

Mr. STEIN. I think Mr. Caruso has spoken well to that issue. But 

the fact that for the better part of the last 20 years, every member 

of SIPC has been charged a paltry $150 per year, that ultimately 

led to the potential trauma that is now being experienced by the 

SIPC fund is beyond comprehension. 

And by the way, the SIPC fund as its presently constituted has 

more than sufficient assets to pay off the advances to all the 

Madoff victims, just as a point to be made. But you get to a very 

important point. And that is, why were the members of SIPC resistant to increasing SIPC fees for the last 20 years, when this 

committee and other committees recommended an an increase to 

the SIPC assessment over the last 20 years? 

We would have a SIPC fund that would have multiples of billions 

of dollars, more than capable of paying for the Stanford and the 

Madoff and, potentially, even some of the MF Global situation had 

there been a proper assessment on the SIPC members. 

Now, the second part of this that Mr. Caruso alluded to is the 

process of underwriting. If you are going to take on a SIPC member 

who increases by their very practice the level of risk, it is important that we find some method to increase the cost for that individual. A high-risk driver should be charged a higher rate than a 

low-risk driver. 

An investment advisor that has custody of their own assets 

should probably be charged a different rate than one that doesn’t. 

So to get to the ultimate part of it, I think we have to find an assessment level that is consistent with the risk, and also begin the 

process of bringing in the private sector to improve the extent of— 

Mr. HURT. Thank you, Mr. Stein. My time has expired, but I 

don’t know if, without objection, there are others who could add to 

that point. Go ahead. 

Mr. HAMMERMAN. Thank you, Congressman. I just wanted to 

echo the concern raised by your question. There are approximately 

5,000 different broker-dealers, many of whom are small business 

operators. Which is why, in my oral statement, I indicated that 

while as a Task Force member I agreed with the notion of increasing the level of protection to the $1.3 million, one piece that we as 

a Task Force just did not really analyze is the cost. 

50 

What will these costs ultimately require for all the broker-dealers, from the smallest firms up to the largest? So I just think that 

is a relevant question, and part of the data analysis that should 

occur. 

Mr. HURT. Mr. Caruso? 

Mr. CARUSO. Thank you, Congressman. Obviously, we don’t have 

access to the member assessments from SIPC as far as who is paid 

what over the past number of years. But looking just a few years 

ago, realize Citigroup global markets, Smith Barney, Merrill 

Lynch, Morgan Stanley—those firms paid a total of $150 apiece. 

So does the system have to be changed? Certainly. You can’t 

have a firm of that size, with thousands of brokers, paying $150. 

To come down here today, the shuttle cost me $800. Now, at $150 

a year, I would have paid my SIPC dues for almost 6 years. 

That is insanity, and that is what is at the core of the problem 

today, and why I would suggest that the SIPC fund, with just one 

more catastrophe, will not be viable any longer on its own or with 

the Treasury backstop. 

Mr. HURT. Mr. Borg? Thank you. 

Mr. BORG. The question of assessments really depends on what 

the focus of the fund is to do. If it is going to be limited to where 

it is now, or at least under the current interpretation, that is going 

to be one assessment. If you are going to expand it to cover potential losses on statements that may be inflated—especially 20 years’ 

worth of Bernie Madoff—that is going to be a completely different 

assessment. 

I think the committee, the Task Force, when looking at this, 

made recommendations not knowing what those costs would be. So 

we took what was the current law—the Dodd-Frank 0.02, quarter 

of 1 percent on revenues—and said that is what the law is now. 

And what we only did was say, look, it is ridiculous to have $150. 

At least have some minimum. But I think it is incumbent upon 

Congress to decide where the parameters are. And I think a lot is 

going to depend on this SEC versus SIPC lawsuit. Because, quite 

honestly, if the SIPC is required to pay the Stanford or the account 

stated on account statements, then I would submit to you I have 

about $4 billion or $5 billion worth of Reg D 506s sold through 

broker-dealers on oil and gas deals and medical facilities that also 

would be required to pay. 

What my concern is on the bills is not what you are trying to accomplish. It is that they only cover certain Americans in certain 

situations. Everybody is entitled to equal protection of the law. If 

you are going to cover Stanford—which, in essence, is going to 

cover an overseas bank, basically turning SIPC into FDIC insurance for an overseas bank—what about one of my cases? Mallory 

is a now-defunct broker-dealer. 

I put them all in jail. There are not assets. But I have probably 

$600 million worth of account statements and folks who invested 

in U.S. projects that were fraudulent. There is no SIPC coverage 

for that. I can’t give them their money back. Lets cover it for all 

Americans. But at that point, you have to look at what that universe is. 

51 

You cannot parcel the universe and say just Stanford or just 

Madoff—cover everybody, or decide not to cover anybody. Or try 

and find some level of protection that everybody can participate in. 

Mr. HURT. Thank you, Mr. Chairman. 

Chairman GARRETT. Sure. 

Just on that last line, I am sorry, I wasn’t familiar with that 

case. So that was not a securities case. That was— 

Mr. BORG. Most of— 

Chairman GARRETT. That last—they were— 

Mr. BORG. Sorry, Mr. Chairman. Yes, Mallory was a broker-dealer out of California. It was FINRA-registered. However, they specialized in the private placements under Regulation 506, which is 

exempt from State securities jurisdiction, except for enforcement. 

There is no gatekeeper function. And what we discovered was that 

out of southern California, they were running an operation where 

they would do multiple 506s; 72 percent to 75 percent of all the 

money went to the company—salaries, bonuses, salesmen. 

There was never any money for projects. They would open up a 

little project, and there was no chance it would ever succeed because there was no money to fund it. And this was a primary 

fraud. We see the same thing with captive broker-dealers in the oil 

and gas industry, where an oil and gas developer will set up a 

broker-dealer and sell only oil and gas placements. 

DBSI out of Idaho was a real estate pool. 

Chairman GARRETT. And that would not come under the SIPC, 

then? 

Mr. BORG. No, because it is all fraudulent statements with false 

profits. It is identical to the Stanford situation. 

Chairman GARRETT. Yes. 

Mr. BORG. But if the case turns out that it is covered, then I 

think all those have to be covered, as well. 

Chairman GARRETT. Yes. 

I have a couple of other particular questions. But I guess Ms. 

Bowen actually raised some of that point before as to there are 

other classes, there are other activities of fraud that are out 

there—and we are trying to address where this fraud should be 

covered, right? 

And I appreciate that. Part of the problem in this particular area 

is, where you were, clearly, in Madoff—which is the more infamous 

one where you are looking in that situation: one, it was covered; 

and two, there was an expectation of coverage. 

Now we get into the two issues that we have in that particular 

case. Obviously, the one that the gentleman from Colorado picks up 

on the most is the feeder fund situation, and what was the expectation in that situation as far as the unlearned, the average investor 

on that situation. 

And the other is the situation about the various pools of funds 

that are available for recovery. And to those separate points, Mr. 

Borg, you raised the point, I guess, in your opening comment. Just 

a side line on this is how mutual funds are treated under this. 

The fact that they have the logo there, so to speak—although I 

guess most people really don’t see that, since you are dealing with 

a lot of this online nowadays—your position was, and I will look 

52 

at the rest of the panel, what the solution is, dealing with mutual 

funds. 

The exemption is appropriate? Or is the exemption similarly removing of that logo, and say since they are not going to— 

Mr. BORG. Mr. Chairman, I disagreed with the rest of the Task 

Force members on this point. I thought mutual funds, because they 

do: one, use the logo; and two, because money is going back and 

forth in brokerage accounts and there are all these mutual funds 

that are being held in a street name for that matter—all those 

shares that back up the mutual funds— 

Chairman GARRETT. Sure. 

Mr. BORG. —I just thought they should not be an exemption. I 

don’t know what that kind of money would bring in, but that is a 

huge industry. 

Chairman GARRETT. Does anybody else want to—since we know 

you were on that—just find where the rest of the panel is? 

Mr. CARUSO. The only thing I would offer, Mr. Chairman, is, 

when we explored that issue as part of the Task Force, one of the 

things we looked at was how often do mutual funds fail. Yes, they 

all use the SIPC logo, but they don’t pay anything for it. And the 

counterargument from the Investment Company Institute—the 

trade association for mutual funds—was, none of our members ever 

fail. 

As Commissioner Borg indicated, mutual funds are a huge business in today’s day and age, and they are part of the securities industry. But historically, they have been carved out. 

Chairman GARRETT. Right. 

Mr. CARUSO. Revenues from mutual funds. And I think given the 

current financial position in the environment, it is something that 

needs to be revisited. 

Chairman GARRETT. Right. Anybody else? 

Mr. HAMMERMAN. The only thing I would add, Mr. Chairman, is 

that many mutual fund complexes have broker-dealers as part of 

the complex. That is how they sell the mutual funds. So there 

would be SIPC coverage and assessment at that level. 

Chairman GARRETT. Okay. The magnitude of those funds is still 

de minimis, based upon the current configuration. 

Mr. Stein? 

Mr. STEIN. I would agree exactly with what Mr. Hammerman 

just said on that. 

Chairman GARRETT. Yes, yes. And also, I am down here, and 

since I can give myself as much time as I want—but I am mindful 

of your time—SIPC says what with regard to the payment methods? Cash-in, cash-out, right, when you are dealing in that equity 

calculation? 

Do you want to just spend a moment on the appropriateness of 

that? And then to bifurcate that issue—and the rest of the panel, 

I will throw it out to you, as well—to bifurcate that issue to the 

fact that you can bifurcate that as far as whether you have one 

pool or two, right? The advances, or the other assets—back? 

And your comment would be in general, should there be a distinction when you are dealing with both pools? 

Mr. STEIN. Sure. 

Chairman GARRETT. Okay. 

53 

Mr. STEIN. Sure. Sure, let me get to that. 

Chairman GARRETT. Okay. 

Mr. STEIN. All right. So when Congress passed SIPA law in 1970, 

at the same time that it was moving away from the use of physical 

securities that you referred to earlier today, it was doing so at the 

same time it was making an agreement with the American public 

of offering a degree of assurance that what was going to be replacing that physical security had to be meaningful. 

It was intended to be modeled on the kinds of assurances that 

were provided by the Federal Deposit Insurance Corporation 

(FDIC). In fact, the original legislation was essentially a cut-andpaste from the original FDIC legislation. But the upshot, it was 

trying to protect the small investor and create a state of certainty, 

so that an investor knew that when we were dealing with something that was on an account statement, it was a true and honest 

and legitimate reflection of what they owned. Congress made this 

recommendation amidst a background of failed brokers, of Ponzi 

schemes, of thefts. The circumstances all existed, that we are talking about today, in various forms. 

And Congress still said, we are creating a SIPC fund. This fund 

is going to protect the net equity based on understood-to-mean final 

account statement. So that an investor knew, when they looked at 

their statement, that they owned something. And it was necessary. 

Because after all, we were looking at protecting the smaller investor. 

Richard Nixon’s statement, when he signed that legislation, was 

a profoundly powerful one. And what it does tell us, very clearly, 

is that investors who are in their later years, who are now living 

on their retirement funds, cannot afford to think that their protections are being reduced by the amount of money that they pull out 

of those funds. 

That the profits that their hard-earned savings have made on 

those funds in those accounts, whether it is at a bank or a financial 

institution, have to be protected. And that worse still, somewhere 

down the road, no trustee can come in 20 years hence and say no, 

you have to give that money back. 

That is precisely what is going on now. So the SIPC fund itself 

has to be based upon reasonable expectations of final account statements. And frankly, if the statements are outrageous or wrong, 

then we really have to get to whether or not a person receiving 

those statements was willfully turning a blind eye. 

The courts have the ability to say no, you are getting 40 percent 

return—maybe you don’t get that protection. But when we come to 

the issue of the recovery of customer property—and I think that is 

where so much of the time has been spent—maybe there is a different standard. 

The trustee has had the flexibility to apply a different standard 

and a reasonable standard. And that standard could incorporate 

the time value of money, it could find some way to equitably determine what the fair distribution would be of the recoveries of those 

monies. 

But it should not eliminate the use of final account statement 

and reasonable expectations on the core of this protection, which is 

the SIPC fund. So customer property has an opportunity to have 

54 

all kinds of equitable, ratable methodologies applied to it to come 

up with a good solution based upon what the trustee sees at that 

particular time. 

The fund, however, that belongs to SIPC, the SIPC fund, is inviolate. It cannot be modified or changed. It is what the customer has 

to be relying upon for their protection. 

Chairman GARRETT. The rest of the panel? 

Mr. CARUSO. The only thing I would add, Chairman Garrett, is 

the one thing that has been clear from today’s hearing is that how 

you stop this problem is you don’t allow people to prepare their 

own account statements. If Madoff had not prepared his own account statements on one side of his floor, none of this would have 

happened. 

So, a very simple solution, if we want to keep this from happening again, is that I cannot prepare my own statements. That 

solves the problem. 

Chairman GARRETT. Mr. Borg? 

Mr. BORG. In my office, investment advisors are looked at once 

every 3 years on a rotating cycle. We use a risk assessment. If they 

have custody and control, they go way to the top of the list and 

they are looked at a lot sooner and a lot quicker. 

If they are strictly financial advisors that just give advice, and 

they have no custody, no control—no physical custody of the property—then they go to the bottom of the list. Because there is a 

clearing firm or someone else out there. The comment was made, 

and we try and encourage at least the investment advisors under 

our jurisdiction—Madoff would have been under the SEC jurisdiction—to get a clearing firm. 

Again, I agree. A lot of the problems with these Ponzi schemes, 

if they are going through either a brokerage, or usually an IA, can 

be eliminated by actually having a dual or triple control. Because 

now you have three entities that have to conspire to make it all 

work. 

Chairman GARRETT. Unless, of course, you control all three entities, and, as in the Madoff situation, where— 

Mr. BORG. In that case, I would consider that as a unitary control because Mr. Madoff actually had control over both ends of his 

business. There has to be a Chinese wall between the two. Even 

where there are clearing firms that self-clear, we look at the controls between the two. Usually it is an outside auditor or an outside advisor, or some other third party that has to certify that they 

have looked at those systems and those systems are intact. 

Chairman GARRETT. Have you ever had the case where you have 

a situation like that? Where there is collusion, and it doesn’t solve 

the problem, as Mr. Caruso suggests? 

Mr. BORG. I have not seen—yes, one time that I can think of. In 

fact, it gets tied up with that Mallory case because there was a separate organization called Capital Guardian which handled the trust 

accounts. 

Chairman GARRETT. Okay. 

Mr. BORG. In other words, if you had an IRA and there was collusion between the two. There was joint ownership, but it was so 

cleverly disguised it took us a little while to find it. 

Chairman GARRETT. Find it, yes. 

55 

Mr. BORG. But it didn’t last 20 years. 

Chairman GARRETT. Yes. That is because you had good folks over 

there digging into it on a regular basis— 

Mr. BORG. Thank you, Mr. Chairman. I appreciate that. 

Chairman GARRETT. Sure. 

If Mr. Hurt does not have any other questions at this time, I will 

dismiss the panel, and thank you all very much for your testimony 

today. And without objection, I will put into the record a statement 

from the Financial Services Institute, and also from the Bond Dealers of America (BDA). Without objection, it is so ordered. And 

again, I very much appreciate this entire panel for your information and discussion today. 

The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 30 days 

for Members to submit written questions to these witnesses and to 

place their responses in the record. 

Thank you. The hearing is adjourned. 

[Whereupon, at 12:42 p.m., the hearing was adjourned.] 

(57) 

A P P E N D I X 

March 7, 2012 

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75077.001

TESTIMONY OF 

JOSEPH P. BORG 

Director, Alabama Securities Commission 

before the 

COMMITTEE ON FINANCIAL SERVICES 

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE 

AND GOVERNMENT SPONSORED ENTERPRISES 

United States House of Representatives 

March 7,2012 

Chairman Garrett, Ranking Member Waters and Members of the Subcommittee: 

Thank you for the invitation and opportunity to participate in your hearing focusing on 

the Securities Investor Protection Act (SIP A) and the Securities Investor Protection Corporation 

(SIPC). I am Joseph Borg, Director of the Alabama Securities Commission and today [ appear 

in my capacity as Director of the Alabama Securities Commission (ASC). While I served as a 

member of the SIPC Modernization Task Force, I am not a spokesperson for the Task Force or 

for SIPC. 

As the state securities regulator [or the State of Alabama, our office has administrative, 

civil and criminal authority under the Alabama Securities Act, and, specifically, with respect to 

investor fraud. Ase investigates Ponzi and pyramid schemes, illegal blind pools, fraudulent 

private placement offerings under Regulation D and other scams which have led to numerous 

ej:}forcement cases and criminal prosecutions. 

The majority of U.S. households now invest in capital markets in one form or another, 

whether through direct equity investments, retirement plans, mutual funds or similar investment 

vehicles (up from 1 in 18 in 1978-the year of the last significant amendments to SIPA). These 

investments by "Main Street" investors have become the primary method by which Americans 

save for their future, accumulate weaJth and plan for a secure retirement. Financial fraud 

therefore has a profound impact and threatens the future of a great number of working families. 
59 


75077.002

Beginning June 10, 2010, the SIPC Modernization Task Force conducted a series of 

meetings (including industry and govemment agencies) and telephone discussions, as well as 

document reviews and research, which resulted in the Task Force presenting its "Report and 

Recommendations of the SIPC Modernization Task Force" to the SIPC Board of Directors in late 

fall of201 I. 

As I previously testified I in hearings held by this Committee on September 23, 20 I 0, the 

Task Force focused on 12 main areas: 

I. Adequacy of the SIPC Fund 7. Customer Property 

2. Audit Responsibilities 8. Direct Payment 

3. A voidance Actions 9. Fictitious Securities 

4. Corporate Governance 10. International Rclations 

5. Customer Definition 11. Investor Education 

6. Customer Name Securities 12. Levels of Protection 

The published "Report and Recommendations" covers 15 recommendations 

encompassing the 12 general areas mentioned above. As a member of Subgroup #1,2 I shall 

discuss the recommendations primarily examined by our subgroup, namely Recommendations I 

through 4, 14 and 15. 

I Testimony of Joseph Borg before the Committee on Financial Services Subcommittee on Capital Markets, 

Insurance and Government Sponsored Enterprises, United States House of Representatives, September 23, 2010. 

[Copy attached as Appendix "A"]. 

2 The Task force was split into two subgroups with specific areas of review. 

2 
60 


75077.003

RECOMMENDATION NO.1: INCREASE MAXIMUM PROTECTION TO $1.3 

MILLION and INDEX THE LEVEL OF PROTECTION TO INFLATION 

I strongly supported an increase in the levels of protection and I stand by my previous 

testimony before this committee: 

" .. .It is my belief that the level of protection with regard to the SIPC Fund should 

be increased from $500 thousand to $1 million. It is clear that in today's society, 

Americans are heavily invested in the markets and that a large portion of their 

retirement savings consist of securities investments in addition to savings in 

banks. Further, the $1 million level of protection would match SIPe's Canadian 

counterpart, the Canadian Investor Protection Fund (CIPF), which is currently at 

the $1 million (CAN). Secondly, I believe that the levels of protection should be 

indexed to inflation. Part of the public's concern with SIPC is the lack of 

adjustments over the years to the levels of protection, and indexing to inflation 

would allow some measure of increased protection going forward.,,3 

The recommendation of $1.3 million reflects my original opinion of an increase to $1 

million plus an adjustment for indexing to inflation in recognition that Americans increasingly 

look to the markets and investments to secure tbeir long term future goals. Congress has 

recognized the importance of "Main Street" investors in our markets and has consistently 

introduced legislation to further encourage small investors to continue investing in start-up 

companies, existing small businesses, and our markets. Ifwe continue to encourage investments, 

we must recognize that the standards of the 1970s and 1980s can no longer apply in today's 

economic environment. The days of realizing the American dream of a secure future by saving 

only in a bank account or a certificate of deposit are long gone, especially with current rates 

generally below 40 basis points. 

During the deliberations of the Task Force and after discussions with various government 

agencies, it became clear that concerns existed with regard to this recommendation; specifically, 

diverging from the historical relationship between FDIC and SIPC protection levels. Part of the 

3 Testimony of Joseph Borg before the Committee on Financial Services Subcommittee on Capital Markets, 

Insurance and Government Sponsored Enterprises, United States House of Representatives, September 23, 2010. 

3 
61 


75077.004

concerns are evident in recent SIPC matters and can be traced in part to a lack of understanding 

of the differences of FDIC and SIPC coverage. This public perception stems partly from the 

historical notion of maintaining parity. The insurance of FDIC to bank accounts and the 

coverage (non insurance) of SIPC to securities is fundamentally different both in statutory 

application and practical application under existing law. 

RECOMMENDATION NO.2: ELIMINATE THE DISTINCTION IN THE LEVELS 

OF PROTECTION FOR CASH AND SECURITIES 

The distinction of cash vs. securities in brokerage accounts is meaningless in today's 

markets. For example, money market accounts were relatively small in 1978--<:ertainly not the 

$2.7 trillion4 now held by investors. In addition, brokerage cash 'sweeps' into money markets or 

bank accounts overnight with the result that substantial investor cash is routinely held in 

brokerage accounts (which funds deserve the full amount of SIPC protection). Further, this 

distinction has caused inconsistent court decisions, investor confusion and in some cases loss of 

customer funds 5

. This was an issue I discussed in my previous testimony before this Committee 

on September 23, 2010: 

" ... A major issue is the treatment of claims based on a securities position which 

never actually existed. The Task Force is aware of the conflicts between decisions 

from the Second and Sixth Circuit Courts of Appeals in this area. I believe that 

the problem which stems from SIPA's distinction between cash and securities 

(currently $250,000.00 cash limit) could be eliminated by ending the disparate 

protection between claims for cash and claims for securities. For example, a 

person selling their securities portfolio and receiving a check in excess of the 

maximum SIPC advance for cash claim where the brokerage firm failed before 

the check was cashed, would be limited to the cash limitation. Therefore the 

current law may, in some cases, result in unintended and inequitable results. I 

would also note that the Canadian Investor Protection Fund (CIPF) eliminated a 

distinction between claims for cash and claims for securities in J 998. In a 

4 Presentation ofInvestment Company Institute ("IC]") to the SlPC Task Force. 

S See examples set forth in the Task Force recommendations. 

4 
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discussion with SIPC statf, it appears that a change in favor of eliminating the 

cash vs. securities distinction would not alter the risk models used by SIPC .... ,,6 

Again, as with the increase of protection in RECOMMENDATION NO. I, there was 

significant discussion of the concerns by banking authorities that the SIPC will offer greater 

protection against cash losses than the FDIC. The artificial "connection" between FDIC and 

SIPC levels of protection is meaningless in today's economic society and maintaining 'parity' 

does not benefit investors. Rather than trying to maintain the lowest level of parity, we should 

allow the realities of today's markets to determine the actual and appropriate need for the benefit 

of all investors. 

RECOMMENDATION NO.3 PROTECT PARTICIPANTS IN PENSION FUNDS 

ON A PASS-THROUGH BASIS 

Many Americans have their retirement accounts as part of a 'fund' or 'plan'. These 

investors should be able to avail themselves of SIPC protection and not be discriminated against 

because their generally small accounts are part of an overall defined benefit, defined contribution 

or deferred profit sharing plan. This recommendation comports with the trust and fiduciary 

provision under the Employee Retirement Income Security Act of 1974 ("ERISA"). 

My testimony at this Committee's September 23,2010 hearing included the following: 

" .... The Task Force has had initial discussions with regard to indirect investors. It 

is my opinion that certain retirement plans are appropriate for customer eligibility. 

I am unsure with respect to the hedge fund arena due to the nature of hedge fund 

investing, including lack of transparency, lack of oversight and higher risk 

strategies. However, this matter is on the agenda for further discussion with the 

Task Force. The Task Force is also aware that certain pension plans and employee 

benefit plans have been covered by FDIC and NCUA on a pass-through basis 

since 1978. The limitation is that each beneficiary could only receive the "present 

vested and ascertainable interest of each beneficiary". Issues concerning deferred 

compensation plans and non-bank covered pension funds are issues for Task 

Force discussion. It appears to me that pension plans and employee benefit plans 

6 Testimony of Joseph Borg before the Committee on Financial Services Subcommittee on Capital Markets. 

Insurance and Government Sponsored Enterprises, United States House of Representatives, September 23. 2010. 

5 
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matching those covered by FDIA and FeUA would be appropriate for protection 

under SIPA.,,7 

The Task Force recognizcs that SIPe staff will need to review and implement specific 

mechanisms and procedures (claim filing, documentation, etc). SIPe accounting may also need 

to determine if the slPe Fund target should be adjusted. The Task Force asked the SIPe staff if 

the costs would have been material based on a historical review. In response, SIPe staff advised 

that had this recommendation been previously implemented, the effect on the SIPe Fund would 

not have been material. 

RECOMMENDATION NO.4 AMEND THE MINIMUM ASSESSMENT TO THE 

GREATER OF 1) $1,000.00; OR 2) THE AMOUNT SET BY SIPC BYLAW NOT TO 

EXCEED 0.02% OF THE MEMBER'S GROSS REVENUES FROM THE SECURITIES 

BUSINESS. 

SIPe staff reported to the Task Force that 25% of the SIPe membership paid a flat 

$150.00 based on net operating revenues. After Dodd-Frank, based on 0.02% of gross revenues, 

many of the same members would pay less than $150.00, and in some cases, $0. If members are 

utilizing SIPe in marketing materials and benefitting from the SIPe program, they should pay a 

minimum amount. Similarly, considering the size of the industry and the touting of SIPe 

coverage in advertising, a reasonable minimum assessment should be required. While I 

personally thought $1,000.00 was low, the general consensus was that $1,000.00 would be a 

reasonable amount in the current environment. 

Another area discussed by the Task Force involved whether Mutual Fund Dealers and 

Assessments on Mutual Fund Revenues should be included. Representatives from the mutual 

fund industry appeared and made a case that there is no significant history of losses to investors 

7 Testimony of Joseph Borg before the Committee on Financial Services Subcommittee on Capital Markets, 

Insurance and Government Sponsored Enterprises, United States House of Representatives, September 23,2010. 

6 
64 


75077.007

on mutual funds and that structural differences between retail broker dealers and mutual fund 

distribution do not warrant such assessments. I did not agree with the majority of the Task Force 

not to assess mutual fund revenues on the theory that the mutual fund industry utilizes the SIPC 

logo, touts the SIPC coverage and billions of dollars of mutual fund shares are held in street 

name8 However, the fact that there is a history of minimal losses was persuasive to the majority 

of the Task Force. Further, SIPA §78ddd (c)(3)(C) currently exempts " ... revenues received by a 

broker or dealer in connection with distribution of shares of a registered open end investment 

company .... " 

RECOMMENDATION NO 14 INTERNATIONAL RELATIONS: SIPC TO ASSIST 

IN THE CREATION OF AN INTERNATIONAL ASSOCIATION 

In today's "global" economy, geographical boundaries have little meaning. The crossborder effects of a failure of a multi-national business (Lehman, MF Global) have local, national 

and international implications. While the financial sectors have transcended political and 

geographical boundaries, the mechanisms for resolution when a major failure occurs are still 

rooted in the laws of the respective national jurisdiction. This 'sorting out' of laws, rules, 

regulations and procedures incurs substantial expenditure of time and resources. Thc creation of 

an international forum specifically dedicated to resolution of a failed entity should be seriously 

considered. The Task Force recognized that an international association will take time to 

develop, but beginning with a forum for discussion of international securities investor protection 

initiatives may provide the basis for future dispute resolution. In past years, I have served as the 

States' representative through NASAA9 to the International Organization of Securities 

Commissions ("IOSCO") and between 2004 to 2009 a~ a U.S. Delegate in an expert capacity to 

6 Members ofIC! manage assets of$12.33 trillion with 90 million shareholders according to ICI. 

7 
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75077.008

the United Nations Committee on International Trade and Law (UNCITRAL). That experience 

convinced me that the establishment of direct contacts and combining efforts specifically 

targeted to develop methods for coordination of a cost effective, transparent and efficient claims 

process would be a substantial benefit to investors. The Task Force recommendation encourages 

SIPC to continue its Memorandum of Understanding Program but to now elevate this program to 

a new level in taking the lead in the development of an International Association oflike entities. 

RECOMMENDATION NO 15 SIPC TO CONTINUE INVESTOR EDUCATION 

EFFORTS 

As one of the Task Force members who participated in both of the SIPC public forums 

and answered telephone questions from the public, it was painfully evident that many investors 

consider FDIC and SIPC to be virtually identical, that is, insurance against theft, loss and fraud. 

I stand by my testimony at this Committee's September 23,2010 hearing: 

" .. .It is clear that there is a general public misconception that SIPC is some type 

of insurance, akin to FDIC insurance for banks. It is also clear in SIPe's 

application of the law that SIP A was not intended to be insurance for fraud, but 

only for replacing cash, as well as securities missing from customer accounts not 

connected to the actual value of investment into the securities purchased or 

believed to have been purchased, and not based on a risk of loss fundamental. If 

Congressional intent is to change SIPC into FDIC type insurance-based 

protection, then the parameters of the level of funding would change. The 

misconception has been historically exacerbated by references to FDIC as a 

comparison and by the broker-dealer community who tout the SIPC protection 

levels. Education initiatives to correct the misconception have proven to be 

inadequate. Therefore, I would suggest that to seriously educate investors with an 

understanding as to what levels of protection are available and the true nature of 

SIPC protection, a constant and systemic notification (education) effort will be 

required. I would suggest that every brokerage account statement that is sent to 

investors include a page or a section that clearly underscores what SIPC is and is 

not. I would also suggest that it include examples which change every quarter so 

that the public can see what to expect or not to expect from SIPC. The fact of the 

matter is that television advertisements, public presentations and newspaper 

reports are one-shot efforts that will not overturn a history of belief and 

9 NASA A (International Securities Administrators Association) is a voluntary association whose membership 

consists of67 state, provincial and territorial securities administrators in the 50 states, the District of Columbia, 

Puerto Rico, the U.S. Virgin Islands, Canada, and Mexico. 

8 
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75077.009

expectation. I would also not recommend an insert into the account statements as 

they have a tendency to be discarded, instead, every account statement would 

have a portion of a page dedicated to SIPC coverage. It may take several years of 

constant message delivery to reverse the current tide of misconception. This is not 

to say that elimination of other types of investor education is desirable. However, 

for true education, the repetitive nature of account statement receipt should assist 

in disseminating correct information of the purpose and role of SIPe. I am also 

aware that SIPC does not have the power or authority to require this type of 

account statement inclusion and the matter would have to be implemented 

through the SEC and FINRA .... " 

The Task Force considered the recommendations above but were unable to determine the 

costs to the industry and the potential effectiveness of these efforts. The issue is left with the 

SIPC Board for further study. The Task force did, however, unanimously recommend that a 

dedicated investor education employee be hired to enhance existing efforts and develop new 

initiatives. 

VIEWS ON PENDING LEGISLA TION: 

The Committee's invitation further requested any views on pending legislation, 

specifically the following: 

H.R. 757 "EQUITABLE TREATMENT OF INVESTORS ACT" 

H.R. 1987 "PONZI SCHEME INVESTOR PROTECTION ACT OF 2011" 

ILR. 4002 "IMPROVING SIPC ACT OF 2012" 

When a fraud occurs, the purpose of the fraudster is simple .... deprive honest people of 

their funds to benefit the crook ..... In essence, stealing with paper and pen (now computers and 

technology) rather than at gunpoint or through a burglary. In a perfect world we would want 

anyone so injured to get back what they lost. The question is then, what should they get back? 

Is it what they put in, that is, the actual investment that was stolen and distributed as 'profits' to 

9 
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other victims (less the amount taken by the crook) or what was promised, that is, the 

representations or promises of potential proiit?IO Our office has been faced with numerous 

ponzi, pyramid and other scams that affect our citizens. The Alabama Securities Commission 

currently has 48 defendants awaiting trial for various forms of securities fraud. So far in this past 

year we have convicted 16 individuals for fraud upon our investors. The problem is always the 

same-limited assets to distribute. While the intent of HR 757 is noble, it is not equitable and 

therefore confers an unequal benefit to some victims over other victims, all of whom are 

innocent and all of whom relied on the con artist. The investor rule then becomes: be the first in 

on a ponzi scheme, always take out your profit to guarantee the money can't be touched and save 

all your account statements. The goal is to be an early investor at the expense of later investors. 

In one case II prosecuted by my office, fictitious account statements were issued 

indicating substantial profits from options trading. In fact, what trading did occur consistently 

lost money. What little assets remained were proportionately distributed based on the actual cash 

invested. Had our office distributed assets based on the account statements, and not considered 

the payouts already received, the vast majority of the later investors would have received 

nothing. 

In a Ponzi scheme, early investors may receive distributions in excess of their initial 

investment but their ever increasing account statements show substantial amounts the victims 

believe to be in existence. With a limited amount of assets to distribute, we must treat every 

investor equitably by first attempting to make everyone whole on their initial investment 

(amount invested-amount received=actual cash lost). Rarely is there ever enough money to 

10 For example, in Alabama Securities Commission vs. Greater Ministries International Church the promise was 

"Double your money in 17 months". Over 20,000 victims invested with losses of over $500 million. Account 

statements were sent quarterly for nine (9) years. Likewise, In the matter (if MN Partners, the promise of a $300.00 

investment that would return $1,800 as month for life tax ITee after 5 years, resulted in over 18,000 victim investor 

accounts. 

11 ASC v. Wealth Builders International and Networker 2000. 

10 
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accomplish this task. In my 18 years of experience only once were we able to return 100 cents on 

the dollar of actual investments (not promised returns). Unless there is an endless supply of funds 

to pay 'promised' returns, it becomes difficult if not impossible from assets available to cover all 

promises or expectations without a 'bailout' from someone else, whether it be the federal 

government or increased costs to the industry (with costs passed on to other investors). 

The fundamental problem with the 'last statement' approach is that when thievery is 

involved the statements will match the fraudulent representations made (historical or otherwise) 

regardless of reasonableness, market conditions or reality. Fraudulent representations of "double 

your money" or 20% returns and statements to match are commonplace. 

While H.R. 757 attempts to fix a terrible problem for many, it creates a problem for many 

others. I concur with a suggestion made by Prof. John Coffee at the September 23, 2010 

Committee hearing in his discussion of "Net Winners" and "New Losers" in a ponzi scheme on a 

possible compromise solution: 

" ..... One can certainly understand the desire to protect the smaller Net Winner, 

who withdrew only a small amount in excess of his or her cash investment in the 

Ponzi scheme. Most likely, the SIPC trustee would not sue the smaller Net 

Winners, but a de minimus exception could be created, instructing a SIPC trustee 

not to bring suit against persons whose withdrawals exceeded their investment by 

a given amount (say, $500,000). This would give peace of mind to many, but it 

would not impede the trustee in his pursuit of the larger Net Winners ...... 

Another more limited exemption may also be justified. It can be argued 

that early investors in a Ponzi scheme should be given credit for the imputed 

interest on their investments, and such amounts should not be regarded as 

"fictitious profits." To illustrate, assume that two investors both invest $1 million 

in a Ponzi scheme, and both withdraw $2 million. But Investor A invested his $1 

million ten years ago, while Investor B invested his $1 million only last year. 

Thus, Investor A made a profit of $1 million (the $2 million withdrawn minus a 

$1 million initial investment) over ten years (or a 10% annual rate of return), 

while Investor B made the same $1 million profit in one year (or a 100% rate of 

return). 

These two investors look very different once we recognize the time value 

of money. From such a perspective, Investor A's real rate of return was only 10% 

per annum. In this light, Congress could immunize some minimum annual rate of 

return from the concept of "fictitious profits." This could be done either in the 

Bankruptcy Code or (less desirably) in SIPA. Thus, Section 8A(f) 12 could instead 

12 Prof. Coffee's reference is to H.R. 5032 (2011), now H.R. 1987 (2012). 

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instruct the SIPC trustee not to seek to the recovery of profits from any investor in 

a Ponzi scheme without first subtracting a credit against these profits equal to a 

defined interest rate (say, 10%) times the principal amount invested each year. On 

this basis, Investor A would not have received "fictitious profits," while Investor 

B would have. For the sake of simplicity, I am not considering the compounding 

of interest in this hypothetical. 

This distinction rests on a real economic difference between these two 

investors, subtracting a credit against these profits equal to a defined interest rate 

(say, 10%) times the principal amount invested each year. On this basis, Investor 

A would not have received "fictitious profits," while Investor B would have." 13 

Perhaps HR 757 should be revisited and drafters may wish to consider revisions 

reflecting a basis as described by Prof Coffee in order to maintain equitable balance among the 

victims of a ponzi scheme. 

HR 1987: 

To the extent that HR 1987 contains similar concepts as HR 757, the same commentary 

would apply. HR 1987 also seeks to limit the trustee of a Ponzi scheme on recovery of funds 

from investors who have received funds from later investors (clawback). The net effect is 

subordinating the claims of later investors, the 'net losers' under Prof. Coffee's terminology, to 

the interests of the 'net winners'. Reducing the pool of assets injures the later investors to a 

greater degree. When faced with a ponzi scheme situation, all the assets, including the transfers 

stolen from later investors and given to earlier investors should be pooled to benefit all investors 

without preferential treatment. There are no real 'profits' in a ponzi scheme and payments to 

earlier investors are proceeds of a crime unbeknownst to both the earlier and later investors. All 

victims are equal, and unlike George Orwell's Animal Farm, some victims should not be more 

equal than other victims 14. 

13 Testimony of Prof John Coffee Before the Subcommittee on Capital Markets, Insurance, and Government 

Sponsored Enterprises of the Committee on Financial Services, United States House of Representatives September 

23,2010. 

12 
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I note that HR 1987 Section 8 (A) (h) would apply the law retroactively with a threshold 

of $1,000,000,000. Our experience in prosecuting these schemes confirms that even a small 

ponzi scheme can wipe out investors life savings and destroy the hopes and dreams of entire 

families. Such a threshold is artificial and is not fair to all investors. Only those investors in 

'large' frauds get the benefit of the law and smaller frauds essentially don't count. The 

devastating effect on families occurs regardless of the size of the scheme. If Congress is 

considering retroactive application, why not retroactively apply the law to all ponzi schemes 

affecting all American investors, perhaps retroactive to March of2000 157 

With regard to 'indirect investors', while the Task Force discussed the concept of 

coverage for indirect investors, the Task Force chose to limit the discussion to similarities in 

existing law (see discussion of RECOMMENDATION NO 3 above). Considering the large body 

of law on limitations on claims against third parties (such as limitations on class actions and 

recent decisions not allowing derivative claims, etc.) and considering that investors who dealt 

with 'feeder' funds placed reliance in the feeder funds and not the brokerage entity, pass through 

liability to SIPC may not be appropriate. The 'feeder fund' is the client of the failed entity. The 

investors in the 'feeder fund' have claims against that 'feeder fund' for any violation of duty of 

care, failure of due diligence, etc. However, one provision of H.R. 1987 proposes a maximum 

amount for indirect ponzi scheme investors which may have merit prospectively if fully 

researched and developed. Coverage for "indirect investors" is feasible if clear rules are in place 

including transfer of potential claims similar to subrogation on insurance, up tront disclosures by 

feeder funds to the brokerage entity of its clients, disclosure by the feeder fund to its investors of 

the pass through coupled with transparency as to fees charged for the service, and clear 

disclosure as to what actual services the feeder fund is doing for its fee. 

14 Orwell, George, Animal Farm (1945)" ... all animals are equal but some animals are more equal than others. 

13 
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This Bill is specifically directed to the unfortunate situation created by the massive 

Stanford fraud. The matter is in litigation and will apparently be decided by the courts. 

Depending on a final court decision, the one-time payments being proposed may be correct, may 

be subject to recapture or may be determined to be inappropriately paid. 

The pending issue is whether SIPC has the statutory power to reimburse the 

investors/victims in the alleged Stanford Ponzi scheme since it appears they did not lose money 

in a failed brokerage firm. Investors lost as they purchased CDs from an offshore "bank" 

instead of an FDIC insured institutionl6. The bank issuing the CDs was chartered, domiciled, 

regulated and audited in Antigua. Investors purchased the CDs for the interest rates being paid 

which were substantially higher than rates paid by U.S. regulated banks. 

The potential result of the pending action may have wide ranging effects. If in fact a 

foreign (non - U.S. regulated) bank can sell CDs (or similar products) through a brokerage then it 

makes sense for anyone contemplating the purchase of a CD to find an offshore bank (through a 

brokerage) paying substantially higher than any U.S. Bank, therefore knowing that if a loss 

occurs by fraud they will be covered by SIPC at a possibly higher rate than currently offered by 

the FDIC. In such a case, why would anyone invest in a U. S. bank CD at substantially lower 

interest rates for the same or a lesser guarantee of coverage? At this point SIPC becomes the 

virtual equivalent of FDIC coverage for non U.S. regulated banks. If Congress has not yet sought 

the opinion of the federal and state banking regulators on this issue, I suggest that such a request 

be made. 

15 Beginning of the first major crash oflhe century, commonly referred to as the '~ech wreck". 

16 Based on information available, including comments by SIPC and its Trustee, it does not appear that investors 

placed funds in the Stanford brokerage unit and that the brokerage failed to purchase the Certificates of Deposit. If 

the brokerage unit had failed to transfer funds to the bank's accounts either in the U.S. or directly to Antigua for the 

CD purchase then clearly, SIPC coverage would be in effect. 

14 
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75077.015

Let me be clear, as a state securities regulator, I always look for ways to have investor 

losses covered when legally possible, If the current litigation between the U.S. Securities and 

Exchange Commission and SIPC detem1ines that coverage is available for a foreign bank CD 

fraud, then we should expect that all similar cases of securities fraud should also be covered, not 

just foreign bank CDs. For example, the Alabama Securities Commission has investigated the 

matter of Mallory Investments 17, a defunct registered broker-dealer who sold millions of dollars 

of fraudulent Regulation D 506 private placement offerings to investors. Similar frauds exist 

through brokerages and investors in those cases should be covered as well ifthc decision in SEC 

vs. SIPC requires coverage in a situation even more remotely removed from a brokerage than the 

private placement offerings. 18 

At this time, it appears that the more prudent course would be to allow the judicial system 

to finalize the issue so Congress can consider the result and act accordingly to support, modify or 

overturn the Court's action through appropriate legislation. 

Improvements to SIPA and SIPC can and should be made but must be made for the 

benefit of all investors equally. 

Thank you for the honor to once again submit testimony on these critical issues. 

17 To date, ASC has criminally convicted 5 individuals from California connected with the Mallory fraud. Other 

cases such as DBSI, MedCap and others may also become eligible for coverage. 

18 During the period 1996-1999, the Alabama Securities Commission was the lead state investigating the micro-cap 

frauds ofthe time, including such firms as Stratton Oakmont, Duke & Co., Biltmore Securities, etc. (Testimony of 

Joseph Borg, "Fraud in the Micro-Cap Markets and Penny Stock Fraud", before the Permanent Subcommittee on 

Investigations of the Committee on Governmental Affairs, United States Senate, September 22, 1997). We 

proffered the idea that the SEC, SIPC and Congress consider the issue ofSIPC coverage for brokerage fraud in the 

micro-cap area. The idea was rejected. 

15 
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75077.016

APPENDIX A to Testimony of ,Joseph P. Borg before the Committee on Financial Services 

Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises (March 7, 2012) 

TESTIMONY OF 

JOSEPH P. BORG 

Director, Alabama Securities Commission 

before the 

COMMITTEE ON FINANCIAL SERVICES 

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE 

AND GOVERNMENT SPONSORED ENTERPRISES 

United States House of Representatives 

September 23, 2010 

Chainnan Kanjorski, Ranking Member Garrett and Members of the Subcommittee: 

I am Joseph Borg, Director of the Alabama Securities Commission and I welcome the 

opportunity to participate in your hearing focusing on the Securities Investor Protection Act 

(SIPA) and the Securities Investor Protection Corporation (SIPC). Today I appear as a member 

of the SIPC Modernization Task Force and in my capacity as Director of the Alabama Securities 

Commission (ASC). Our office has administrative, civil and criminal authority under the 

Alabama Securities Act and specifically with respect to investor fraud, ASC investigates Ponzi 

and pyramid schemes, illegal blind pools, fraudulent private placement offerings under 

Regulation D and other scams which have led to numerous enforcement cases and criminal 

prosecutions in this arena. 

With about 55% of US households now investing in our capital markets, up from 1 in 18 

in 1978 (the year of the last significant amendments to SIP A), financial fraud has a profound 

impact on a great number of working families. 

With regard to SIPC, I was invited to participate on its Modernization Task Force in late 

May of 2010. Since that time, we have had a series of telephone conferences, three in-person 

meetings discussing various issues related to SIP A and SIPC, as well as dedicated website access 

to exchange infonnation and ideas. I would like to take a few minutes and advise you of my 

position with regard to certain "modernization" issues which I have either proffered or have 

supported. These views do not necessarily reflect those ofSIPC or of the Task Force. The Task 

Force discussions are concentrating on twelve particular areas as follows: 
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75077.017

L Adequacy of the SIPC Fund, 7. Customer Properly, 

2. Audit Responsibilities, 8. Direct Payment, 

3. Avoidance Actions, 9. FictitiDus Securities, 

4. CDrpDrate GDvernance, 10. InternatiDnal Relations, 

5. CustDmer DefinitiDn, 11. InvestDr EducatiDn, and 

6. CustDmer Name Securities, 12. Levels ofProtectiDn. 

In order tD mDve the prDcess alDng in an efficient manner, the Task FDrce has been 

subdivided intD two groups. Later, the subgrDups will join tDgether fDr discussions on the 

various subjects for final recommendatiDns. I would like to take a moment to commend the SIPC 

staff for prompt responses to my specific requests for information, data, reports and souree 

materials in order for the Task Force to become adequately informed in certain areas. My 

particular areas of concern are as follows: 

I. Levels of ProtectiDn. It is my belief that the level of protection with regard to the 

SIPC Fund should be increased from $500 thousand tD $1 milliDn. It is clear that in 

today's society, Americans are heavily invested in the markets and that a large 

portiDn of their retirement savings consist Df securities investments in additiDn tD 

savings in banks. Further, the $1 million level of protectiDn would match SIPe's 

Canadian counterpart, the Canadian InvestDr ProtectiDn Fund (CIPF), which is 

currently at the $1 million (CAN). Secondly, I believe that the levels of protection 

should be indexed to inflation. Part of the public's concern with SIPC is the lack of 

adjustments over the years tD the levels of protection, and indexing to inflation would 

allow some measure Df increased prDtection gDing forward. 

2. Fictitious Securities. A majDr issue is the treatment of claims based on a securities 

positiDn which never actually existed. The Task FDrce is aware of the conflicts 

between decisions from the Second 1 and Sixth Circuit Courts Df Appeals2 in this area. 

I believe that the problem which stems from SIPA's distinction between cash and 

securities (currently $250,000.00 cash limit) could be eliminated by ending the 

disparate protection between claims for cash and claims for securities.3 For example, 

a person selling their securities portfolio and receiving a check in excess of the 

maximum SIPC advance for cash claim where the brokerage firm failed before the 

1 In Re: New Times Securities Services, Inc., 371 F.3rd 68 (2nd Cir. 2004) 

2 Plumbers & Steamfitters Local No. 490 Severance and Retirement Fund v. Appleton (In Re: First Ohio 

Securities Co., No. 93-3313, 1994 US App. LEXIS 31347) (6th Cir. Nov. 1, 1994) 

3 1f Subsection (a)(1) of SIPA § 78fff-3 is deleted, the disparity would no longer exist. 

2 
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75077.018

check was cashed, would be limited to the cash limitation. 4 Therefore the current law 

may, in some cases, result in unintended and inequitable results. I would also note 

that the Canadian Investor Protection Fund (CIPF) eliminated a distinction between 

claims for cash and claims lor securities in 1998. In a discussion with SIPC staff, it 

appears that a change in favor of eliminating the cash vs. securities distinction would 

not alter the risk models used by SIPCs 

With respect to increasing the limit to $1 million and eliminating the cash vs. 

securities distinction, the banking industry and/or banking regulators could be 

expected to oppose such a change as there has been an apparent historical progression 

of matching levels of FDIC protection to SIPC limits even though the operation of 

FDIC insurance is completely different to the operation of SIPC as a securities 

replacement vehicle. Certainly discussions with the Securities & Exchange 

Commission (SEC), Treasury, Federal Reserve Board and views of the industry 

(SIFMA) and other authorities would be appropriate. 

3. Increase the Line of Credit from Treasury. Considering the explosive growth of the 

markets and investor participation therein since the enactment of SIP A and the 

expected continuation of growth in the securities markets, a change in coverage to $1 

million cash or securities and indexed to inflation may require an increase in the line 

of credit from Treasury. The Task Force has requested the staff of SIPC to review the 

effect of protections at the $1 million level. It is my personal feeling that a line of 

credit of $5 billion matched with reserves of $5 billion would be appropriate going 

forward. At the current level of assessments, it will take a number of years to reach 

those levels. However, I believe those levels to be realistic and planning for them 

should begin now. 

4. Assessments. Prior to enactment of the Dodd-Frank Wall Street Reform and 

Consumer Protection Act (Dodd-Frank Act), assessments by SIPC had a floor of 

$150.00 with a maximum of .25% of revenues. The SIPC staff has also informed the 

Task Force that there are some SIPC members under the new Dodd-Frank Act who 

now pay zero assessments6 It is my belief, as well as other members of the Task 

4 Investors do not routinely accumulate cash with a broker and an investor's position is only "caught" in a 

cash position when the brokerage firm fails. 

5 It is my understanding that the sufficiency of the SIPC Fund Analysis is premised upon paying each 

claim up to the maximum limit for securities. 

6 Due to deductions for expenses, etc., in some cases. certain broker-dealers, based on net operating 

revenues, now pay zero due to elimination of any floor for assessments. 

3 
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Force, that there should be a minimum assessment of some amount I believe that 

minimum amount should be at least $1,000.00 and preferably in the range of 

$2,000.00 to $2,500.00. Based on infornlation Irom the SIPC staff, SIPC receives 

about 80% of the assessment revenue from the larger firms and at current levels it 

will take approximately 5 years for the fund to reach the current target of $2.5 billion. 

I was surprised to learn that in computing assessments that revenues on mutual funds 

are not included. I am of the opinion that since all investors benefit from SIPC 

protection, that revenues on mutual funds should be included for assessment purposes 

as well. 

Regardless of the target level that the Task Force recommends or what target level 

of funding for SIPC is finally adopted, any time that a target level is reached, there 

should be another determination of whether assessments are adequate based on the 

current level of investors assets in the market and whether new targets should then be 

considered. Also, it appears to me that the current arrangement with the Treasury for 

a line of credit, which is a term loan, should actually be a revolving loan in order to 

ensure continuity and flexibility in the ability of SIPe to protect investors where and 

when needed. 

5. Investor Education Efforts. It is clear that there is a general public misconception that 

SIPC is some type of insurance, akin to FDIC insurance for banks. It is also clear in 

SIPC's application of the law that SIPA was not intended to be insurance for fraud, 

but only for replacing cash, as well as securities missing from customer accounts not 

connected to the actual value of investment into the securities purchased or believed 

to have been purchased. and not based on a risk of loss fundamental. If 

Congressional intent is to change SIPC into FDIC type insurance-based protection, 

then the parameters of the level of funding would change. The misconception has 

been historically exacerbated by references to FDIC as a comparison and by the 

broker-dealer community who tout the SIPC protection levels. Education initiatives 

to correct the misconception have proven to be inadequate. Therefore, I would 

suggest that to seriously educate investors with an understanding as to what levels of 

protection are available and the true nature of SIrC protection, a constant and 

systemic notification (education) effort will be required. I would suggest that every 

brokerage account statement that is sent to investors include a page or a section that 

clearly underscores what SIPC is and is not. I would also suggest that it include 

4 
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75077.020

examples which change every quarter so that the public can see what to expect or not 

to expect from SIPC. The fact of the matter is that television advertisements, public 

presentations and newspaper reports are one-shot efforts that will not overturn a 

history of belief and expectation. I would also not recommend an insert into the 

account statements as they have a tendency to be discarded, instead, every account 

statement would have a portion of a page dedicated to SIPC coverage. It may take 

several years of constant message delivery to reverse the current tide of 

misconception. This is not to say that elimination of other types of investor education 

is desirable. However, for true education, the repetitive nature of account statement 

receipt should assist in disseminating correct information of the purpose and role of 

SIPC. I am also aware that SIPC docs not have the power or authority to require this 

type of account statement inclusion and the matter would have to be implemented 

through the SEC and FINRA. 

Response to Issues Presented in the Subcommittee's Invitation of September 16,2010: 

In the September 16,2010 invitation to appear before this Subcommittee, there 

were certain issues that the panelists were invited to address. I will respond to them in the order 

presented. 

1. Whether the SIPC board should include a representative of the Securities & 

Exchange Commission (SEC) and what, if any, other modifications to the 

government structure may be appropriate. It is my understanding that SIPC 

reports to the SEC by way of required records and reports, as well as the filing of 

an audited annual report, and that SIPC must obtain SEC approval for changes to 

its operational rules and bylaws. Although I see little harm in having an SEC 

representative on the SIPC board, caution should be exercised. It appears that 

since SIPC, in essence, reports to the SEC, an SEC representative could possibly 

exercise undue influence over the board in its recommendations or positions 

which may, in some instances, become a conflict of interest. It appears that the 

question of an SEC representative should be addressed to an expert on corporate 

governance for a determination of possible conflicts in this area. In any case, an 

SEC representative should continue to attend each SIPC board meeting as an 

observer or adviser, which I am advised is currently done. 

5 
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75077.021

2. Whether the statutory minimum balance of the SIPe Fund should be adjusted in 

light of the recent increase in the target balance, and if so, explain how it should 

be adjusted. As J mentioned earlier, J believe the balance in the fund should be 

adjusted substantially upwards given the effect that a major case may have on 

SIPC's reserves. According to the SIPe starr, the former $1 billion balance has 

historically proved adequate to meet the requirements of SIPe cases, however, it 

is my belief that in light of the growth of the securities industry, plans should be 

made for a larger target and that is why I have recommended a target of $10 

billion, composed of $5 billion in reserves and $5 billion revolving line of credit. 

I have no mathematical formula for this opinion. However, by increasing the 

coverage amount to $1 million, essentially a doubling of the current $500,000.00 

limit, and looking at the possibility of the potential impact of future fraud cases, 

it appears prudent to be prepared so that assessments over time will be realistic 

and that the balance of the fund is also increased over time. 

3. Whether any trustee appointed by SIPe should also be subject to bankruptcy court 

approval and whether trustees appointcd in civil liquidations have been as 

etlicient and efrective as those appointed under similarly sized non-SIPe 

liquidations. It is my understanding that the bankruptcy court appoints the 

trustees in slPe cases and that there must be a designation that the trustees are 

"disinterested parties". The Task Force has asked lor further infoffi1ation from 

the SIPe staff on the history of trustee appointments and details on liquidations. 

This information will be studied as discussions continue. 

4. Whether the standard to file a SIPe claim is too low and whether it results in 

frivolous claims that slow down the liquidation proceedings or otherwise creates 

an expectation on behalf of the customers that their claim is bona fide. I think it 

can be reasonably assumed that when people file claims with regard to any type 

of action, they believe they are entitled to some recompense. From that point or 

view there is a possibility that filing a SIPe: claim creates an expectation, 

however, limiting a potential claim may cause greater harm in that the claimant 

who fails to file a timely claim but was eligible will be barred from recovery. 

From a public policy point of view it appears that encouraging investors to file a 

claim when they think they have a claim is preferable than trying to eliminate 

claims on the front end and then discovering that some with viable claims have 

6 
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75077.022

not filed. Since this is a fine line, I would err on the side of encouraging anyone 

who believes they have a claim to make the appropriate filing. Although this 

may result in an increase in time and perhaps costs, covering the universe of 

potential claimants is preferable to inadvertently leaving someone eligible out of 

the claims process. We are advised by staff that they have no historical 

indication that there have been a large number of frivolous claims in SIP A 

proceedings. Understanding that the MadofJ situation may be unique, the MadofJ 

matter may be an exception to the general rule. 

5. Whether SIPA's direct payment procedures result in an efficient and effective 

way to return customer property and whether and how such criteria ought to be 

modified. In discussions with the SIPC staff and reviewing SIPC's direct 

payment procedures, it is my opinion that the direct payment procedures appear 

to be efficient and effective in returning customer property.7 I have suggested to 

the Task Force that the direct payment amount threshold should be increased8 to 

utilize the efficiency of the direct payment procedures. The Task Force is 

currently discussing what that proper amount should be and I have recommended 

that the Task Force consider $2 million as the appropriate amount. 

6. Whether the statutory definition of a customer eligible for SIPC coverage remains 

relevant given indirect investing increa~es via retirement plans and hedge funds. 

The Task Force has had initial discussions with regard to indirect investors. It is 

my opinion that certain retirement plans arc appropriate for customer eligibility. 

I am unsure with respect to the hedge fund arena due to the nature of hedge fund 

investing, including lack of transparency, lack of oversight and higher risk 

strategies. However, this matter is on the agenda for further discussion with the 

Task Force. The Task Force is also aware that certain pension plans and 

employee benefit plans have been covered by FDIC and NCUA on a passthrough basis since 19789 The limitation is that each beneficiary could only 

receive the "present vested and ascertainable interest of each beneficiary". 

Issues concerning deferred compensation plans and non-bank covered pension 

7 SIPC records indicate that the direct payment procedure has been used in 35 of the 204 proceedings 

since 1978. 

• Current law authorizes use of out-ai-court direct payment procedure where aggregate claims are less 

than $250,000.00 [15 U.S.C. '78fff-(4)(a)]. 

7 
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funds are issues for Task Force discussion. It appears to me that pension plans 

and employee benefit plans matching those covered by FDlA and FCUA would 

be appropriate for protection under SIP A. 

7. Whether and how SIPA's definition of customer property should be amended in 

light of the changing nature of customer arrangement with their broker-dealer, 

including account balances tied to client commission agreements and innovative 

investment vehicles such as security based swaps and to be-announced security 

transactions. Thcre is a substantial diflerence between individual retail investors 

and large institutional investors (including large sophisticated investors) who 

have interrelated and complex agreements with brokerage firms. Clearly the 

original intent of SIP A in 1970 was protection of the retail market and it appears 

that the complex relationship investment arrangements implicit in the question 

werc not contemplated at the time. While this area deserves study, truly 

sophisticated investors, especially institutional investors, are in most cases a 

different type of investor and therefore it may be appropriate for these non Main 

Street large investors to be subject to a different standard than traditional SIPA 

protected investors. 

8. Whether and how SIPA's definition of "net equity" should be revised to 

address situations whereby a customer statement from their broker-dealer does 

not agree with the broker-dealer's books and records and the extent to which 

customers should be entitled to rely on a statement they have received. 

Historically, customers net equity has been determined by the securities position 

shown on the customer's account statements. And again, historically, the 

account statements would show accurately the transactions that occurred, but the 

securities were then missing. In most cases, where statements are received the 

securities positions that had been purchased at the customer's instructions are 

accurate and those securities are expected to be in their accounts. It is a different 

matter, however, when securities positions are fictitiously created, as in the 

MadoJJ case. The Madoff customers expected that the money given to Madoff 

would be placed in legitimate trading circles. Concocting account statements 

with 20/20 hindsight is more akin to the type of Ponzi and pyramid schemes 

9 Allowing for each beneficiary of a pension, profit sharing plan (401(d) of IRS Code) or individual 

retirement account (408(a) of IRS Code) FDIA amended in 1991 to allow for 457 plans (deferred 

8 
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generally seen by state regulators in which no slPe member is involved. The 

vast majority of these cases which occur on an alanningly frequent basis cause 

the same monumental damage to individual investors as any MadofJ or Stanford 

case. These situations have generally been handled through the cash-in cash-out 

method of calculating equity. In the 15 years my office has been handling cases 

involving Ponzi, pyramids and other schemes outside the SIPe arena, most cases 

only return pennies on the dollar with the assets marshaled through a 

receivership and distributed based on a cash-in cash-out basis. Where there are 

inflated account statements, they do not reflect actual cash in but a promise of 

expectation computed retroactively or completely fabricated. Where there are 

insufficient assets to pay all parties, the most fair detennination has been to 

compute all cash in, all distributions out, resulting in the net loss, then 

detennining the pro rata basis for payments of whatever assets have been 

marshaled. This is significantly different than a customer who directs a broker to 

buy a speci fic security, the trade is paid for and the broker sends a false 

confinnation. In a non-SIpe covered fraud, this would be of no effect since 

there is no coverage for said transaction. However, under SIPA, the customer's 

net equity would be the market value of the security the broker should have 

purchased that the customer actually paid for and the broker-dealer lied about 

having purchased. SIPe would then obtain the security in the marketplace or 

credit the customer with the actual market value as of the appropriate filing date. 

Utilizing the last inflated account statement would give a preference to earlier 

investors while disenfranchising later investors. It should be noted that the timevalue of the funds is not considered in the non-SIPA cases generally handled by 

the states. Most Ponzi schemes do not last for decades, are relatively short in 

time and therefore the time value interest differential is generally not significant. 

It is my understanding that the SEe has taken a position with regard to the 

MadofJ case that the calculations could include a factor with regard to time value 

or time equivalent (constant dollars) 10. It would appear that each case would 

have to be reviewed for a detennination based on the amount of investments and 

the time that the fraud was ongoing. I would respectfully suggest, based on our 

compensation plans) and certain non-profits. 

9 
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history of cases and prosecutions involving Ponzi schemes, that generally the 

cash-in cash-out is the most equitable method in most cases. However, cases 

involving a situation of long-standing ongoing fraud could consider a cash-in 

cash-out and a factor of time value or time equivalent conversion, except that 

each investor's claim should be measured from a date certain, whereupon an 

inflation factor would be applied. This type of time value of money approach 

appears to require a statutory change to SIP A as this variable treatment is not 

recognized under current law. 

Judging from thc complexity and duration of certain current Ponzi schemes, 

some flexibility in the SIPA rules and SIPe administration is due to be considered 

and should be reviewed by the Task Force. 

9. Whether the requirement for SIPe to pay interest on customer named securities 

and customer property not distributed within 60-days of filing the SIP A 

Liquidation Application is an effective way to ensure that customer claims are 

properly satisfied. In discussions with the slPe staff, it appears that the issue of 

substantial delays rarely arises. We are advised that the typical liquidation 

involves a transfer to a solvent brokerage. However, provisions requiring SIPe 

to pay interest on property not distributed within 60-days may not be much of a 

motivating factor (0 encourage customer claims to be paid promptly and, further, 

could add to the complexity of the payment calculation. Questions may arise as 

to when the 60-days begin to run, or, if claimant waits until the end of the six 

month period to file a claim. Also, it appears that, in general, interest is not paid 

on bankruptcy claims. For these reasons, I believe a provision for the payment 

of interest would not effectively ensure claims are satisfied more efficiently. On 

the other hand, one issue to be considered is that under state law if an improper 

sale of securities has occurred or where a recission is ordered by the state 

securities regulator, each state may apply a statutory rate of interest. For 

example, in Alabama, a recission of a transaction order or a buy-back includes a 

6% interest factor. Other states will have varying amounts of statutory interest. 

Whether this has any practical value in a SIPe claims situation has not yet been 

discussed by the Task Force. 

10 U.S. House Committee on Financial Services, Subcommittee on Capital Markets - Testimony of Mr. 

Michael Conley, Deputy Solicitor, U,S. SEC. December 9, 2009. 

10 
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10. Whether the avoidance powers granted to a trustee in a SIPA liquidation should 

diner from US Bankruptcy Code. The US Bankruptcy Code has been a primary 

vehicle with regard to determining avoidance powers and setting precedents. I 

see no reason to create a separate system for SIP A liquidations that differ from 

the US Bankruptcy Code. Not only will a different system cause confusion, but 

considering there is a national system in place under the US Bankruptcy Code, 

uniformity with respect to avoidance powers would be preferable. At the present 

time, the Task Force has this matter under consideration and after further 

discussion I believe a recommendation will be made. 

II. Whether the mechanics for informing investors about the existence of and 

protections afforded by SIPC should be altered. The issue with regard to 

investor education and the existence and levels of protection afforded by SIPC 

was discussed earlier and I would refer the Subcommittee back to Page 4 of this 

paper. 

12. Whether the private sector could provide primary coverage ill the event that 

SIPA was moditied to eliminate and replace SIPe's coverage with a requirement 

for broker-dealers to obtain private coverage comparable to the coverage 

currently provided by SIPe and whether excess SIPC coverage by the private 

sector is appropriate. For all practical purposes, a meaningful broker blanket 

bond does not exist with respect to fraud claims. A number of brokers have 

minimal capital requirements to begin with. Problems will exist as to whether or 

not the broker who has placed itself in financial jeopardy would continue the 

blanket bond and whether the damage, already done to investors, would have any 

real recompense. Without a central entity, such as SIPC, the "coverage" is only 

as good as the insurance company behind the blanket bond, assuming that it 

remains in clTee! and generally, in the business community, fraud claims are 

either not covered or vigorously defended. I do not believe this would be a 

practical approach and in the current environment, private insurers are generally 

not interested in selling this type of coverage. If available, the cost could be 

prohibitive to most brokers thereby reducing the competitive nature of the 

industry. This is not an area that I have studied in any great detail and would 

leave to others more qualitied to comment, however replacing SIPC which a 

private sector insurer does not appear workable or desirable. 

11 
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13. Whether the capital adequacy rules for broker-dealers are sufficient to prevent 

significant customer losses. In my experience as a state regulator, the capital 

rules are generally insufficient to cover losses. This is an area for SEC and 

FINRA to utilize their experience to consider the capital rules in light of to day's 

environment and issue a report and recommendation. In a situation where fraud 

exists or other obligations such as an award in arbitration that has not been paid, 

there is generally insufficient capital to cover those customer losses. 11 

14. Whether investment advisers should be scoped into and subject to assessments 

under SIP A or a similar protection regime. In general, investment advisers do not 

hold customer assets, as the assets and the transactions involving those assets are 

held at a broker-dealer who would be a SIPC member. In light of the current 

switch of a significant portion of the investment adviser population from SEC to 

state level, the question by the Subcommittee has prompted my office to 

undertake a review of the activities of those investment advisers, between $25 

million and $100 million, to determine the differences in their operations with 

respect to the investment advisers we have historically regulated (those under 

$25 million). I expect to share the results of my staff's examination with the 

Task Force. Until such time of the determination as to whether or not this is a 

significant issue, I am reserving an opinion. 

International Relations. 

In addition to the above discussion, I have been requested by the Task Force to look at 

SIPe's involvement in international relations. For a number of years I have been honored to 

represent NASAA 12 at the International Organization of Securities Commissions (IOSCO) and 

the Council of Securities Regulators of the Americas (COSRA). From 2004 through 2009 I 

served as a U.S. Delegate as an expert on securities fraud to the United Nations Committee on 

International Trade and Law (UNCITRAL). In reviewing SIPe's activities, it is apparent that 

SIPC has taken a more active role in international affairs as broker-dealers increasingly have 

overseas affiliates or subsidiaries, and, as demonstrated by the failure of Lehman Bros., these 

overseas affiliates and subsidiaries can have world-wide implications. The questions being 

asked by the Task Force include: 

11 Please also see related discussion in Item 12 above. 

12 NASAA (International Securities Administrators Association) is a voluntary association whose 

membership consists of 67 state. provincial and territorial securities administrators in the 50 states, the 

District of Columbia, Puerto Rico, the U.S. Virgin Islands, Canada, and Mexico. 

12 
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1. "Does SIP A adequately protect customers in the event of the insolvency of a member 

which is a multi-national corporation?" 

2. "How can membership in an international association of investor protection agencies 

be used effectively?" 

3. "What lessons can be learned from the liquidation of Lehman Bros., Inc.?" 

SIPe's records show that it has entered into Memoranda of Understanding with a number of 

foreign regulators, including the Financial Services Compensation Board (United Kingdom), 

Canadian Investor Protection Fund, Securities and Futures Investor Protection Center (Taiwan), 

Korea Deposit Insurance Corporation, China Securities Investor Protection Fund Company, Ltd., 

and Egyptian Investor Protection Fund. Recently SIPC has joined IOSCO as an auxiliary 

member. The SEC is the primary member of IOSCO for the United States, followed by the 

North American Securities Administrators Association (NASAA) as an affiliate member, FINRA 

as an affiliate member, and SIPC as an auxiliary member beginning in 2009. Current discussions 

are underway concerning creation of a new organization to deal exclusively with investor 

protection in the context of cross-border financial intermediary collapse. It is therefore 

appropriate for SIPC to enter discussions with the Secretary General ofIOSCO concerning a new 

international association of investor protection entities. There appears to be preliminary interest 

from the IOSCO Secretariat in the creation of this entity under the auspices of IOSCO. Such an 

international cooperation mechanism could formulate and develop policies as: 

1. Formal rules on cross-border protection issues, 

2. Create a dispute resolution mechanism with a team of experts available, 

3. Develop a platform for exchange of information, and 

4. Establish cooperative principles. 

Work towards development of an international forum has already begun through the 

efforts of Mr. Chen Gongyan, Chairman of the China Securities Investor Protection Fund 

Corporation and a member of the Task Force. Discussions with SIPC to build an international 

cooperation mechanism were brought about primarily due to the Lehman Bros. case and 

Chairman Gongyan has indicated his willingness to co-sponsor an international forum together 

with SIPC and the Canadian Investor Protection Fund. Communications with the IOSCO 

Secretary General are underway to organize an open forum to discuss the issues and determine 

protocols for creation of such an international organization. Work in this arena is extremely 

preliminary and is subject to a number of factors, including relevant application of law to cross13 
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border investor protection, varying laws involving bankruptcy, development of an information 

sharing platform and transparency with regard to the rules of compensation and protection to 

ensure that investors within the country and abroad have a fair chance to submit an application 

for compensation and access to relevant information. 

I thank you again for the invitation and opportunity to appear before you today. 

(cwdocsJ2010 house subcommittee testimony/20l0 testimony borg.14) 

14 
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75077.030

Statement 

Of 

Sharon Y. Bowen, Acting Chair 

Securities Investor Protection Corporation 

Before the 

Capital Markets and Government Sponsored Enterprises Subcommittee 

of the 

House Committee on Financial Services 

March 7, 2012 

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 ("SIPC"). 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 address the forward looking issues raised by the Task Force and Mr. Harbeck, 

President and CEO of SIPC, will address the operational and other matters the Subcommittee 

requested we cover in our testimony. 

SIPC is a non-profit membership corporation created under the Securities Investor 

Protection Act ("SIPA")! in 1970. With some narrow exceptions, every registered securities 

' 15 V.S.c. §78aaa£!lli!. 
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75077.031

broker or dealer is a member of SIPC. Membership in SIPC is not voluntary; it is automatic upon 

registration as a broker or dealer. By statute, SIPC is not a government agency or establishment. 

Its policies are set by its seven-member Board of Directors, five of whom are appointed by the 

President and confirmed by the Senate. Three of the five Directors are selected from the 

securities industry and two are non-industry Directors. The remaining two Directors, 

respectively, are representatives ofthe United States Treasury and the Federal Reserve. 

A central goal of SIPC is to protect customers of failed securities brokerage firms that are 

members of SIPC and that are in liquidation under SIPA. A firm is placed in liquidation upon an 

application by SIPC in federal District Court. In this regard, SIPC works closely with the United 

States Securities and Exchange Commission and securities self-regulatory organizations. 

Because SIPC has no investigatory or regulatory authority, these entities must notify SlPC when 

a broker- dealer is in financial trouble and unable to meet its obligations to customers. Once a 

District Court places a firm in S[PA liquidation and appoints a trustee to administer the 

liquidation, the case is removed to Bankruptcy Court where the matter proceeds like a 

bankruptcy case but with special customer protection features. 

SIPC administers a Fund which is comprised of assessments paid by its members. The 

Fund is used to support SfPC's mission of customer protection and to finance SIPC's operations. 

Should the Fund become inadequate for its purposes, SIPC may borrow against a $2.5 billion 

line of credit from the United States Treasury. In its nearly 40-year history, SIPC has never 

drawn on the credit line. 

Every customer is protected by SIPC up to $500,000 against lost or missing cash and 

securities deposited with the broker or dealer for the customer's account. Of the $500,000, up to 

$250,000 may be used to satisfY a claim for cash only. SIPC advances also may be used to pay 

2 
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the expenses of administering the liquidation proceeding where the debtor's general estate is 

insufficient. 

To date, SIPC has overseen the administration of 324 customer protection proceedings 

which have involved the distribution, through 2010, of roughly $109.3 billion of assets for 

customers. Of that sum, approximately $108.2 billion has come from debtors' estatcs and $1.1 

billion has come from the SIPC Fund. 

The Report and Recommendations ofthe SIPe Modernization Task Force Report 

Former 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 ("SIP A"), and SIPe's operations, since the significant amendments to SIPA in 

1978. The SIPC Modernization Task Force has completed its work, and the Report and 

Recommendations of the SIPC Modernization Task Force is attached as Exhibit A. 

The Task Force was composed of professionals with differing backgrounds and 

approaches. The group contained investor advocates, state regulatory officials, an academic 

expert, a trustee experienced in the 'real world' problems of brokerage firm insolvency, the 

Chairman of SIPe's Chinese counterpart, and securities industry representatives. Their 

divergent views make for a balanced set of proposals worthy of serious consideration. 

The Task Force conducted a live forum in New York to receive the personal views of 

individual investors, and held an internet "question and answer" dialogue with investors, as well. 

A website was also established to advise the public of the issues being considered and to solicit 

input from investors on those topics. In addition, the Task Foree received presentations from 

investor education experts and representatives of the mutual fund industry, as well as a briefing 

from representatives of the Treasury and Federal Reserve Board. 

3 
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75077.033

For purposes of analysis, and to assist the Subcommittee, [ believe it would be useful to 

divide the Task Force Recommendations into four categories, and summarize the conclusions of 

the Task Force. The categories are: 

• Recommendations which will require legislation. 

• Recommendations which will require SEe rule changes. 

• Recommendations where the Task Force studied possible changes, but determined 

existing law should not be changed. 

• Recommendations SIPe can implement now. 

In particular, the Task Force reviewed issues raised by recent liquidations, and in some 

instances, the Task Force recommended changes to the outcomes under SIPA as currently 

enacted, while in other instances the group determined that the existing law should remain 

unchanged. I can tell the Subcommittee that all viewpoints were aired, discussed, and debated. 

In the end, each Recommendation represented the consensus of the group. 

Recommendations Which Will Require Legislation 

1. Increasing the maximum level of protection. 

The Task Force concluded that the SIP A should be amended to allow for inflation since 

1980. In that year, the maximum SIPe advance was set at $500,000. In inflation-adjusted 

current dollars, that level of protection would be $1,300,000, and the Task Force concluded that 

sum should be periodically adjusted for inflation. 

2. Eliminating the distinction in the levels of protection for cash and securities. 

The Task Force was presented with numerous historical examples of cash being "caught" 

at a moment just prior to a securities purchase, or subsequent to a securities sale, and thus subject 

to lower protection. Because these results are arbitrary, the Task Force suggests a change to 

eliminate the disparate treatment of claims for cash and claims for securities. 

4 
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75077.034

3. Protection for pension plan participants. 

SIP A was designed to protect small investors. Since such small investors often have so 

much of their wealth in pension plans, the Task Force recommends "pass-through" SIPe 

protection for pension plan participants not found in current law. I would note that the Task 

Force limited this suggestion to pension funds, and no other forms of collective "pooled" 

investments. 

4. Setting a minimum assessment of $1,000 on SIPe members. 

In what I believe was an unintentional consequence of a Dodd Frank amendment to 

SIPA, some SIPe members actually had their SIPe assessments reduced. This recommendation 

resolves this oversight. 

I would add that the four recommendations above have financial consequences not only 

for customers, but for SIPe members, and, possibly, for the Treasury, which can provide a credit 

line to SIPA. I will recommend a full analysis of the economic consequences of these proposals 

be considered by the SIPe Board before SIPe seeks legislative change. 

S. Expanded use of the "direct payment procedure" to assist customers 

expeditiously. 

SIPe has had considerable success since 1978 in using a streamlined procedure to pay 

victims swiftly and directly in smaller brokerage failures. This recommendation would amend 

SIP A to expand this very efficient and effective program. 

5 
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75077.035

Recommendations Which Will Require Rule Changes 

6. Auditors should file audit reports with SIPC. 

The Task Force reviewed situations where, arguably, audit reviews of SIPC members 

were severely deficient. SIPC and Trustees under SIP A have rarely sued such auditors. 

However, SIPC has been faced with a defense that SIPC had not relied directly upon the audit --

because it did not receive it and did not have access to its contents -- and thus had no standing to 

sue. 

The Task Force recommends that SIPC receive and review those audits. SIPC would 

demonstrably rely upon those audits, and this fact would be known to auditors. SIPC would thus 

have standing to recover losses incurred from negligent or tortious conduct related to an audit. 

7. Safeguarding customer assets by Rule. 

The heart of SIPC's protection to investors is to deliver assets left on deposit with 

brokerage firms. The Task Force recommends that the SEC issue an interpretive release 

clarifying SEC Rules on the segregation of customer assets. 

I am very pleased to report that the Supreme Court of the United Kingdom has, last week, 

clarified British rules in this regard in the Lehman Brothers case. I urge the SEC to consult with 

slPe in light of this recent ruling. 

Recommendations where the Task Force studied possible change but determined 

existing law should not be changed 

8. Vesting SIPA Trustees with avoiding powers. 

The so-called "avoiding powers" possessed by bankruptcy trustees also apply in SIP A 

cases. Their powers have been highlighted in the Madoff case. After debate, the Task Force 

concluded that a Trustee in a SIP A case should have the same tools available to distribute limited 

assets as equitably as possible that any other bankruptey trustee may have. 

6 
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75077.036

9 -12. Other Recommendations requiring no change. 

It bears repeating that SIP A was conceived and designed by Congress to protect small 

investors. In any bankruptcy. creditors will naturally seek the most protected status possible. In 

a SIPA case, "customer" status is such a preferred category. The Task Force reviewed a number 

of transactions and other situations involving institutional and sophisticated retail customers and 

determined that the outcome under existing law should not be changed. Thus: 

• Participants in repurchase and reverse repurchase agreements should continue to 

be treated as general creditor claims. 

• Open "to be announced" contracts should continue to result in general creditor 

claims. 

• "Soft dollar" arrangements should continue to result in general creditor claims. 

• Commission or underwriting fees should continue to result in general creditor 

claims. 

Recommendations SIPe can implement now 

13. A study concerning asset segregation. 

The Task Force recommends that SIPC and the SEC consult on resolving discrepancies 

between SEC Rule l5c3-3 and the SIPA defined term of "customer property." The object of this 

exercise is to reconcile the two regimes to avoid disputes as to what assets are to be segregated 

for investors. 

14. International Relations. 

The Task Force recommends that SIPC assist in creating an international association of 

investor protection entities. While SIPC has memorandum of understanding agreements with a 

number of similar organizations, the Lehman and MF Global cases show that international issues 

will only increase in future eases. An organization addressing those issues on a regular basis 

seems prudent. 

7 
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75077.037

15. SIPC should continue investor education efforts. 

SIPA is a complex statute. Describing both the protections and the limitations of those 

protections is important. The Task Force urged that SIPC continue to develop programs to do so. 

CONCLUSION 

On behalf ofSIPC, I would like to take this opportunity to thank the members of the Task 

Force for their thoughtful consideration of SIPe's work. I would be happy to discuss any 

particular Recommendation that is of interest to the Subcommittee. 

8 
95 


75077.038

Report and Recommendations of the 

SIPC Modernization Task Force 

Presented to the Board of Directors 

Securities Investor Protection Coroor,atio 
96 


75077.039

MEMBERS OF THE 

SIPC MODERNIZATION TASK FORCE 

<:::lli!!rm,,1} 

Orlan M. Johnson, Chainnan of the Board, SIPC 

Saul Ewing LLP 

Y~_<::Jgljr[l}~Il 

Sharon Y. Bowen, Vice Chainnan of the Board, SIPC 

Latham & Watkins LLP 

Philip M. Aidikoff 

Aidikof/: Uhl & Bakhtiari 

Joseph P. Borg 

Director, Alabama Securities Commission 

Steven B. Caruso 

Maddox Hargett & Caruso, P.e. 

Chen Gongyan 

Former Board Chairman, China Securities Investor Protection Fund Corporation Limited 

John C. Coffee, Jr. 

Adolf A. Berle Professor of Law, Columbia University School of Law 

James W. Giddens, Trustee of Lehman Brothers Inc., Trustee ofMF Global Inc. 

Hughes Hubbard & Reed LLP 

Ira D. Hammennan 

Senior Managing Director and General Counsel, 

Securities Industry and Financial Markets Association (SIFMA) 

William H. Heyman 

The Travelers Companies, Inc. 

Observer: Michael A. Macchiaroli 

Associate Director, Division of Trading and Markets 

u.s. Securities and Exchange Commission 
97 


75077.040

A Mess_~ft()_m Orlan M. Johnson, Chairman of the SIPC Modernization Task Force: 

When I began my tenure as SIPC's Chainnan in February 2010, SIPC faced challenges 

unprecedented in its 40 year bistory. The financial crisis had caused SIPC to initiate a 

liquidation proceeding in September 2008 for Lebman Brothers Inc., one of the world's largest 

brokerage finns. Barely tbree montbs later, in December 2008, SIPC was confronted with thc 

stunning exposure of tbe long running fraud at Bernard L. Madoff Investment Securities LLC, 

reportedly the largest Ponzi Scheme in bistory. These two cases placed SIPC at the epicenter of 

both the financial crisis and the public eye. 

The last significant overhaul of the Securities Investor Protection Act ("SIP A") occurred 

in 1978. In February 2010, SIPC's Board of Directors autborized the fonnation of tbe SIPC 

Modernization Task Force to review SIPA and SIPC's operations and policies comprehensively, 

and propose refonns to modernize SIPA and SIPe. 

The Task Force includes investor advocates, regulatory specialists, and academic experts. 

As a member of the Task Force, tbe Trustee for the liquidation of Lehman Brothers Inc. (and 

more recently, MF Global Inc.) offers tbe practical perspective of a trustee dealing with the 

complexities of a large scale brokerage failure. Tbe failures of Lebman, Madoff, and now, MF 

Global, have profound international consequences. The addition to tbe Task Force of Chainnan 

Cben Gongyan of the China Securities Investor Protection Corporation (who has moved on to 

become Chainnan of the Securities Association of China) brings a unique perspective to the 

international aspects of brokerage failures. 

In the Report, the Task Force has made a number of recommendations which will require 

further empirical study by SIPC's Board of Directors. The recommendation to eliminate the 

distinction between claims for cash and claims for securities is an example, as is tbe 

recommendation to protect individual participants in certain pcnsion programs. SIPC will have 

to evaluate the financial and otber consequences of those proposals before deciding whether to 

recommend possible legislation going forward. It is my pledge to the hard working members of 

the Task Force that SIPC will move promptly on those evaluations. 

In addition to bringing together the Task Force, comprised of volunteers, SIPC 

commissioned an independent Corporate Governance Review by Professor Lawrence A. 

Cunningham, the Henry St. George Tucker III Research Professor of Law, of the George 

Washington University Law School. The thorough Review will, I am sure, guide the Board in a 

number of areas. 

My heartfelt thanks go to the Vice Chainnan, and each member of the Task Force, for 

their valuable contributions, and their selfless devotion of time and energy to the production of 

the following Report and Recommendations. 

Orlan M. Johnson 

Chainnan 

SIPC Modernization Task Force 
98 


75077.041

REPORT AND RECOMMENDATIONS OF THE 

SIPC MODERNIZATlQN TASK FOR(:Ji: 

INTRODUCTION 

At its inaugural meeting in June 2010, the SIPC Modernization Task Force considered a 

broad range of issues to determine which were appropriate for review. The Task Force separated 

into two working subgroups, each of which would undertake a review of half of the issues and 

make recommendations to the full Task Force. The Task Force decided that, as a whole, it 

would consider the following three issues: any change to the minimum assessment amount, the 

preservation of the avoidance powers of a trustee appointed pursuant to the Securities Investor 

Protection Act, 15 U.S.c. section 78aaa et seq. ("SIP A"), and the increased use of the Direct 

Payment Procedure. 

Over the course of the next year, the subgroups met individually, both in person and by 

telephone conference, to discuss and debate the issues before them. The subgroups researched 

the issues, conducted briefings with experts on particular topics, and considered public 

comments. In addition, the Task Force met with outside guests, including SIPC's Government 

Directors, investor education experts from the Securities and Exchange Commission ("SEC") 

and the Financial Industry Regulatory Authority ("FINRA"), and representatives of the 

Depository Trust & Clearing Corporation and the Investment Company Institute. In total, the 

Task Force held 14 meetings either in person or by telephone; each of the subgroups met four 

times, and the full Task Force met six times. 

The Task Force was acutely interested in hearing from the public. To that end, the Task 

Force created a web site, www.SIPCModemization.org, which explained the various issues to 

the public and solicited comments. Since its launch in June 2010, www.SIPCModernization.org 

received approximately 70 comments. In addition, the Task Force solicited and received 

numerous letters and emails. The Task Force also held two live events - a web event during 

which the public made comments and asked questions of Task Force members, and a live public 

forum held at the Grand Hyatt Hotel in New York City where attendees offered comments to 

Task Force members. The Task Force reviewed and discussed the various comments made by 

the public through the web site, individual letters, and the forums. Finally, in testifYing before 

the House Financial Services Committee, Task Force members listened to concerns about the 

adequacy and effectiveness of SIPA, as expressed by various members of Congress during the 

hearing.! 

After undertaking a comprehensive review of the issues, the subgroup voted on a 

resolution for each issue. The resolutions, whether approved or rejected by either of the 

subgroups, were presented to the full Task Force for a vote. 

! Assessing the Limitations of the Securities Investor Protection Act: Hearing Before the 

Subcomm. on Capital Markets. Insurance. and Government Sponsored Enterprises of the H. 

Comm. on Financial Services, Illth Congo (2010) 
99 


75077.042

This Report sets forth the recommendations of the Task Force. The Report also includes 

a corporate governance review of SIPC, annexed hereto as Appendix A, which was undertaken 

by a corporate governance expert, Professor Lawrence A. Cunningham, Henry St. George 

Tucker III Research Professor of Law, The George Washington University Law School. 

The Task Force Report and the recommendations therein are being presented to SIPC's 

Board of Directors for consideration. It is the Task Force's hope that the recommendations will 

be reviewed by the Board, and ultimately presented to Congress for adoption as appropriate. The 

Task Force wishes to stress that its recommendations are made in consideration of the purposes 

of SIP A as understood at the time of the formation of the group, namely, to protect public, retail 

customers of a member broker-dealer, within specified limits, against the loss of their customer 

property custodied with the broker-dealer. The recently raised issue of protecting investors 

against market loss or damages resulting from fraud, misrepresentation, or wrongful aets similar 

to the Stanford situation has not been considered. The recommendations of the Task Force 

should be evaluated by SIPC's Board in the context of the historical legislative purposes and 

judicial interpretations of SIPA, and changes may be necessary if Congress passes expansive 

legislation or courts determine that SIPA should be interpreted differently. 

Respectfully submitted, 

The SIPC Modernization Task Force2 

Orlan M. Johnson, Chairman 

Sharon Y. Bowen, Vice Chairman 

Philip M. Aidikoff 

Joseph P. Borg 

Steven B. Caruso 

Chen Gongyan 

John C. Coffee, Jr. 

James W. Giddens 

Ira D. Hammerman 

William H. Heyman 

2 After making significant contributions, particularly on the subject of investor education, 

Melanie Senter Lubin, Securities Commissioner, Office of the Attorney General, Division of 

Securities, State of Maryland, and Daphne Smith, Assistant Commissioner for Securities, 

Tennessee Department of Commerce and Insurance, Securities Division, withdrew from the Task 

Force, due to other pressing obligations. 

Task Force materials were made available to representatives of the SEC and the Department of 

the Treasury who attended many of the meetings of the Task Force. On occasion, an SEC 

representative participated in the Task Force's discussions. 

2 
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75077.043

Recommendation No.1: 

[ncrease the Maximum Level of Protection to $1.3 million 

Index the Level of Protection to Inflation ................................ ... ............................... 5 

Recommendation No.2: 

Eliminate the Distinction in the Levels of Protection for Cash and Securities 8 

Recommendation No.3: 

Protect Participants in Pension Fund~ on a Pass-Through Basis ............................ 12 

Recommendation No.4: 

Amend the Minimum Assessment to the Greater of I) $1,000; or 

2) the Amount Set by SIPC Bylaw Not to Exceed 0.02% of the 

Member's Gross Revenuesfrom the Securities Business ......................................... 15 

Recommendation No.5: 

Allow for the Use of the Direct Payment Procedure in Cases in which 

the Total Amount o.fClaims Aggregates Less than $5 million ................................. 16 

Recommendation No.6: 

Require Auditors of SIPC Members to File Copies of Audit Reports with SIPC ..... 18 

Recommendation No.7: 

Affirm the Obligation of Banks and Other Custodians to Safeguard 

Rule 15c3-3 Accounts and to Reaffirm That Such Accounts Are Subject to 

Trustee Control Upon Broker-Dealer Liquidation ................................................... 21 

Recommendation No.8: 

Continue to Vest the SIPA Trustee with the Same Avoidance Powers 

as a Trustee in a Case under the Bankruptcy Code .................................................. 24 

3 
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75077.044

TABLE OF CONTENTS 

(cont'd) 

Recommendation Nos. 9-12: Summary oftbe Law.............................................. 26 

Recommendation No.9: 

Continue to Treat Claims Arisingfrom Repurchase and Reverse 

Repurchase Agreements as General Creditor Claims . .... .......... .......... ......... 29 

Recommendation No. 10: 

Continue to Treat Claims Arisingfrom Open TBA Contracts 

as General Creditor Claims ........................... ......... ...... ................................ 31 

Recommendation No. 11: 

Continue to Treat Claims Arising From Credits Received Pursuant 

to Soft Dollar Arrangements as General Creditor Claims ........................... 33 

Recommendation No. 12: 

Continue to Treat Claims for Fees Earned in Connection with 

Underwriting or Other Transactions Effected by a Syndicate 

as General Creditor Claims .............. ............ ..... ...... .................................. ... 34 

Recommendation No. 13: 

Study Discrepancies Between SEC Rule 15c3-3 and 

"Customer Property" Under SlPA............................................................................ 35 

Recommendation No. 14: 

lnternational Relations: SlPC to Assist in the Creation of an 

International Association .................... ...................... ................................................ 36 

Recommendation No. 15: 

SIPC to Continue Investor Education l:-1forts ............................................................ 39 

Comment: 

SlPA's Mandate of Customer Protection Generally Means that Committees 

Representing Unsecured Creditors of the Debtor's General Estate 

Serve Little Purpose ........... ................................ ....................................................... 4 I 

4 
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75077.045

Recommendation No.1: 

Increase the Maximum Level of Protection to $1.3 Million 

Index the Level of Protection to Inflation 

Overview 

The Task Force considered whether the current level of protection a maximum of 

$500,000, up to $250,000 of which may be in satisfaction of a cash claim is sufficient to 

protect customers and instill investor confidence in the securities markets. The $500,000 

maximum has not been increased since 1980. In 2010, the Dodd-Frank Wall Street Reform and 

Consumer Protection Act, Pub. L. No. 111-203, § 929H (2010) (the "Dodd-Frank Act"), 

increased the cash maximum from $100,000 to $250,000, and created a mechanism for indexing 

the level of cash protection to inflation. 

The Task Force has determined that the $500,000 maximum should be meaningfully 

increased. Increasing the level of protection while continuing to index the amount to inflation 

furthers the important objective of modernizing SIP A. 

Task Force Recommendation 

The Task Force recommends that the maximum limit o/protection be increased 

to $1.3 million and that the limit continue to be indexed to inflation. 

SIPA's Levels 0/ Protection 

The SIP A limit of protection for cash claims has tracked the corresponding amount 

protected by the FDIC throughout SIPC's history. The initial limits of protection in 1970 

included advances from SIPC of up to $50,000, with a maximum of $20,000 for cash. The 

$20,000 cash protection matched the level of FDIC protection at the time. Pub. L. No. 91-

151,83 Stat. 375 (1969). 

In 1978, SIP A was amended to permit an advance of up to $100,000 for each 

customer, with a maximum of $40,000 for cash. Pub. L. No. 95-283, 92 Stat. 249 (1978). 

The increase in cash protection was designed to match a 1974 increase for depositors with 

institutions protected by the FDIC or the Federal Savings and Loan Insurance Corporation. 

See H. R. Rep. No. 95-746, at 40 (1977). 

5 
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75077.046

A similar increase in SIPA's levels of protection was enacted in 1980, when 

Congress raised the amount that SIPC could advance for a customer to up to $500,000, of 

which a maximum of $ I 00,000 could be based upon a claim for cash. Pub. L. No. 96-433, 

94 Stat. 1855 (1980). FDIC protection had been increased to $100,000 as well. Pub. L. No. 

96-221,94 Stat. 147 (1980). 

On July 22, 2010, pursuant to the Dodd-Frank Act, the cash level of protection under 

SIPA was increased to $250,000. The Dodd-Frank Act also made permanent the FDIC 

protection increase to $250,000. See Dodd-Frank Act § 335. 

Policy Considerations 

The Task Force looked at various factors to determine the appropriate level of protection. 

Ultimately, the Task Force was strongly influenced by the following considerations in arriving at 

its Recommendation: 

• The level of protection should be sufficient to protect 90% or more of retail customer 

accounts. See Securities Investor Protection: Hearings on HR. 13308. HR. 17585, 

HR. 18081, HR. 18109 and HR. 18458 before the Subcomm. on Commerce and 

Finance of the H Comm. on Interstate and Foreign Commerce, 91st Congo 339-340 

(1970) (Statement of Hon. Hamer H. Budge, Chairman, Securities and Exchange 

Commission) (explaining that the level of protection was set at $50,000, which was 

sufficient to protect fully 94.5% of cash and margin accounts); 

The level of protection should be consistent with the rate of inflation, and $500,000 in 

1980 is worth $1.3 million in 2011, see Consumer Price Index Inflation Calculator, 

available at the Bureau of Labor Statistics website, http://data.bls.gov/cgibin/cpicalc.pl; 

In 1980, James F. Keegan, Chairman, Board of Governors, National Association of 

Securities Dealers, Inc., stated that SIPC should protect 100% of customer claims: 

"We believe that the coverage provided by the SIPC fund should ultimately extend to 

all customer claims and that [the increase in the level of protection to $500,000] will 

take us one step further toward the realization of that goal." See Securities Investor 

Protection Act Amendment: Hearing Before the Subcomm. on Consumer 

Protection and Finance of the H Comm. on Interstate and Foreign Commerce, 

96th Congo 27 (1980); and 

The level of protection should "be consistent with one of the fundamental principles 

guiding the establishment of SIPC, and that is that it protect the small investor, but 

not the professional." Id. at 5. 

6 
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75077.047

An increase in the level of protection also may increase the amount of claims asserted 

against the SIPe Fund. The Board of Directors may wish to study the additional amount that the 

SIPe Fund will be required to absorb as a result of such a change, and whether the target level of 

the SIPe Fund will need to be increased as well. 

The Board of Directors also may wish to consider this increase together with a 

recommendation to eliminate the distinction between claims for cash and claims for securities. 

Should the distinction be eliminated, the protection for cash claims would increase from 

$250,000 to $1.3 million. On the other hand, if the limit on claims for cash remains at $250,000, 

the disparity between protection for cash claims and securities claims will increase. 

7 
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75077.048

Recommendation No.2: 

Eliminate the Distinction in the Levels of Protection for 

Cash and Securities 

Overview 

The Task Force examined whether the current distinction in the levels of protection for 

cash versus securities claims adequately protects customers and is appropriate in light of the way 

that customer assets are kept at modem broker dealers. Currently, the level of protection per 

customer is capped at $500,000, up to $250,000 of which may be in satisfaction of a customer's 

cash claim. 

The Task Force has determined that the distinction between the protection based on 

claims for cash and claims for securities should be eliminated. This distinction leads to arbitrary 

resolution of claims as between customers, may no longer reflect the way that cash and securities 

are held at broker dealers, and has created confusion over the way that claims based on fictitious 

securities are treated. 

Task Force Recommendation 

The Task Force recommends that the distinction in the level of protection 

between claims for cash and claims for securities be eliminated. 

The Method of SatisfYing Claims for Securities 

A goal of a SIP A proceeding is to restore customers to their accounts as nearly as 

possible as the accounts existed on the "filing date," as defined in SIPA section 78111(7). See 

SIPA § 78fff-2(d). See also S. Rep. No. 95-763 at 2 (1978), reprinted in 1978 U.S.C.CAN. 765 

("By seeking to make customer accounts whole and returning them to customers in the form they 

existed on the filing date, [the 1978 amendments to SIPA] ... would restore the customer to his 

position prior to the broker-dealer's financial difficulties."). As such, customers who are owed 

securities typically receive securities in satisfaction of their claims. See, e.g., H.R. Rep. No. 95-

746, at 21, 41 (1977) ("Our expectation is that, in almost all cases, a customer's claim for 

securities would be satisfied by the delivery of securities .... "). If the fund of customer 

property does not include enough securities to satisfy customer claims, the trustee will purchase 

8 
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75077.049

securities that are available in a fair and orderly market. SIP A § 78fff-2( d)3 If replacement 

securities are not available in a fair and orderly market, however, the trustee may satisfY a claim 

for securities by providing cash equal to the market value of the security on the filing date. SIPA 

§ 78fff-2(b). 

The Cash Sweep 

At the time that SIP A was drafted, cash for the purpose of purchasing securities 

generally was held in customers' securities accounts. Since the 1970s, however, the use of 

money market funds has increased dramatically: with many customers now having their 

brokerage cash swept overnight into money market funds or bank deposit accounts. See, 

e.g., Jane J. Kim, Wall Street Cuts Yields on Investors' Cash, Wall St. J., August 31, 2005, 

available at http://online.wsj.com/article/NA_WSJ ]UB:SB 112545003610027383.html. 

Customers of broker dealers using such sweeps are more likely to have cash in their 

brokerage accounts only when it is "caught," that is, when a customer deposits cash into his 

account immediately before the firm's failure, or his securities have been liquidated and, at 

the time of the brokerage failure, the customer has not yet reinvested the cash or withdrawn 

the cash sales proceeds. Because of this random timing, the customer is left with a claim for 

cash and lesser protection than if his assets were held in securities. 

Courts are Divided on Whether a Claim for Fictitious Securities Is a Claim for Cash or a 

Claim for Securities 

Currently, two federal courts of appeals are divided over whether a claim for fictitious 

securities is a claim for cash or a claim for securities under SIPA. The Sixth Circuit, in Plumbers 

& Steamfitters Local No. 490 Severance and Ret. Fund v. Appleton (In re First Ohio Secs. Co.), 

1994 U.S. App. LEXIS 31347 (6th Cir. Nov. I, 1994) ("First Ohio"), ruled that certain claims 

involving fictitious securities should be treated as claims for cash, while the Second Circuit, in In 

re New Times Sec. Servs. Inc., 371 F.3d 68 (2d Cir. 2004) ("New Times"), ruled that certain 

claims for fictitious securities should be treated as claims for securities. This distinction is 

3 The trustee's authority to satisry claims in either cash or securities is preserved in certain 

circumstances. See H.R. Rep. No. 95-746, at 41-42 (1977) ("One chief concern is that the trustee 

not be required to make purchases in a market which is being improperly controlled or 

manipulated."). Likewise, if a claim for securities is not timely filed, the trustee may satisfY the 

claim in cash or securities, or both, as the trustee decides is most economical. SIP A § 78fff2(a)(3). 

4 By 1978, total net assets held in money market funds had grown to over $5 billion. See Marcia 

Stigum, The Money Market: Myth, Reality and Practice, 534 (1978). However, in 1978, money 

market funds "still play[ed] a relatively small role." Id. According to the Investment Company 

Institute, for the week ended February 1,2012, the total net assets for money market funds was 

$2.69 trillion. See Weekly Money Market Mutual Assets, available at http://wwwoici.org/ 

research#statistics. 

9 
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75077.050

important because claims for securities have a higher limit for the SIPC advance than cash only 

claims: the overall SIPC advance is limited to $500,000, but the cash portion is limited to 

$250,000, subject to an inflation adjustment. SIPA § 78fff-3(a), (d). 

The New Times interpretation is inconsistent with how claims for securities are to be 

satisfied under SIPA. Under SIPA, customers who are owed securities receive either the 

securities or their filing date market value. Thus, it is impossible to deliver securities or a filing 

date market value of securities when the "securities" are fictitious. Nevertheless, the New Times 

position holds that the customer who is owed fictitious securities has a claim for securities, the 

claim is protected up to $500,000, and the value of the "securities" is not the market value of 

zero, but the amount of cash deposited by the customer with the broker to pay for the 

"securities." The New Times position therefore requires a trustee to satisfy a claim for fictitious 

securities differently than claims for legitimate securities. 

Problems with the Cash/Securities Distinction 

The cash/securities distinction has been problematic throughout SIPe's history. 

Examples include the following: 

I. A customer sold her entire securities portfolio and ordered the proceeds to be sent to 

her. That portfolio exceeded the then current maximum of $20,000 SIPC could 

advance for a cash claim. She received a check, but it was not honored because the 

brokerage firm failed before she could cash the check. A sympathetic bankruptcy 

judge held that the customer was "an involuntary cash depositor," in an attempt to 

avoid the clear limit of protection5 On appeal, the United States District Court 

reversed, noting that the court below had disregarded the explicit language of the 

statute. 6 

2. A pension plan ordered its portfolio liquidated, and the brokerage firm complied. The 

pension plan sought to avoid the consequences of the sale so that it could have a 

claim for securities, but the court ruled, correctly, that the pension plan had a claim 

for cash7 

5 In re Weis (Estate of Irene H Tuchler, Claimant), No. 73 Civ. 2332, slip op. at 14 (S.D.N.Y. 

Nov. 7, 1975) (Babitt, B.l.) 

6 In re Weis (Estate of Irene H Tuchler, Claimant), No. 73 Civ. 2332, slip op. at 1 (S.D.N.Y. 

Dec. 28,1977) (Knapp, D.l.) 

In re Morgan, Kennedy & Co., Inc., 3 Bankr. Ct. Dec. (eRR) 15 (Bankr. S.D.N.Y. 1977) 

to 
108 


75077.051

3. Customers who had sold their securities tried to avoid the consequences of that sale 

by arguing that the brokerage firm had never delivered the securities to the buyers. 

This argument was unsuccessful8 

The pattern in the foregoing cases is inescapable. When confronted with a "claim for 

cash" that exceeds SIPA's capacity to satisfy, claimants attempt to shoehorn their particular fact 

pattern into a "claim for securities." The law as plainly written requires opposition to such 

attempts. 

Policy Considerations 

Eliminating the distinction between claims for cash and claims for securities resolves 

potential disparate treatment of customers, as well as the split between the courts of appeals over 

whether fictitious securities give rise to claims for cash or claims for securities. In addition, it 

increases the amount of protection available to customers of broker-dealers. As a result of this 

increase in protection, however, the amount of claims against the SIPC Fund also may increase 

commensurately. The Board of Directors may wish to examine the additional amount that the 

SIPC Fund would be required to absorb as a result of such a change. 

It is also worth noting that if the distinction between claims for cash and claims for 

securities is eliminated, SIPC will offer greater protection against the loss of cash than the FDIC. 

This would depart from the practice of the cash limit under SIPA tracking that of the FDIC. 

Accordingly, the Board of Directors may wish to study whether an increase in the amount of 

cash protection will result in customers holding more cash at broker dealers, taking into 

consideration, among other things, the different purposes for which cash is left on deposit with 

each institution and the modem-day practice that favors sweeps of funds out of the brokerage. 

8 Murray v. McGraw (In re Bell & Beckwith), 821 F.2d 333 (6th CiT. 1987). 

11 
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75077.052

Recommendation No.3: 

Protect Participants in Pension Funds on a Pass-Through Basis 

Overview 

Currently, under SIPA, persons without accounts at the brokerage, but invested with a 

plan or a fund with an account at the brokerage, are not eligible for separate SIPC advances. In 

that situation, the fund or the benefit plan is the "customer," and it alone is eligible for SIPC 

advances. 

The Task Force examined whether pass-through protection should be provided for 

individual claimants without an account. Among other things, the Task Force considered the 

possible expansion of protection in conjunction with a review of the trust and fiduciary 

provisions under the Employee Retirement Income Security Act of 1974,29 U.S.C. § 1001 et 

seq. ("ERISA"). 

Task Force Recommendation 

The Task Force recommends that SIPA be amended to provide pass-through 

protection for individual participants in the following ERISA-qualified plans: 

defined benefit pension plans, defined contribution plans, and deferred profit 

sharing plans. Each individual participant should be subject to the SIPC 

protection limits. The combined net equities of all plan participants should not 

be greater than the net equity of the plan's assets held by the SIPC member. 

Overview of SIP A 's Treatment of Claimants Without an AC'count 

In a brokerage firm liquidation under SIPA, SIPC funds may be used to replace missing 

assets for each brokerage "customer," as that term is defined in section 78111(2) of SIPA. 

Currently, persons without accounts at the brokerage, but invested with a plan or a fund with an 

account at the brokerage, arc not eligible for separate SIPC advances. In that situation, the fund 

or the benefit plan is the "customer," and it alone is eligible for SIPC advances. 

Most claimants who do not have an account at a brokerage firm in their name (or as 

beneficiaries of a nominee or agent) are not treated as separate "customers" under SIPA. See, 

SIPC v. BLMIS, 454 B.R. 285 (Bankr. S.D.N.Y. 2011). aff'd, In re Aozora Bank Ltd., (SIPC v. 

BLMIS), 2012 WL 28468 (S.D.N.Y. Jan. 4., 2012); Plumbers & Steamfitters Local No. 490 

Severance and Retirement Fund v. Appleton (In re First Ohio Sec. Co.), 1994 U.S. App. LEXIS 

12 
110 


75077.053

31347 (6th Cir. Nov. I, 1994); SlPC v. Morgan Kennedy & Co., 533 F.2d 1314 (2d Cir.), cert. 

den. sub nom., Trustees of the Reading Body Works, fnc. v. SIPC, 426 U.S. 936 (1976). SIPA 

creates an exception to this general rule for customers and broker dealers of banks where the 

broker dealer or bank is the account holder. In that situation, customer status "passes through" to 

a customer of a broker, dealer or bank that, acting on behalf of such customer, has a net equity 

claim against the debtor. When a broker, dealer or bank has a net equity claim against a debtor 

arising out of a transaction on behalf of its customers, each such underlying customer is 

considered to be an individual "customer" of the debtor. SIPA § 78fff-3(a)(5). 

Categories of Investors Without an Account at the SIPC Member Broker Dealer 

The following are currently not eligible for pass-through protection, and the Task Force is 

recommending no change to their treatment: 

I. Individual shareholders, where a corporation is the account holder; 

2. Individual limited or general partners, where a partnership is the account holder; 

3. Individual members of an unincorporated association, where the association is the 

account holder; and 

4. Investors who own shares of a hedge fund, fund of funds, or mutual fund, where the 

fund is the account holder. 

The Task Force determined that the treatment of claimants in these categories should not change. 

The investors in these categories have no relationship with the broker and may have recourse 

against their corporation, partnership, or association to the extent that their investment was not 

proper. In addition, much of the information concerning the underlying investors and the size of 

their investments is proprietary, and generally is unavailable to the broker. Without access to the 

books and records of the underlying funds, it is impossible to ascertain the amount of additional 

exposure to the SIPC Fund if protection is extended to this group. Accordingly, the Task Force 

recommends that these investors be educated that their investments are not protected. 

The following are currently not cligible for pass-through protection, but the Task Force is 

recommending that treatment of these individuals be changed: 

I. Individual participants of a defined benefit pension plan, where the plan is the 

account holder; 

2. Individual participants in a defined contribution plan, where the plan is the account 

holder (whether or not the broker send~ statements to each of the participant:,~;9 and 

9 If the defined contribution plan is the account holder and sole customer, and the broker does 

not send account statements to each of the participants, the individual participants normally 

would not separately be eligible for SIPC advances. On the other hand, if the broker sends 

account statements to each participant, and each participant exercises authority to make trades in 

his or her account, each participant currently is treated as a separate customer. 

13 
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75077.054

3. Individual participants in a deferred profit sharing plan. where the plan is the 

account holder. 

Privately sponsored pension plans hold the assets of over 40 million active participants, 10 

million of which are retirees. See, e.g., Lee T. Polk, ERISA Practice and Litigation 1:5 (2010). 

Over the past 50 years, there has been a shift in the way that savings are held and an increased 

use of retirement accounts by typical retail investors. See Finances of Employee Benefits, 

1960-2003, Employee Benefits Research Institute, available at http://www.ebri.org/ 

pdf/publications/facts/0205fact.b.pdf (explaining that payments to individuals from private 

employer pension and profit sharing plans increased from $1.7 billion in 1960 to $320.4 billion 

in 2003). The Task Force believes that this recommendation would be an important 

modernization to SIPA, particularly because these investments typically represent the retirement 

accounts and life savings of many indirect investors who do not have a choice in where their 

plans' assets are held. 

Carve-Out for Avoidance Actions 

In making this Recommendation, the Task Force does not intend to suggest that a SIPA 

trustee should not be allowed to pursue avoidance actions against any claimant in any of the 

categories listed above. In the case of defined benefit plans, beneficiaries may have benefited 

from the receipt of avoidable transfers, and a defined benefit plan should not be allowed to 

recover the amount of its pro rata share of customer property and retain the avoidable transfer. 

As such, it should be made clear that the full amount of any avoidable transfer should be 

deducted from the amount of a fund's distribution to thc extent that the avoidable transfer was 

not recovered by the trustee. 

Policy Considerations 

Because of the way that pension fund assets are currently held, the Task Force expects 

that most pension funds, particularly large pension funds, will continue to keep their cash and 

securities in banks even if they execute trades through their brokerage accounts. However, as the 

scope of protection is increased, the amount of claims asserted against the SIPe Fund may also 

increase. As part of any change to the scope of protection, the Board of Directors may wish to 

consider whether a commensurate increase to the target level of the SIPe Fund is necessary. 

It also will be important to consider how the specific mechanisms of protection would 

work, such as which parties will be required to file claims and the level of proof that is neccssary 

to determine whether a claimant is actually a participant in the fund and the extcnt of its 

participation. The Task Force is not making a recommendation as to these procedural issues. 

14 
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75077.055

Recommendation No.4: 

Amend the Minimum Assessment to the Greater of 1) $1,000; or 

2) the Amount Set by SIPC Bylaw Not to Exceed 0.02% of the 

Member's Gross Revenuesfrom the Securities Business 

Overview 

Under SIPA section 78ddd(d)(I)(C), SIPC may impose upon each of its members a 

minimum assessment in an amount to be set from time to time by SIPC Bylaw within limits set 

by Congress. Under the Dodd-Frank Act, § 929V, Congress amended the minimum assessment 

amount to be no greater than 0.02 percent of gross revenues from the securities business of each 

member. Prior to the enactment of the Dodd-Frank Act, the minimum assessment was no greater 

than $150 per annum. See SIPA § 78ddd(d)(I)(C) (2009). 

Currently, members are assessed on 0.25% of their net operating revenues from the 

securities business. In 2009, for approximately 25% of the membership, 0.25% of net operating 

revenues was between $0 and $150. Prior to the enactment of the Dodd-Frank Act, these 

members would have paid a flat $150 asscssment fec. After the amendment, these members pay 

less than $150 and in some cases, $0. Thus, under the Dodd-Frank Act, in some instances, the 

assessments actually have decreased or been eliminated. 

Because all SIPC member broker-dealers benefit from the SIPC program, the Task Force 

has determined that all members should pay an assessment fee. 

Task Force Recommendation 

The Task Force recommends that all S/PC members pay an assessment fee 

which is the amount set by S/PC Bylaw and the minimum amount of which 

shall not be more than 0.02% of the member's gross revenues from the 

securities business, but if the aforementioned amount is less than $1,000, the 

member shall pay a minimum assessment fee of $1,000. 

15 
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75077.056

Recommendation No.5: 

Allow for the Use of the Direct Payment Procedure in Cases in Which the 

Total Amount of Claims Aggregates Less than $5 million 

Overview: 

The Task Force considered whether the use of the Direct Payment Procedure should be 

updated and/or expanded. Currently, a Direct Payment Procedure is available only if SIPC 

determines that: 

the SIPC member cannot meet its obligations to customers; 

one or more of the conditions specified in SIP A section 78eee(b)(1) are present; 

the claim of each customer is within the limits of protection under SIPA; 

the cost of satisfying customers in the Procedure will be less than the cost under a 

liquidation proceeding; 

the member's broker-dealer registration has terminated or the member has 

consented to usc of the Procedure; and 

the claims of all customers of the member total less than $250,000. 

The $250,000 claim limit has not been adjusted since 1978. 

Task Force Recommendation 

The Task Force recommends that the Direct Payment Procedure be available in 

cases in which the aforementioned conditions are present except that the total 

amount of claims should aggregate less than $5 million instead of$250,000. 

Direct Payment Procedure 

The Direet Payment Procedure includes notice and claims procedures similar to those in a 

judicial liquidation proceeding, but limits bankruptcy court involvement to the review of the 

determination of any "customer" claim as to which proper objection has been filed in court 

within six months of the date SIPC mails the determination. Significantly, it is the claimant who 

initiates court involvement by the filing of an objection. All allowed claims are satisfied from 

SIPC advances; there is no collection of customer property. 

16 
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75077.057

The Direct Payment Procedure is designed to enable SIPe quickly, and inexpensively, to 

make customers whole, without the use of the more time-consuming and expensive procedures 

ofajudicial liquidation proceeding. [n SIPC's experience, Direct Payment Procedures have cost 

less, have provided an efficient mechanism for returning missing cash and securities to 

customers, and are advisable where the brokerage is judgment proof and there is little or no 

customer property to be had. 

The Task Force has determined that the Procedure affords customer protection in a 

manner that is cost-effective and time-efficient. The Task Force recognizes, however, that 

because the Procedure is conducted out of court, it is only suitable in certain instances. 

17 
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75077.058

Recommendation No.6: 

Require Auditors o/SIPC Members to File Copies 0/ 

Audit Reports With SIPC 

Overview 

For more than sixty years, in order to safeguard customers' assets, the SEC, by means of 

its Rule 17a-5, 17 C.F.R. § 240.17a-5, has required an independent public accountant to provide 

certain assurances regarding financial information reported by the broker-dealer. See Exchange 

Act Release No. 3338, 7 Fed. Reg. 9917 (Dec. I, 1942). Toward that end, the accountant must 

perform an "examination of accountabilities and responsibilities of a firm resulting in a report to 

regulatory bodies concerning that firm's fiduciary obligations to customers." See SEC, Study of 

Unsafe and Unsound Practices of Broker-Dealers ("SEC Study"), H.R. Doc. No. 92-231, at 152 

(1971). The information is filed with the SEC and the securities self-regulatory organizations. 

The information provides these authorities "with a sufficiently early warning to enable them to 

take appropriate action to protect investors before the financial collapse of the particular brokerdealer involved." Touche Ross & Co. v. Redington, 442 U.S. 560, 570 (1979) (footnote omitted). 

The purpose of the accountant's audit report is the same as that of SIPA: to provide 

greater protection to customers. The accountant's audit report includes detailed information 

regarding the SEC's net capital requirements (Rule ISc3-1) and customer reserve requirements 

(Rule 15c3-3). Non-compliance with these Rules requires the SEC to inform SIPC for the 

benefit of customers. See SIPA § 78eee(a)(l). However, SIPC does not receive a copy of 

accountants' audit reports. As a result, SIPC cannot rely directly on these audit reports and thus 

has been held by courts not to have standing to sue an auditor for any negligent or tortious 

conduct related to the audit. 

Task Force Recommendation 

The Task Force recommends that SIPC members be required to file audit 

reports with SIPC concurrently with their filing with the SEC. The purpose of 

such a requirement would be to allow SIPC to rely on the audit report and 

provide SIPC with standing to sue an auditor for any negligent or tortious 

conduct related to an audit. 

18 
116 


75077.059

Related Litigation in SIPA Liquidation Proceedings 

SIPC and/or SIP A trustees have taken action against accounting firms based on the firms' 

audit responsibilities in six liquidation proceedings. Settlements were reached regarding the 

actions in three of those proceedings. lO In the other three liquidation proceedings, the courts held 

that the accountant could not be held liable to SIPC. See SIPC v. BDO Seidman (In re A.R. 

Baron & Co.), 245 F.3d 174 (2d CiT. 2001); SIPC v. Munninghoff Lange & Co. (In re Donahue 

Securities, Inc.), 2004 WL 3152763 (Bankr. S.D. Ohio Nov. 23, 2004); SIPC v. Cheshier & 

Fuller (In re Sunpoint Sec., Inc.), 377 B.R. 513 (Bankr. E.D. Tex. 2007), aff'd sub nom., 

Richardson v. Cheshier & Fuller LLP, 2008 WL 5122122 (E.D. Tex. Dec. 3, 2008). In Sunpoint 

Securities, the court explained that "[b]ecause SIPC was never aware of the contents of the audit 

reports, it cannot demonstrate that it justifiably relied on any statement made by the auditors in 

those reports, and it cannot recover against C&F upon a theory of negligent misrepresentation." 

377 B.R. at 561. 

Proposal to Change Applicable SEC Rule 

Presently, SEC Rule 17a-5(d)(6), 17 C.F.R. § 240.17a-5(d)(6), provides that the audit 

report is to be filed with the SEC in Washington, D.C., the SEC's office in the broker-dealer's 

region, and the principal office of the broker-dealer's designated examining authority. While the 

report is thus available for regulators' use in monitoring the broker-dealer's financial health, the 

report is not provided to SIPC even though it ultimately may trigger the start of a liquidation 

proceeding. See Rule 17a-5(e)(3). 

Against this background, SIPC has proposed recommending that SEC Rule 17a-5(d)(6) 

be changed to require that the audit reports also be filed with SIPc. 11 Including SIPC as a 

10 The three liquidation proceedings were (I) R.D. Kushnir & Co.; (2) Rocky Mountain 

Securities and Investments, Inc.; and (3) NEBS Financial Services, Inc. 

II The proposed rule change would revise SEC Rule 17a-5(d)(6) 10 add SIPC as a designated 

entity to receive a copy of the annual audit report tiled with the SEC. The rule is set forth below, 

and the proposed revision is italicized. 

The annual audit report shall be filed at the regional office of the 

Commission for the region in which the broker or dealer has its principal 

place of business, the Commission's principal office in Washington, D.C., 

and the principal office of the designated examining authority for said 

broker or dealer. Copies thereof shall be provided to all self-regulatory 

organizations of which said broker or dealer is a member, and to the 

Securities Investor Protection Corporation ("SIPC"). 

The addition of SIPe to Rule 17a-5(d)(6) would require a technical amendment to SEC Rule 

17a-5(e)(4), striking the reference to the "Securities Investor Protection Corporation," and 

substituting "SIPC" in its place. 

19 
117 


75077.060

designated recipient would further the goal of investor protection by providing another layer of 

review of the report by an organization directly affected by its contents. In addition, including 

SIPC as a recipient would help to address the persistent concern that any signs of "financial 

weakness, as by non-compliance with net capital requirements or otherwise, [be] watched very 

carefully and followed up" in order to augment the financial responsibility requirements SIP A 

was intended to enhance, and to provide greater investor protection. See SEC Study, supra at 25. 

20 
118 


75077.061

Recommendation No.7: 

Affirm the Obligation of Banks and Other Custodians to Safeguard Rule 

JSc3-3 Accounts and to Reaffirm That Such Accounts Are Subject to 

Trustee Control Upon Broker-Dealer Liquidation 

Overview 

SEC Rule 15c3-3, 17 C.F.R. § 240.15c3-3, also referred to as the Customer Protection 

Rule, like SIPA, is designed to ensure, among other things, that customers who entrust cash or 

securities to a broker-dealer for the purpose of effecting securities transactions are able to 

recover that property, even if the broker-dealer fails financially. 

Under Rule 15c3-3, banks and other custodians acknowledge or agree in writing (for 

example, by way of a "no lien letter"), with respect to accounts opened by broker-dealers in 

order to comply with Rule 15c3-3 ("Rule 15c3-3 Accounts"), that the accounts are not subject to 

any "right, charge, security interest, lien, or claim of any kind in favor of the bank or any person 

claiming through the bank." The Task Force has determined that it should be made clear that 

banks and other custodians are not permitted to hypothecate or subject to a lien any assets carried 

in Rule 15c3-3 Accounts. It also should be made clear that, in the liquidation of a broker-dealer 

under SIP A, banks or other custodians carrying the broker-dealer's Rule 15c3-3 Accounts are 

required to tum over to the liquidation trustee all property in a Rule 15c3-3 Account, and that a 

failure to tum over such property may subject the bank or other custodian to sanctions for 

violating Sections 362 and 562 of the Bankruptcy Code, 11 U.S.c. § 101 et seq. ,12 as well as any 

applicable court order, and may expose them to sanctions (potentially including punitive 

damages for a willful refusal) for violating such sections (and, where applicable, any order). 

Task Force Recommendation 

The Task Force recommends that SIPC request that the SEC issue an 

interpretive release with respect to Rule J5c3-3 that makes clear that 

after providing an acknowledgment or agreement (including without 

limitation a "no lien letter") that an account used for compliance 

with Rule 15c3-3 is not subject to any right, charge, security interest, 

lien, or claim of any kind in favor of such bank or custodian or any 

12 Under SIPA section 78fff(b), specified sections of the Bankruptcy Code apply in a SIPA 

liquidation to the extent not inconsistent with SIP A. 

21 
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75077.062

person claiming through the bank or custodian (a "Claim"), a bank 

or other custodian may not subsequently create a Claim against 

such account, and 

a request by a trustee for the liquidation of a broker-dealer for 

control of such an account or any property on deposit therein shall 

put the bank or custodian on notice that its failure to comply with 

such a request may subject the bank or custodian to possible 

sanctions and/or penalties for violating Sections 362 and 542 of the 

Bankruptcy Code, or aiding and abetting a violation of, Rule 15c3-3. 

Background 

SEC Rule JSc3-3 provides, in relevant part: 

(c) Control of securities. Securities under the control of a broker or dealer shall be 

deemed to be securities which: ... 

(5) Are in the custody or control of a bank as defined in section 3(a)(6) of 

the Act, the delivery of which securities to the broker or dealer does not 

require the payment of money or value and the bank having acknowledged 

in writing that the securities in its custody or control are not subject to any 

right, charge, security interest, lien or claim of any kind in favor of a bank 

or any person claiming through the bank; or ... 

(t) Notification of banh. A broker or dealer required to maintain the reserve bank 

account prescribed by this section or who maintains a special account referred to 

in paragraph (k) of this section shall obtain and preserve in accordance with 

§ 240. I 7a-4 written notification from each bank in which he has his reserve bank 

account or special account that the bank was informed that all cash and/or 

qualified securities deposited therein are being held by the bank for the exclusive 

benefit of customers of the broker or dealer in accordance with the regulations of 

the Commission, and are being kept separate from any other accounts maintained 

by the broker or dealer with the bank, and the broker or dealer shall have a written 

contract with the bank which provides that the cash and/or qualified securities 

shall at no time be used directly or indirectly as security for a loan to the broker or 

dealer by the bank and, shall be subject to no right, charge, security interest, lien, 

or claim of any kind in favor of the bank or any person claiming through the bank. 

Notwithstanding the notification to banks and other related provisions of SEC Rules, 

bank custodians at times have refused to release to the SIPA trustce property in Rule 15c3-3 

22 
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75077.063

Accounts. In some cases, the refusal was purportedly based upon assertions of a subsequently 

granted right, charge, security interest, lien, or claim of any kind in favor of a bank or any person 

claiming through the bank (a "Claim") against the Rule 15c3-3 Account. It would facilitatc and 

expedite the recovery of customer property by the trustee for the benefit of customers if it is 

made clear that banks and other custodians may not create Claims over Rule 15c3-3 Accounts, 

that property in a Rule 15c3-3 Account is subject to the SIPA trustee's control and disposition 

upon the commencement of a SIP A liquidation proceeding, and that the trustee shall be 

authorized to recover from the custodian any property improperly released, seized or 

hypothecated by the bank in violation of its agreement. This clarification would further the 

enforcement of Rule 1503-3 and reaffirm existing applicable case law. See, e.g., Dowden v. 

Cross County Bank (In re Brittenum), 97 B.R. 503 (E.D. Ark. 1987) (holding that a Rule 15c3-3 

deposit is not subject to bank's setoff claim). 

In that regard, the Task Force believes that this proposed clarification with respect to the 

treatment of customer property by a custodian is best accomplished through the issuance of an 

interpretive release by the SEC respecting Rule 15c3-3. The following language is suggested to 

be made part of an SEC release: 

Upon the commencement of a liquidation under the Securities Investor Protection 

Act, 15 U.S.c. § 78aaa et seq. ("SIP A"), of any broker or dealer, funds or 

securities deposited by or on behalf of such broker or dealer in any bank account 

at any point acknowledged or agreed by the bank not to be subject to any "right, 

charge, security interest, lien, or claim of any kind in favor of the bank or any 

person claiming through the bank" including without limitation by way of a "no 

lien letter" (a "Rule 15c3-3 Account") shall be subject solely to the control and 

direction of, and disposition by, the trustee appointed for the liquidation of such 

broker-dealer (the "Trustee"). A broker-dealer violates Rule 1503-3 if it creates 

any right, charge, security interest, lien, or claim of any kind in or over a Rule 

15c3-3 Account (or the asscts from time to time on deposit therein) in favor of the 

bank or any person claiming through the bank (a "Claim") against a Rule 15c3-3 

Account; therefore any bank accepting or acting on the basis of such a 

subsequently granted Claim shall be deemed to be aiding and abetting a violation 

of Rule 15c3-3. A request to a bank by the Trustee for control of funds or 

securities in a Rule 15c3-3 Account carried by such bank shall put the bank on 

notice that its failure to comply with such request will violate Sections 362 and 

542 of the Bankruptcy Code and/or aid and abet a violation of Rule 15c3-3, and 

may subject the bank to sanctions (including punitive damages). 

23 
121 


75077.064

Recommendation No.8: 

Continue to Vest the SIPA Trustee with the Same Avoidance 

Powers as a Trustee in a Case under the Bankruptcy Code 

Overview 

The Task Force considered whether the avoidance powers available to a trustee under 

SIPA should be modified. Currently, the avoidance powers vested in a SIPA trustee are the 

avoidance powers available to a trustee in a case under the Bankruptcy Code. 

The Task Force has determined that avoidance powers are an important tool for returning 

customers as nearly as possible to their accounts as they existed prior to the commencement of 

the liquidation proceeding. Allowing a trustee to avoid certain transfers ensures that creditors 

are treated equally and that certain creditors are not favored over others. Avoidance actions are 

particularly important when, for example, the debtor broker-dealer has transferred customer 

assets to a third party (including a customer) within a specified time period preceding the date of 

liquidation and other than in the ordinary course of business. If these transfers are not recovered 

by the trustee, the third party or customer who received the funds pre-filing is able to receive 

100% of the money transferred, to the detriment of other customers for whom fewer assets 

remain in the broker's possession for distribution. The avoidance powers, however, allow 

trustees to recover under specified conditions amounts transferred and to redistribute those assets 

to all customers, so that all customers share equally. 

The Task Force recognizes that in light of SIPA's close interrelationship with the 

Bankruptcy Code, any change to the avoidance powers should first be made under the 

Bankruptcy Code. Because under SIPA, the avoidance provisions of the Bankruptcy Code 

automatically apply to a SIPA case, unless inconsistent with SIPA, such changes would apply 

without the need for an amendment to SIPA. 

Task Force Recommendation 

The Task Force recommends that SIPA trustees continue to be vested with the 

same avoidance powers as trustees in cases under the Bankruptcy Code. To the 

extent that any adjustments to the avoidance powers are warranted, the 

adjustments should be made to the avoidance provisions of the Bankruptcy 

Code, and thereby incorporated by reference into SIPA. The Task Force does 

not recommend that the avoidance powers of a SIPA trustee be limited, as they 

would be under the proposed Ponzi Scheme Investor Protection Act. 

24 
122 


75077.065

The Proposed Ponzi Scheme Investor Protection Act 

Pending legislation in the draft Ponzi Scheme Investor Protection Act of 20 II \J ("Draft 

Bill"), which, on May 25, 2011, was referred to the House Committee on Financial Services, 

seeks to limit a trustee's avoidance powers in SIPA liquidations involving Ponzi schemes. The 

Draft Bill was introduced after the Ponzi Scheme Investor Protection Act of 2010 14 died in 

Committee. 

Section 8A(f) of the Draft Bill states that the "trustee of a Ponzi scheme may not seek to 

recover money, including profits, from any investor in the Ponzi scheme unless such investor (1) 

was complicit in the Ponzi scheme; or (2) was registered, or should have been registered, with 

the Commission under the securities laws as an investment adviser, broker, dealer, or other 

person with a fiduciary duty to the customers or investors of the person." As explained above, 

divesting a trustee of his power to avoid transfers inevitably results in inequitable distributions to 

customers by favoring some customers over others. This is particularly troublesome in the case 

of a Ponzi scheme where no actual investments are made and funds that have been paid to certain 

customers consist of other customers' money. Customers who received no transfer of funds 

from the broker-dealer before its failure would be subject to a potentially more limited 

distribution in the SIP A liquidation proceeding. 

13 H.R. 1987,1 12th Congo (2011). 

14 H.R. 5032, 111 th Congo (2010). 

25 
123 


75077.066

Recommendation No.9: 

Continue to Treat Claims Arising from Repurchase and Reverse 

Repurchase Agreements as General Creditor Claims 

Recommendation No. 10: 

Continue to Treat Claims Arising from Open TBA Contracts as General 

Creditor Claims 

Recommendation No. 11: 

Continue to Treat Claims Arising From Credits Received Pursuant to Soft 

Dollar Arrangements as General Creditor Claims 

Recommendation No. 12: 

Continue to Treat Claims for Fees Earned in Connection with 

Underwriting or Other Transactions Effected by a Syndicate as General 

Creditor Claims 

Recommendations 9 through 12 were considered together, as they each rely on common legal 

principles and policy considerations. Specifically, each Recommendation addresses a 

potential claim by either institutional customers or sophisticated retail customers, which are 

customers not intended to have their claims satisfied out of funds advanced by SIPC by the 

original drafters of SIPA. In addition, each of these Recommendations depends upon the 

definition of key terms under SIPA such as "customer," "customer property" and "security." 

The below summary of the law therefore applies to each of the Recommendations. 15 

"Customer" and "Customer Property" Under SIPA 

"Customer" status under SIPA is limited. Customer status is only available to those 

persons who, on the "filing date," have a claim to securities or cash held in custody by the broker 

for the customer as an investor in securities. [n determining the nature of a claimant's status in 

relation to the debtor, the court must look at the claimant's account, as it existed on the books 

and records of the debtor on the "filing date." In order to be a "customer" under SIP A, a 

claimant in a SIPA liquidation proceeding must have a claim to securities or cash custodied in a 

15 Mr. Hammerman indicated that his approval of Recommendations 9 through 12 reflected 

SIFMA's view that the recommendations were meaningful recommendations for the 

improvement of SIP A, but were prospective only and should not be used to inform the current 

state of the law. 

26 
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75077.067

securities account in his, her or its name and must have established a relationship with the debtor 

as a securities investor. Thus, under the definition of "customer" in SIPA, customer status is 

imparted on persons pursuant to their "transactional relationship:" broker-investor transactions 

are distinguished from the ordinary debtor-creditor relationships. 16 

Courts have held that the actual entrustment of securities or cash into the possession of a 

debtor is a "bright line" test that separates customer claims from all other claims. As the Fifth 

Circuit stated in In re Stalvey & Assocs., lnc., "in 'the absence of actual receipt, acquisition or 

possession of the property of a claimant by the brokerage finn under liquidation, '" a claimant is 

not entitled to customer protection under SIPA. 17 For purposes of customer status under SIP A, 

entrustment means both the transfer of possession of property to the broker, and that this transfer 

be "in the ordinary course of its business as a broker or dealer." SIPA § 78111(2). This 

contemplates a "public" customer who tenders securities "for the purpose of having them traded" 

by the broker]8 Thus, at a minimum, to qualifY for "customer" status under SIPA, claimants 

must demonstrate that cash or securities were entrusted to the debtor for the purpose of effecting 

protected securities transactions. Such entrustment of property for the purpose of trading creates 

the broker-customer fiduciary relationship that is the essence of customer status under STP A. 

Contracts, Loans, and Executory Contracts are Not Protected by SIPA 

As the court explained in In re Weis Securities, SIPA only protects customers "with 'an 

unrestricted right to receive on demand these [sic] securities which belong to them.",19 For 

example, in In re Adler Coleman Clearing Corp., the court rejected broker-dealers' attempts to 

attain "customer" status for commissions held at the firm, concluding that the account did not 

contain "customer property" as defined in SIPA § 78111(4).20 Accordingly, claims for fraud and 

breach of contract are not protected by SIPA21 Likewise, lenders22 and parties to executory 

contracts2

] are not protected by SIPA. 

16 See, e.g., Stafford v. Giddens (In re New Times Securities Services, Inc.), 463 F.3d 125, 128 

(2d Cir. 2006), citing SEC v. F.O. Baroif, 497 F.2d 280,284 (2d Cir. 1974). 

17 750 F.2d 464, 469 (5th Cif. 1985), quoting SEC v. Kenneth Eove & Co., 378 F.Supp. 697 

(S.D.N.Y. 1974). 

18 In re Hanover Square Secs., 55 B.R. 235,240 (Bankr. S.D.N.Y. 1985). 

19 1977 WL 1043, at *4 (S.D.N.Y. Sept. 29,1977), quoting H.R. Rep. No. 91-1613 (1970). 

20 21 6 B.R. 719, 724-25 (Bankr S.D.N.Y. 1998). 

21 See, e.g., In re MV Sees., Inc., 48 B.R. 156, 160 (Bankr. S.D.N.Y. 1985) ("SIPA does not 

protect customer claims based on fraud or breach of contract." (quoting SEC v. Howard 

Lawrence & Co., Inc., 1 Bankr. Ct. Dec. 577,579 (Bankr. S.D.N.Y. 1975». 

27 
125 


75077.068

Policy Considerations 

Only investors who qualitY as "customers" under SIPA share in "customer property," that 

is, the cash and securities custodied with the broker for its customers. By limiting the investors 

who share in such property to "customers," the interest of such investors in a limited pool of 

customer assets is not diluted by non-customer claims against it. Thus, if the definition of 

"customer" were expanded, the only beneficiaries to share in customer property would be 

persons with non-customer claims against the broker. 

22 In re New Times Sec. Servs., Inc., 463 F.3d at 129 ("The promissory notes held by [claimants] 

... are just the type of debt instruments whose possession brings claimants within the category 

of unprotected lenders."); In re Hanover Square Sec., 55 B.R. 235, 238 (Bankr. S.D.N.Y. 1985) 

("Lenders are simply not a class to be specially protected under SIP A and in fact were expressly 

excluded from the definition of customer upon the enactment of the 1978 amendments to 

SIP A."). 

23 See Securities Investor Protection Act Amendments of 1975: Hearings Before the Subcomm. 

on Consumer Protection and Finance of the H. Comm. on Interstate and Foreign Commerce, 

94th Congo 171 (1975) (considering, but not enacting, proposed changes to the statutory 

definition of "customer" to extcnd protection to persons who had not yet entrusted property but 

held "executory contracts" for the purchase of securities). 

28 
126 


75077.069

Recommendation No.9: 

Continue to Treat Claims Arising from Repurchase and Reverse 

Repurchase Agreements as General Creditor Claims 

Overview 

In repurchase ("repo") transactions, a broker-dealer, as ostensible "seller," transfers to a 

counterparty, the ostensible "buyer," certain identified securities (the "Purchased Securities"), 

against the transfer of funds by the buyer. Simultaneously, the parties agree that the brokerdealer will buy back or repurchase, at a specified future date, the same securities for the same 

price plus a financing charge or "Pricing Rate," which is fixed during the life of the repo 

agreement. As in securities lending transactions, the rcpo buyer essentially earns interest on the 

cash that it transferred to the seller for the securities, and has the freedom to use the securities in 

its business following the initial purchase until the date of repurchase. 

Unlike typical customer claims under SIPA, a claim by a repo counterparty is not seeking 

the return of cash or securities on deposit by the customer for trading purposes. Rather, in a 

broker-dealer liquidation, a counterparty to an "open" repo or reverse repo transaction often 

seeks contract damages arising from the broker-dealer's default on its obligation to resell or 

repurchase. The amounts claimed generally consist of the difference between the repurchase 

price of the Purchased Securities (including interest due upon performance) and the Filing Date 

value of the Purchased Securities, plus any accrued interest. Those counterparties who failed to 

take possession of their repo collateral may claim the collateral in the liquidation. For example, 

if the repo participant agreed to lend the broker $1 million in exchange for securities but left the 

securities on deposit with the broker, the counterparty might claim the securities if the brokerage 

fails. 

The following factors set these types of claims apart from typical "customer" claims 

under SIPA: 

Repo transactions are in economic effect secured loan transactions rather than 

securities investment transactions as contemplated by SIP A; 

The repo contract itself is not a "security" under SIPA; 

29 
127 


75077.070

Breach of a repo agreement gives rise to a contract claim for damages; and 

The counterparties do not entrust cash or securities to a broker-dealer for trading 

purposes so as to create the custodial function that is essential to customer status 

under SIP A. 24 

Task Force Recommendation 

The Task Force recommends that claims arising out o/repurchase agreements 

and reverse repurchase agreements not be treated as "customer" claims under 

SIPA. The Task Force has not addressed hold-in-custody repurchase 

agreements and takes no position on them. 

24 Under Rule \5c3-3, a broker-dealer is generally not obligated to segregate any property in 

connection with repo transactions. One exception to this rule is where the transaction is a repo 

transaction where the broker- dealer retains securities it has transferred to the buyer (a "hold-incustody" or "HIC" repo). See 17 CF.R. § 240.15c3-3(b)(4)(i)(D). This Rule requires that the 

broker-dealer obtain the repurchase agreement in writing, and confirm the securities subject to 

the repurchase agreement in writing. See 17 CF.R. § 240.15c3-3(b)(4)(i), (iii). In a liquidation 

of the broker-dealer, the HIC repo counterparty may attempt to claim the securities subject to the 

repo. (For example, if the counterparty provided $1 million to the broker-dealer in exchange for 

$1.1 million of securities left on deposit with the broker-dealer, the counterparty might attempt to 

claim the securities if the broker-dealer fails.) Significantly, the broker-dealer also must 

"[aJdvise the counterparty in the repurchase agreement that the Securities Investor Protection 

Corporation has taken the position that the provisions of the Securities Investor Protection Act of 

1970 do not protect the counterparty with respect to the repurchase agreement." 17 CF.R. 

§ 240.15c3-3(b)(4)(i)(A)-(C); see 17 CF.R. § 240.15c3-3(b)(4)(iii) (specifying additional 

requirements regarding the right to substitute securities subject to the agreement). The SEC 

explained that it amended Rule 15c3-3 as a result of "the apparent lack of understanding of hold 

in custody repo counterparties of their rights and liabilities." Customer Protection Rule, 

Exchange Act Release No. 24778, 52 Fed. Reg. 30331 (Aug. 14, 1987); see also Securities; Net 

Capital, Customer Protection, Recordkeeping and Quarterly Securities Count Rules, Exchange 

Act Release No. 23602, 51 Fed. Reg. 32658, 32659-60 (Sept. IS, 1986). See generally Cohen v. 

Army Moral Support Fund (Matter 0/ Bevill, Bresler & Schulman Asset), 67 B.R. 557 (S.D.N.Y. 

1986). 

30 
128 


75077.071

Recommendation No. 10: 

Continue to Treat Claims Arising from Open TBA Contracts as 

General Creditor Claims 

Overview 

TBA contracts are forward contracts for the futurc purchase or sale of "to be announced" 

U.S. agency debt obligations. In TBA contracts, the parties promise to buy or sell at a future 

date "to be announced" mortgage-backed obligations of U.S. Agencies,25 i.e., obligations having 

defined characteristics (issuing agency, coupon rate, maturity, etc.) but not yet specified (and 

often not yet in existence) at the time the TBA contract was entered into by the parties. TBA 

contracts are bilateral agreements between the debtor and the TBA claimants, and are not traded 

on any securities or commodities exchange or registered with the SEC. The rights of the parties 

typically are governed by the Master Securities Forward Transaction Agreement (the 

"MSFT A"), an industry-standard contract designed for transactions of this nature. 

This resolution pertains to TBA contracts that are "open" on the "filing date" of the 

liquidation proceeding because as of that date, the time for performance (the "settlement date") 

has not occurred and the obligations of the parties to purchase or sell remain wholly 

unperformed. Because no securities are specified to the contracts as of the filing date and no 

securities or casb are transferred to the debtor, the claims in this group are not, like typical 

customer claims, for the return of cash or securities; instead, they are contract damages claims 

arising from the debtor's breach of the TBA contracts. Damages are the breach remedy provided 

in the MSFT A and established by custom and usage in the industry. 

The following factors set these contract damage claims apart from typical "customer" 

claims under SIP A, and support the argument that they actually are, at best, general creditor 

c1aims:26 

TBA claimants do not "entrust" eash or securities to the debtor but exchange 

promises of future performance; 

25 Such obligations are issued, guaranteed, or issued and guaranteed by the Federal National 

Mortgage Corporation, the Federal Home Loan Mortgage Corporation, or the Government 

National Mortgage Association. 

26 In In re Lehman Brothers Inc .. 2011 WL 6098067 (Bankr. S.D.N.Y. Dec. 8, 2011), the court 

held that claims arising from TBA contracts did not qualifY as customer claims under SIP A. 

31 
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75077.072

The TBA contract itself is not a "security" under SIPA; 

The relationship ofTBA claimants and a debtor is contractual, typically governed by 

the industry-standard MSFTA, which disclaims any fiduciary relationship and 

contains other features that are inconsistent with SIPA customer status; and 

Open TBA contracts are executory contracts, and Congress declined to amend SIPA 

to consider executory contracts for the purchase of securities as the subject of 

"customer" claims. 

Task Force Recommendation 

The Task Force recommends that because parties to a TBA agreement merely 

hold col1lract rights to purchase or sell as yet unidentified securities on a TBA 

basis, they not be deemed "customers" under SIPA. 

32 
130 


75077.073

Recommendation No. 11: 

Continue to Treat Claims Arising From Credits Received Pursuant to Soft 

Dollar Arrangements as General Creditor Claims 

Overview 

The tenn "soft dollars" refers to arrangements in which "a discretionary money manager 

receives research or other services from a broker-dealer in addition to transaction execution, and 

does so in exchange for the brokerage commissions from transactions for discretionary clients' 

accounts." Thomas P. Lemke & Gcrald T. Lins, Soft Dollars and Other Trading Activities § I: I 

(2010). A typical example of a soft dollar arrangement is where a money manager receives a $1 

credit towards research or brokerage services for every $1.60 in commissions that the broker 

receives. [d. These credits may be used only to pay for research or brokerage services, and 

cannot be used as a credit towards the purchase of securities. 

SIPA imparts customer status only on investors who deposit cash "for the purpose of 

purchasing securities." See SIPA § 78111(2)(B)(i). Because soft dollar credits are only used 

towards the purchase of research or related services, soft dollars do not qualify as "customer 

property" under SIPA. 

Task Force Recommendation 

The Task Force recommends that credits received pursuant to soft dollar 

arrangements not be deemed customer property and nol give rise to "customer" 

claims. 

33 
131 


75077.074

Recommendation No. 12: 

Continue to Treat Claims for Fees Earned in Connection with 

Underwriting or Other Transactions Effected by a Syndicate as General 

Creditor Claims 

Overview 

Brokers may hold fees earned by syndicate members in connection with underwriting or 

other transactions effected by a syndicate. These fees, however, are not part of the customary 

broker/customer relationship, as they are not held for the purpose of investment by customers. 

Accordingly, the fees do not qualitY as "customer property" under SIPA. 

Task Force Recommendation 

The Task Force recommends that fees earned in connection with underwriting 

or other transactions effected by a syndicate not be deemed "customer property" 

underSIPA. 

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Recommendation No. 13: 

Study Discrepancies Between SEC Rule J5c3-3 and "Customer Property" 

UnderSJPA 

Overview 

The Task Force has identified, examined, and discussed various discrepancies that exist 

between SIPA and the "Customer Protection Rule" Rule 15c3-3, promulgated by the SEC under 

the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. Whether and to what extent tbe 

discrepancies should be reconciled, and in what respect, will require substantial study and 

consultation between SIPC and the SEC, taking into account the stated concerns of interested 

parties. Because a thorough analysis of the reasons for, and the policies that underscore, the 

differences, and of whether and to what extent the differences should be reconciled, if at all, is 

best done by SIPC in concert with the SEC, the Task Force makes the following 

recommendation: 

Task Force Recommendation 

Although there are discrepancies between SEC Rule 15c3-3 and provisions of 

SIPA, the discrepancies may be necessary. Both the Securities Exchange Act of 

1934 and SIPA share the goal of customer protection, but in some cases, the 

regulatory functions of the SEC may compel one approach while the limited 

protection afforded under S1PA may require a different approach. The Task 

Force recommends that S1P[~ in consultation with the SEC, taking into 

account the stated concerns of interested parties, study the discrepancies 

between SEC Rule J5c3-3 and SIPA, and determine whether resolution of these 

discrepancies is appropriate, and if so, to what extent and in what manner. 

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Recommendation No. 14: 

International Relations: 

SIPC to Assist in the Creation of an International Association 

Overview 

Broker-dealers increasingly have overseas affiliates or subsidiaries and do business 

across the globe. As such, the failure of a multi-national brokerage can have cross-border 

implications affecting domestic and foreign customers. In light of the realities of modern day 

broker-dealer operations, the Task Force is considering how customers of a multinational brokerdealer may be better protected by SIPC and whether membership in an international association 

of investor protection entities ("International Association") would further SIPC's mission. 

The Task Force has examined SIPe's past international activity and the cross-border 

issues that have arisen in the liquidation of Lehman Brothers Inc. and its related entities 

("Lehman"). The Task Force believes that membership in an International Association could 

assist in the resolution of these issues in future multi-national firm liquidations. An International 

Association would create a forum for discourse among its members and could promote 

cooperation among securities investor protection organizations. 

Task Force Recommendation 

The Task Force recommends that SIPC, in cooperation with the international 

investor protection community, take a leading role in the creation of an 

International Association, provide suggestions for the primary goals of the 

Association, and study whether the Association should be independent or 

affiliated with an established organization. 

A Brief History of SIPC's International Efforts 

SIre's history of international outreach began in the 1990s with a series of seminars 

regarding the capital markets to former Soviet republics, and the examination by an internal 

SIPC committee of the effect of globalization of the securities markets on SIrc. Since 1999, 

SIrC has made presentations to representatives from countries in the European Union, China, 

Egypt, and Jordan, as they were in the process of forming their respective national investor 

protection schemes. SIrc also has made presentations to, and joined, the International 

Organization of Securities Commissions ("IOSCO") as an affiliate member. 

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The Memorandum of Understanding Program 

Recognizing the importance of international cooperation, SIPC has negotiated and signed 

Memoranda of Understanding ("MoU") with a number of its foreign counterparts. Although they 

arc non-binding at law, these cooperation agreements provide for annual information exchanges 

and a platform to deal with the failure of a financial intermediary that has a footprint in both 

jurisdictions. 

signed: 

The following is a list of SIPC's MoU partners, and the years the agreements were 

Financial Services Compensation Scheme, United Kingdom, 2004 

Canadian Investor Protection Fund, 2005 

Securities and Futures Investor Protection Center, Taiwan, 2006 

Korea Deposit Insurance Corporation, 2007 

China Securities Investor Protection Fund Co., Ltd., 2009 

Egyptian Investor Protection Fund, 2009 

A New International Association of Investor Protection Entities 

The China Securities Investor Protection Fund ("CSIPF") has taken a leadership role in 

international cooperation between and among similar entities, and has moved to solidifY the ties 

between them. In 2009, the CSIPF urged SIPC and the Canadian Investor Protection Fund to join 

with it to create a new entity to deal exclusively with investor protection in the context of 

financial intermediary failure. Chairman Chen Gongyan, former head of the CSIPF and now 

Chairman of the Securities Association of China, recommended the idea of an International 

Association to the Task Force at its initial meeting. 

The Need for an International Association 

The liquidation of large, multinational brokers has required substantial cross-border 

cooperation. An International Association could help to forge relationships between and among 

the securities investor protection entities. An International Association could also facilitate the 

exchange of information between and among members and provide an established channel for 

communication. This would allow closer collaboration among the affiliated debtors and investor 

protection schemes. Other existing international associations, such as IOSCO and the 

International Insolvency Institute (the "II!'), have created mechanisms for cross-border 

cooperation. For example, in 2001, the III adopted the Guidelines Applicable to Court-to-Court 

Communications in Cross-Border Cases, which were created in conjunction with the American 

Law Institute. A more targeted set of guidelines for investor protection entities could prove 

helpful in cross-border liquidations. 

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The Goals of an International Association of Securities Investor Protection Entities 

An international securities investor protection forum could work towards the following 

specific goals: 

1. Facilitate the communication, coordination and cooperation among all securities 

investor protection entities and tribunals, when appropriate; 

2. Promote cooperation among securities investor protection entities with respect to 

cross-border compensations for securities investors; 

3. Provide for the sharing of relevant information and data among members when 

appropriate; 

4. Explore potential mechanisms for the preservation of the value of a debtor's 

worldwide assets and the maximization of recovery for all securities investors; 

5. Promote methods for coordination of an efficient and transparent claims process; 

6. Promote discussion of comity among independent jurisdictions; 

7. Promote the development of securities investor protection internationally; and 

8. Explore methods for international dispute resolution in cases involving cross-border 

issues. 

An International Association May be Independent or Affiliated 

An International Association may be affiliated with an existing international securities or 

insolvency association or be a completely stand-alone entity. Having an affiliation with an 

existing international association, such as IOSCO or the Ill, could be advantageous because each 

of these organizations has an infrastructure in place, including annual meetings, a mechanism for 

leadership and decision making, and established channels for communication. In addition, the 

relationships forged between investor protection entities and other members of the existing 

organizations could prove beneficial. On the other hand, an International Association as a standalone entity allows complete independence, autonomy, and authority, although it may place a 

greater burden on the members to create an infrastructure and increase administrative duties. 

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Recommendation No. 15: 

SIPC to Continue Investor Education Efforts 

Overview 

Since 2000, SIPe investor education efforts have included 0) literature and a web site in 

investor friendly terminology; (ii) five separate public service announcement (PSA) campaigns; 

and (iii) a paid million-dollar advertising campaign. 

Task Force Recommendation 

Subject to SIPe's consultation with FINRA and the SEC, the Task Force 

recommends that: 

(1) The Board should consider the feasibility of including plain-English 

information about SIPC on brokerage statements and whether its 

benefits would outweigh its costs; 

(2) SIPC recommend an increase in the amount of information that 

brokers are required to learn about SIPC as part of their continuing 

education; 

(3) SIPC hire a dedicated investor education employee; and 

(4) SIPC ask state regulators to include information about SIPC as part 

of their outreach efforts. 

The Task Force also recommends that SIPC conduct a study, including 

through the use of focus groups, both before and after implementing these 

changes to determine investors' level of knowledge of SIPC and the 

effectiveness of these changes. 

(I) The Board Should Consider the Feasibility of Including Plain-English Information about 

SIPC on Brokerage Statements and Whether Its Benefits Would Outweigh Its Costs 

The Task Force recognizes the importance of educating the investing public through the 

information provided by broker-dealers. Thus, certain members of the Task Force suggested 

including information on SIPe protection on the initial brokerage statement, whether provided in 

paper or electronic form, and periodically thereafter. They emphasized that the information 

included on the brokerage statement should be simple, easy to understand, and eye-catching. In 

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addition, the information should provide the scope and limits of protection, including what is not 

protected by SIPe. 

Certain other members of the Task Force expressed concerns at the cost and effectiveness 

of including information on the brokerage statement. The Task Force is therefore presenting this 

issue to the Board to consider in conjunction with the below recommendation to hire a dedicated 

investor education employee. 

(2) SIPC Should Recommend an Increase in the Amount of Information that Brokers Are 

Required to Learn about SIPC as Part of Their Continuing Education 

Pursuant to FINRA Rule 1250, securities professionals have a continuing education 

requirement. See FINRA Rule 1250, available at http://finra.complinet.com/cn/display/ 

display _ main.html?rbid=2403&elemenljd= I 0204. In addition, firms are required to establish a 

formal training program for their registered representatives. See id.; Continuing Education, 

FINRA, available at http://www.finra.org/Industry/Compliance/ContinuingEducation/. As a 

way to ensure that registered individuals are relaying accurate information about SIPC to their 

customers, the Task Force recommends that registered individuals be required to learn about 

SIPC as part of FINRA's continuing education requirements. SIPC staff can work in 

conjunction with FINRA to develop this information, which should include an explanation to 

investors of SIPC protection. 

(3) SIPC Should Hire a Dedicated Investor Education Employee 

A dedicated investor education employee may enhance SIPe's investor education efforts. 

He or she could work with the SEC, FINRA and state securities regulators to coordinate investor 

education and ensure that accurate information about SIPC is reaching investors. The Task 

Force recommends that SIPC hire a dedicated investor education employee. 

(4) SIPC Should Ask State Securities Regulators to Include Information about SIPC as Part 

of Their Outreach Efforts 

State securities regulators regularly engage in outreach to investors. SIPC should request 

each state securities regulator to include information on SIPC and SIP A as part of its regular 

outreach. This recommendation would be a cost-effective way to achieve the investor education 

goals of both the state regulators and SIPe. 

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Comment: 

SIP A 's Mandate of Customer Protection Generally Means that 

Committees Representing Unsecured Creditors of the Debtor's General 

Estate Serve Little Purpose in a SIP A Case 

SIP A does not provide for the appointment of a committee to represent the interests of 

unsecured creditors. Historically, creditors' committees have not played any role in proceedings 

under SIP A in part because the emphasis of these proceedings has been on protecting customers 

through maximization and distribution of the "Fund of Customer Property." 

The creation of a creditors' committee, as a result of several fundamental aspects of 

SIP A, would be of limited or no benefit in most cases, and would potentially even require SIPC 

to advance additional funds for expenses without any material benefit to the estate. For example, 

the supervisory functions that otherwise typically would be performed by a creditors' committee 

in a bankruptcy case are, in a SIPA case, performed by SIPC, which is closely involved in the 

oversight of every SIPA proceeding. In addition, as SIPA provides only for liquidation, not 

reorganization, there is no plan of reorganization for a creditors' committee to participate in 

formulating, and most importantly, there rarely is a materially significant unsecured general 

estate in a SIPA proceeding to be reorganized. Moreover, Congress intended the SIPA 

proceeding to resemble most closely a Chapter 7 liquidation under the Bankruptcy Code and not 

a bankruptcy reorganization. While used in reorganization cases, unsecured creditors' 

committees rarely occur in Chapter 7 cases because unlike the situation in reorganization cases, 

the Bankruptcy Code does not provide for compensation to professionals assisting the committee 

in Chapter 7 cases. 

The creation of such a committee could be detrimental to the goals of the efficient 

administration of the assets and prompt resolution and payment of the claims of securities 

customers who are the intended beneficiaries of a SIPA proceeding and potentially impose 

needless additional administrative costs on SIPC. 27 

Task Force Comment 

The Task Force has concluded that SIPA'5 mandate of customer protection 

generally means that an Unsecured Creditors' Committee serves little purpose 

in a SIPA liquidation. 

27 See In re MF Global, Inc., 2011 WL 5884247 (Bankr. S.D.N.Y. Nov. 23, 2011). 

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ACKNOWLEDGMENT~ 

The Task Force extends its appreciation to those persons who met 

with the Task Force and shared their time, experience and valued 

insight on issues of concern to the Task Force. This includes 

representatives of the Securities and Exchange Commission, the 

Financial Industry Regulatory Authority, the Depository Trust & 

Clearing Corporation, the Investment Company Institute, and the 

Government Directors of the Securities Investor Protection 

Corporation from the Department of the Treasury and the Federal 

Reserve Board. 

The Task Force also wishes to thank those members of the public 

who took the time to share their views, opinions, and concerns on 

matters relating to SIPA and SlPC. 

Finally, the Task Force expresses special gratitude for the 

assistance rendered by our colleagues and associates in the firms or 

organizations that we represent, and by staff members of the 

Securities Investor Protection Corporation. 
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APPENDlXA 

CORPORATE GOVERNANCE REVIEW 

by 

Professor Lawrence A. Cunningham 

Henry S t. George Tucker III Research Professor of Law 

The George Washington University Law School 
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REPORT FOR SIPC MODERNIZATION TASK FORCE: 

SIPC CORPORATE GOVERNANCE REVIEW 

By Lawrence A. Cunningham 

A1!glJst 13,2010 

Thank you for the opportunity to provide this report of my independent corporate 

governance review of some of the operations of the Securities Investor Protection Corporation. I 

understand that, in light of the insolvencies of the brokerage firm Lehman Brothers Inc. and the 

revelation of a Ponzi scheme at Bernard L. Madoff Investment Securities LLC, SIPe's Board of 

Directors formed the SIPC Modernization Task Force to examine SIPC's mandate under the 

Securities Investor Protection Act and operations and make related recommendations. As part of 

that effort, you engaged me to conduct a governance review and provide this report. I was 

delighted to conduct the review and am pleased to provide this report. 

I. My Review and this Report 

In my review, I communicated with nearly half the members of SIPC's staff, many inperson, several by telephone, and several by electronic mail, and made similarly varied inquiries 

of outside lawyers who have he en involved in SIPC customer protection proceedings. My 

review included reading the Securities Investor Protection Act (including as amended by the 

Dodd-Frank Act of2010); related rules appearing in the Code of Federal Regulations (known as 

the Series 100 through Series 500 Rules); SIPe's By-Laws (Nov. 2009 rev. ed.); SIPe's Annual 

Reports for 2009 and 2008; SIPe's statement of Organization and Responsibilities (May 12, 

2010); SIPe's Operations Manual (August 2004); SIPe's Trustee's Guide (undated), including 

exhibits containing scholarly commentary; SIPC's Personnel Guide (Sept. 2006 rev. ed.); SIPe's 

brochure (in the form accompanying its 2009 Annual Report, apparently dated as of 2007); and 

parts ofSIPC's internet Web site. 

I also read a letter from Representative Paul E. Kanjorski (March 3, 2010) and related 

press release concerning the SIPC Modernization Task Force; reports about SIPC prepared by 

the U.S. General Accounting Office (May 2001 and July 2003) (concerning customer 

information and excess insurance), Ernst & Young (February 2002) (concerning internal audit), 

and Corporate Review Services (April 30, 2004) (concerning selection and supervision of 

external consultants); and an internal SIPC memorandum addressing recommendations of the 

Securities and Exchange Commission (June 2003) (concerning review of fee applications of 

external SIPC trustees and counsel). 

The purpose of my review was to evaluate aspects of SIPC's corporate governance. This 

refers to internal organization, structure, staffing, policies, and procedures concerning operations 

and execution by SIPC's staff of its assigned mission. Outside the scope of this review are 

broader matters concerning SIPe's mission and this Task Force's undertakings. Except in 

passing, therefore, this report does not evaluate SIPC's statutory mandate or specific policy or 

other matters raised by the statute, such as what securities are covered, what asset distribution 

methods are used, or maximum customer protection limits set; relations with member firms, or 

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assessments on them or financial resources; investor knowledge or education about investments 

or SIPe; or the selection, structure, composition, compensation or activities of SIPC's board of 

directors or relations between it and the rest of the corporation; or other similar broad policy 

matters. 

Within those parameters, on the basis of my review, it is my opinion that SIPe's 

corporate governance is excellent. Its organizational structure is coherent; its supporting 

documentation outstanding; its technological capabilities becoming state of the art; its staff of 

optimal size, enabling a nimbleness necessary to respond quickly to execute its mission; its 

professional team exceptionally well-qualified, dedicated and collegial; and its network of 

external consultants and experts rich to enable leveraging internal swiftness and expertise with 

external manpower as nceded. No organization or its governance is perfect, of course, and my 

review enables me to make a few recommendations. 

My recommendations, detailed in what follows, may generally be classified as objects of 

modernization but I have not limited suggestions to that classification: The recommendations I 

suggest considering, in substantially the order of importance, are as follows: 

A. Technj£al Document UJldates: make technical updates to existing documentary 

support, including (I) the statement of Organization and Responsibilities to increase detail and 

uniformity, (2) the Trustee's Guide to reflect technological and other developments and actual 

practices, and (3) the Operations Manual for the same purposes, and to adopt a plan to update 

these using annual supplements followed by regular periodic (five year) revised editions. 

B. Expand Document Wealth: sustain thc accumulation of written experience for 

transmission to incoming staff, including by (I) developing additional corporate manuals 

concerning matters like prevailing brokerage firm practices and securities product innovations, 

and (2) make existing data bases of consultants and trustees accessible to staff rather than within 

the province of senior SIPe officials and consider expanding content. 

C. Human Resources Investment: (I) assure adequate future staffing in SIPC's 

Operations Division by recruiting examiners across generations and be prepared to give them the 

training that the existing team has provided to other relatively recent recruits on a systematic 

basis, (2) compare the organizational structure contemplated by the list of authorized officers in 

SIPe's By-Laws to the existing officer corps, and (3) increase support of professional 

development for staff, including for completing unfinished college degrees and advanced 

specialized degrees relevant to the field, and for promoting the production of written materials 

for external publication. 

D. SubstantivG._ D~J!illt:l1t Updates and Highlights: (1) make substantive updates to 

existing documentary support, in the Trustee's Guide and Operations Manual, to better reflect 

SIPe's prevailing practice on compensation policies for outside consultants and trustees, and (2) 

highlight in distinctive repositories SIPe's mission (by abstracting it from the statute) and ethical 

commitment (by reformatting existing By-Law and Personnel Guide provisions). SIPe may also 

wish to consider whether to have its internal controls audited, though I refrain from 

recommending that. 

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None of these suggestions requires changes to SIPA; most can readily be implemented by 

SIPC's staff; some may warrant or require SIPC Board review or approval; and suggestions 

concerning reformatting some By-Law provisions would require SEC involvement In making 

these suggestions, I emphasizc that my review indicated a highly effective corporate governance 

environment at SIPC and yielded confidence in its existing governance regime. Accordingly, as 

the level of detail provided in the recommendations may also signal, these suggestions should 

not be seen as criticizing SIPe's leadership or staff but to represent expectable ideas that an 

independent outside review might crystallize. 

II. SIPC in Review 

A. Design and Execution 

1. Mission. The Securities Investor Protection Corporation was created by the Securities 

Investor Protection Act of 1970 to provide stated protection to customers of troubled U.S. 

securities brokers and dealers. SIPC is a nonprofit private corporation whose members are 

securities brokers and dealers registered under the Securities Exchange Act of 1934. Though not 

part of the federal government, its seven-member board consists of five presidential appointees 

and two government officials, and it is overseen by the Securities and Exchange Commission. 

Its primary purpose is to take charge of and liquidate failing brokerages and promptly arrange to 

return customer assets and pay customer claims within statutory limits. 

SIPC administers a fund supported by member assessments available when a failing 

firm's general estate is insufficient to cover customer claims and also has access to credit 

through the SEC from the U.S. Treasury. Specific statutory language in SIPA defines the class 

of "customers" covered and provides a term of art to define the "securities" that are covered. 

Other technical legal and business terms arise in SIPe's day-to-day operations, including 

concepts such as customer name securities, customer property, and customer net equity, many 

elaborated in the Series 100 to 500 CFR rules. SIP A prescribes in clear terms rules governing 

the commencement of customer protection proceedings. These include appointment of a trustee 

and applicable judicial procedures and other aspects of the liquidation process. Despite lucidity, 

litigation and practical judgment over the meaning of some of these terms and rules recurs. 

2. Performance. From its inception in 1971 through 2009, SIPC commenced 322 

customer protection proceedings. Over the past decade, it commenced an average of four cases 

annually. In its history, SIPC has returned to more than 700,000 customers some $108 billion in 

assets, most from failed firms' estates, along with about $1 billon from the SIPC fund. Only a 

small minority of claims have exceeded the statutory limits. Eight cases are currently open, due 

to litigation or ongoing claims processing. Internal work flow at SIPC therefore varies over time 

in ways not always predictable but that require the staff and its team of outside consultants and 

trustees to act swiftly whenever new failed firms appear. 

Among current cases are two unprecedented in magnitude that began in 2008: Lehman 

Brothers Inc. (involving some $92 billion in securities of some 135,000 customers) and Bernard 

L. Madoff Investment Securities LLC (involving an entirely fraudulent mirage costing SIPC an 

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estimated $1.6 billion to protect customers, based on assumptions explained in SIPC's 2009 

financial statements, Annual Report, p. 18 n.4). It's unlikely that multiple calamities of that 

magnitude will recur within such short order; recent statutory changes in the Dodd-Frank Act of 

20 I 0 appear to repose considerable responsibility for dealing with systemically important firm 

failure, including broker/dealers, in federal agencies; and SIPC operated effectively in the face of 

this pair of unprecedented failures, following longstanding practice of retaining experts with 

large staffs and resources and participating alongside them throughout related customer 

protection proceedings. 

3. Proceedings. SIPC does not regulate brokers or dealers or supervise them. It relies on 

referrals from regulatory authorities, such as the Financial Industry Regulatory Authority 

(FINRA) and the Securities and Exchange Commission, of pending firm financial difficulties. 

When a referral is received, SIPe's Vice President - Operations and Finance reviews it, 

preparing a worksheet (called Form 26) to evaluate whether to recommend commencing a 

proceeding, in consultation with SIPe's General Counsel. The two rcport recommendations to 

SIPC's President who submits ultimate recommendations to SIPe's Board Chair. The Chair is 

authorized by SIPe's By-Laws to direct the staff to initiate proceedings and that approval on 

recommendation is virtually automatic. This streamlined but collaborative process is welldesigned to enable acting quickly and decisively on referrals. 

Once authorized, the President and General Counsel confer to assign a SIPC staff 

attorney to head up the legal aspects of the proceeding and the Vice President Operations and 

Finance assigns an examiner. SIPC staff members then proceed to their assigned tasks, its 

lawyers obtaining requisite judicial orders and legal staffing and its examiners closing down the 

firm and marshaling its assets in preparation for its liquidation and distributions to customers. 

Throughout, SIPe's and its staffs primary goal is expeditious movement to return and pay 

customer funds. To do that usually involves SIPC making advances to customers, through 

trustees, that it thereafter seeks to recover in later stages of a proceeding. The process is efficient 

and swift, even in large cases. 

B. Approach and Implementation 

l. ~!!:t!cture. SIPe's organizational structure is simple and coherent and its internal 

staffing both sophisticated and lean. Under its Board of Directors, SIPe's President is charged 

with overall corporate responsibility. That includes interacting with Congress and supervising 

SIPe's staff, of about 32 people, consisting of lawyers, examiners, other professionals, and 

support personnel. The staff assumes sole responsibility for the vast majority of customer 

protection proceedings SIPC initiates, with the team of lawyers and examiners managing all 

aspects of the case and claims. 

A network of skilled professionals with expertise in brokerage operations and 

liquidations is available to it nationwide to assist in the process. For larger or unusually complex 

cases, SIPC retains an outside trustee and counsel to carry much of the day-to-day burden of 

managing a liquidation, though its lawyers and examiners remain primarily responsible for the 

case and claims and supervise retained experts closely. This model, invented at SIPe's founding 

by SIPe's initial leadership who hclped draft SIPA and implement it, has served SIPe and 

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securities customers well and continues to do so. As an example, the outside trustee and 

trustee's counsel in the Lehman case deploy more than 100 lawyers on the case, half of whom 

devote substantially their entire practice to that one case for nearly two years already. [t would 

be foolish to expand SIPC itself to be so equipped. 

SIPC is organized into two primary divisions, whose heads arc officers of the corporation 

who report directly to the President: the Legal Division and the Operations & Finance Division, 

with the latter sub-divided into three further units, Operations, Finance, and Information 

Technology. The Legal Division is headed by SIPe's General Counsel and Secretary, and 

staffed by a total of six full-time attorneys, including her. They hold various titles designating 

seniority: General Counsel and Secretary (both officer positions); Senior Associate General 

Counsel; Senior Associate General Counsel for Dispute Resolution; Associate General Counsel; 

Assistant General Counsel; and Staff Attorney. There is also a Law Librarian/Paralegal, who 

provides vital assistance with document maintenance, and two legal secretaries. There is another 

legal secretary slot that is currently vacant. 

SIPC's Operations and Finance Division is headed by a Vice President, an officer of the 

corporation, and each sub-division by an Assistant Vice President (of Operations, Finance, and 

Information Technology). Within Operations, there arc three Senior Examiners and one 

Examiner. All are supported, adequately, by two secretaries. Within Finance, there is a Cash 

Manager, Manager - Accounting (supported by an Accounting Supervisor reporting to Manager 

- Accounting, and a staff accountant below that) and a single person wearing three hats 

(Manager-Member Assessments/Human ResourceslPlant and Facilities), all supported by three 

clerks. Within Information Technology, there are two staff workers, imaging coordinator and 

computer support specialist. About a dozen additional support staff round out the operation. 

2. Documentary Support. SIPC maintains exceptional written materials succinctly 

reflecting the accumulated wisdom of its personnel over four decades. Primary governance 

documents are a comprehensive Trustee's Guide, of particular value to the lawyers in the Legal 

Division, and a detailed Operations Manual, of particular value to the examiners in the 

Operations Division. In addition, SIPC has recently updated its statement of internal 

Organizations and Responsibilities, identifying functions of the Divisions, containing an 

organizational chart, and listing all current stafl members. The Securities Investor Protection Act 

provides specific guidance for SIPC operations and staff responsibilities. SIPe's By-Laws and 

Personnel Guide contain codes of conduct and statements of business ethics. The By-Laws also 

contain governance provisions at the levels of directors, officers and members. The Personnel 

Guide also contains provisions about employee duties and benefits. The Finance Division 

maintains assorted guides and materials concerning accounting procedures and policies. 

SIPe's annual reports mirror the leanness and simplicity of the corporation's operations. 

Its 2009 edition consists of a transmittal letter to the SEC, a succinct Chairman's message, an 

overview of SIPC, list of directors (with photographs) and officers, summary of customer 

protection proceedings, discussion of membership and the SIPC fund, a summary of pending 

litigation and other actions, an auditor's report and accompanying financial statements, followed 

by a table depicting the historical size of the SIPC fund since inception and a series of 

appendices capturing full historical distributions to customers, five-years of revenue-expense 

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analysis, and data on pending and recently completed customer protection proceedings. This 

gives a useful and comprehensive picture of SIPC, all in 35 pages of clear presentation. It also 

otTers a CD in its back cover, containing extensive additional information, including a copy of 

SIPC's brochure and applicable member rules. 

3. Technological Support. SIPC's general computer system provides office-wide access 

to all case materials, including legal documentation in pending and past cases and related forms. 

Virtually all archival materials are preserved using modem imaging techniques. SIPC maintains 

computer operations in its Washington office backed up by separate facilities off-site in Virginia, 

further backed up using a third-party service provider at a site in another nearby state. These 

practices, initially prompted by anticipated national challenges ahead of the tum of the 

millennium (the so-called Y2K bug) and enhanced by the terrorist destruction of computer 

capabilities on September 11,2001, follow prevailing business practice. 

SIPC is in the midst of a computer enhancement project that will enable customers to 

prepare and file claims on-line and examiners to review them electronically. That's important 

because, until now, as the SIPC Web site acknowledges, speaking to customers: "You can't file 

your SIPC claim form electronically, but you can usc this Web site feature to fill out your form 

and print it out. You must still copy the completed form, all attachments, and then mail the 

original to the designated address." 

In response to recommendations GAO made in 2001 and 2003, SIPC updated its Web 

site and brochure to clarifY that investors should register brokerage firm complaints with those 

firms; expanded statements discussing market risk and SIPC coverage; and amended its By-Laws 

(Article II, 4§ (a)(6)), concerning member advertising, to require firms displaying a statement 

about SIPC coverage to include links to SIPC's Web site. SIPC also added to its brochure links 

to its Web site offering information concerning investment fraud. 

C. Human Resources 

1. Expertise. SIPC's staff commands rich and varied experience and boasts extensive 

reservoirs of knowledge. The staff seems to treat SIPC as a destination career site, with seven of 

its current personnel originally employed by SIPC in the 1970s, shortly after its creation, and 

another one-third of the staff each beginning employment in the 1980s and 1990s. Average 

current employee tenure is approximately 18 years, down slightly in the past two years due to 

retirements of two veteran employees and hiring of six new staff members. SIPC's President has 

been employed by SIPC since 1975 and is a former SIPC General Counsel; its current General 

Counsel has been employed by SIPC since 1983; its current Vice President Operations and 

Finance started in 1998; and its Assistant Vice Presidents for both Operations and Finance both 

began working at SIPC in 1973. 

All SIPC's lawyers were hired laterally (not just out of law school), have distinguished 

academic records, and collectively a laddered degree of experience (being out oflaw school, 37, 

32,26, 18, II, and 3 years, respectively, and varying in age accordingly). All the examiners were 

also hired laterally, usually with extensive (multi-decades long) experience in back office 

brokerage operations. They are individually and as a group older than the lawyers. The Finance 

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Division likewise boasts seasoned experts and, like the Legal Division, staff varies widely in age. 

The Information Technology Division is small, consisting of a Vice President and two staffers. 

2. Recruiting .,!nd Training. All professional staff hiring is done laterally. The Legal 

Division emphasizes academic achievement; the Operations Division emphasizes back office 

brokerage experience. As a result, and given that SIPC's overall staff is small, SIPC does not 

maintain any formal in-house professional training programs. Lawyers and examiners, with 

experience in other organizations, bring skills with them. Even so, lawyers may have experience 

and skills in securities and litigation generally, but that may not inelude brokerage firm 

liquidations or even bankruptcy; examiners are assumed to have extensive experience in back 

office brokerage operations and that may include brokerage liquidations but not necessarily. 

Training of new recruits consists primarily of assigned reading of internal documents, especially 

the Trustee's Guide for lawyers and Operations Manual for examiners, along with ad hoc 

direction and supervision in early cases by senior staff in the respective Divisions. Aside from 

professional training, SIPC technology experts offer training in computer and software 

applications. 

3. Culture. SIPC's small personnel size makes for a lean and nimble organization. 

SIPC's statement of Organization and Responsibilities succinctly delineates the functions and 

responsibilities of each Division. Some functions require involvement of more than one Division, 

particularly between its Legal Division and Operations Division concerning presenting financial 

information in court documents and relations with external trustees, but clearly divides 

responsibility and calls for cooperation. 

In response to my questions of people in both Divisions, there's evidence of full 

adherence to that cooperation requirement. Those interviewed, in all Divisions, expressed 

enthusiasm for colleagues, within and across Divisions. Examiners and lawyers alike 

emphasized that work tends to be done in groups, with ongoing consultation among examiners 

and among lawyers. People often described SIPC as akin to a family, where people all get along 

and work for the common good, acknowledging the occasional disagreement or pique. Reports 

indicate that staff gathers annually for regular outings and that more informal socializing occurs; 

many employees regularly exercise in the gym within SIPC's building that's free to employees 

of the building'S tenants. That building and SIPC's offices are first class modern professional 

facilities in downtown Washington DC, offering a comfortable work environment. 

The long length of service of many SIPC employees demonstrates employee satisfaction, 

institutional loyalty, and the opportunity for internal advancement. The continuing recruitment 

of others over recent years shows SIPC's appeal as an employer. SIPC's statement of 

Organization and Responsibilities lists the entire SIPC staff, starting with the Chairman and 

President, and including the receptionist, mailroom and other clerks, and secretaries. That 

reflects a healthy and inclusive organizational identity. There is no mandatory retirement age 

(though the SIPC retirement plan contains provisions keyed to age) and many staff members 

havc worked and do work well into their seventies. 

4. Compensation and B~l}efi!:;. Just as SIPC is not part of the federal government, its 

salary system is independent of the federal government and its compensation scale. Nevertheless, 

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SIPC monitors government pay scales and levels of private industry compensation. SIPC's scale 

probably falls somewhere in between the two. Compensation and employee perfonnance are 

reviewed annually by an employee's direct supervisor; compensation of officers is set by the 

Board. SIPC's benefits package includes a retirement plan, savings plan, flexible spending 

account, and health, life and long-tenn disability insurance coverage. SIPC also pays the cost of 

continuing education, such as for CPE and CLE credits, and absorbs the cost of professional fees 

including state registration fees for attorneys and accountants. The corporation also pays for 

work -related seminars for all employees. SIPC does not pay for tuition to cover finishing a 

college degree or earning an advanced degree. 

No components of SIPC employee compensation involve any fonn of incentives to 

achieve particular results. In fact, the entire operating framework-from the SIPA statute 

throughout internal operations-is designed with essentially neutral incentives, focused on 

expeditious customer protection. The staff members get no more or less whether they open and 

close a particular case or any given number of cases or recover any particular fonn or amount of 

customer property. There's no sense of conflict between paying brokerage customers and 

preserving the SIPC fund, given that most customer distributions are recovered from finn assets 

and how supplemental resources in the fund and available lines of credit are ample. Staff 

members acknowledge psychic satisfaction when they are able to call customers to infonn them 

they are protected and covered under valid claims. 

5. Leveragi~Outsourcillg. Though SIPC prefers to rely upon its internal staff 

whenever possible to handle legal and operational aspects of all customer protection 

proceedings, it also regularly relies upon outside consultants to assist examiners when serving as 

trustee and engages trustees and trustee's counsel in other cases. SIPC staff remains primarily 

responsible for all aspects of any proceeding and work alongside of and supervise closely those 

outside experts. Consultants and trustees tend to be selected on an ad hoc basis in light of 

particular needs of a case, geographic location, and the need to choose professionals 

immediately. Several prominent New York law finns have partners who have developed a 

specialty in SIPC proceedings. Outside trustees SIPC selects are usually partners at such finns 

who in turn retain their law finn as trustee's counsel. That approach is highly efficient and 

minimizes conflicts; to resolve conflicts that may arise, the trustee may also retain a separate 

boutique law firm. 

SIPC maintains careful policies governing retention of external consultants and their 

compensation. Retention policies include maintaining data bases of approved consultants and 

associated oversight as recommended in a 2004 report made by Corporate Review Services after 

an isolated case of a SIPC examiner charged with receiving kickbacks from third-party vendor 

assignments. On cost containment, policies include seeking discounts, commitments that quoted 

rates remain in effect for at least one year, and assurances that work will be performed by the 

least-costly competent personnel. Pricing appears to be competitive, with plenty of consulting 

and law finns available who prize working with SIPC. For complex litigation assignments, 

budgets are requested, and invoices mandated quarterly (or monthly for large cases during busy 

periods), in accordance with SEC recommendations made in 2003. (See Trustee's Guide, page 

11-3.) Likewise in accord with those recommendations, all fee discussions and negotiations are 

documented, usually by exchanges of emails. Legal fees are subjected to numerous rounds of 

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review, first within the outside finn, then between the SIPC lawyer assigned to the case, 

followed by SIPe's general counsel, and ultimately subject to court approval. 

D. Oversight 

SIPC's entire substantive operation is dictated by the Securities Investor Protection Act 

and SIPC is subject to extensive and periodic review and oversight by numerous organizations. 

These include Congress, the SEC, the GAO, various judges overseeing its customer protection 

proceedings, and its regular outside auditor, of recent years, Grant Thornton. Reviews of input 

from those and other organizations in the past decade indicate that SIPC is responsive. SIPC also 

faces de facto oversight from securities brokerage customers nationwide and the outside 

attorneys serving from time to time as external trustees and trustees' counsel. Occasionally, as in 

the aftermath of the Madoff fraud revelation, SIPC faces the scrutiny of media and even of 

advocates in private civil litigation. The Task Force in June 2010 opened a separate Web site to 

solicit input into its process from members of the general public. 

Ill. Report and Recommendations 

Before offering a series of recommendations for consideration, 1 note two modernization 

projects underway or rccently completed that should be sustain cd. The first is enhancing SIPe's 

customer liquidation processing computer system to enable claimants to prepare and submit 

claims over the internet. This will also enable SIPC examiners to review submitted claims and 

support documentation through SIPe's in house computer system and to evaluate and determine 

claims through that system. This process should be completed by year end and any resources the 

Information Technology Division requires to complete and sustain it should be provided. 

The other is the revised statement of Organization and Responsibilities, dated as of May 

2010, prepared for the Modernization Task Force and updating the previous version dating to 

2000. This version adds a SIPC organizational chart. Though some are not enamored of the 

utility of such a chart, it represents prevailing best practice and is useful in thinking about an 

operation and its people, even for a small group like SIPC. 

A. Technical Document Updates 

1. Statement of Organization and Responsibilities (May 1;1~2Q.!..Q2. SIPe's new statement 

of Organization and Responsibilities is substantively excellent, particularly its delineation of the 

functions and responsibilities, especially of the relation between the Legal Division and 

Operation Division concerning matters where issues overlap and require inter-Divisional 

cooperation. Producing this statement obviously required input from various Divisions and 

personnel. The input appeared to vary. That may reflect differing outlooks of the respective 

Division heads. Even so, some harnl0nization may be warranted, in part because of how the 

variation may suggest underlying points warranting improvement. 

All employees are listed. Biographical highlights are abstract and limited, suggesting 

what's seen as most important. The singular detail is the starting employment date at SIPC. 

That seems a matter of pride worth highlighting. Other details vary, some noting prior 

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experience and some not. Some people have college or advanced degrees and some do not, at 

least one has an advanced degree that isn't listed; those who do not are listed as having attended 

a given college or as having attended or completed high school. Closer attention to presentation 

and uniformity in this document may be warranted. 

Policy information concerning the Legal Division is incrementally more detailed than 

that for the other Divisions. It explains (p. 5) that the Legal Division "functions as much like a 

law firm as a corporate environment permits." That means performing most SIPC legal services 

internally, except in rare cases, and explains why SIPC puts "emphasis on high academic 

standards and litigation experience" in recruiting. (This is suggested by but not detailed in the 

abstract biographical data appearing beneath each lawyer's name, with the staff having earned 

law degrees from Georgetown University, New York Law School, St. John's University, 

University of Pittsburgh, Columbia University, and Fordham University. Undergraduate degrees 

are not listed. I understand that one of the lawyers also holds an advanced law degree, the 

LL.M., though this is not listed.) 

The Operations Division's parallel page does not describe what it emphasizes in 

recruiting or why. My review indicates that it emphasizes practical and comprehensive back 

office brokerage experience. It may be worth stating that. Accompanying biographical notes 

state that experience for two senior members of this Division (24 years for the Vice President 

and 23 years for a senior examiner) but not for the others (I found out that one has more than 20 

years and another has nearly 30 years of experience). The four employees designated as 

examiners are all shown to have attended identified colleges, without earning degrees. Listing 

their brokerage experience seems desirable. 

The Finance Division's parallel page also does not describe what it emphasizes in 

recruiting or why. All personnel but two (a secretary and a member status clerk) earned college 

degrees (the phrase High School appears under the names of those two). The description of its 

functions and responsibilities emphasizes handling mostly SIPe's administrative affairs, 

including internal accounting, retirement plan, member assessments, and SIPe's credit 

agreement, along with administration of debtor estates. In practice, although the Finance 

Division occasionally handles administration of debtor estates, and easily has the capacity and 

expertise to do so, most of that work is handled by external trustees or other consultants. The 

Information Technology Division is also silent on recruiting criteria, though it's small, consisting 

of an A VP and two others (one with the phrase High School appearing). 

2. Trustee's Guide (undat~. The Trustee's Guide appears to be a generally reliable 

guide to the law and practice of customer protection proceedings under SIPA that SIPC carries 

out. Newer lawyers in the Legal Division and lawyers working for trustees or counsel attested to 

the value of this Guide. My own impression is that it provides a comprehensive and detailed 

reference for trustees, whether within SIPC or external. It seems to be a vital tool of SlpC's 

corporate governance. It is written clearly, contains copious statutory and other references, and 

includes extensive exhibits of repeatedly used legal forms and other materials central to a 

trustee's duties. It appears to have been prepared by senior or former lawyers in the Legal 

Division and shows a considerable exertion of effort to consolidate relevant and useful 

information in one place. 

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That said, the Trustee's Guide is undated but looks dated, other than a few pages that 

have obviously been updated recently. The first recommendation is to date it and consider 

preparing annual updates with complete incorporating revisions every five or so years. It shows 

its age in several ways, many trivial but some important and all worth updating now. I have not 

compared the Trustee's Guide to relevant statutory requirements as these may have been 

amended since the last publication, and a legal review of that may be warranted. I also 

understand that some advanced complexities in the Lehman case require addressing matters 

beyond the Guide's scope. To the extent those issues may recur, lessons from that proceeding 

should be incorporated into the Guide and its exhibits. 

A cursory review shows that the Trustee's Guide appears to have been written before the 

proliferation of voice-mail, e-mail and the dawn of the internet. Examples that should be 

updated include the following. Add electronic passwords to the list of things the trustee should 

secure (p. 2-2: "get keys, burglar alarm codes, combinations, or anything else which will 

facilitate entry into the premises and files or offices") and to change (p. 2-2, referring to 

changing locks on doors and safes). When directing trustees to post a sign on the brokerage's 

office listing name, address and telephone number (p. 2-2), add the trustee's e-mail address and 

any Web page. When advising trustees to assume control of mail (p. 2-3), add e-mail. Add 

computers and internet access to the list of necessary services that trustees must maintain that 

now lists telephone, electricity, and water (p. 2-7). In the references to various kinds of leases (p. 

2-7), add a reference to computers. When telling trustees to respond to answering machine 

messages and letters (pp. 3-1 and 3-2), change the reference to answering machines to voice-mail 

and add e-mail and advise updating any internet Web sites. 

All these examples prompt suggesting creating a separate section to the Trustee's Guide 

on updating or creating an internet Web site for the failing firm and its liquidation. That would 

also be a logical place to discuss SIPC's new technological capabilities relating to submitting and 

reviewing customer claim forms on line. That page or other sections of the Trustee's Guide 

might discuss other examples of technological modernization the current version addresses but 

that are less obviously outmoded. These include the reference to making publication in 

newspapers (p. 5-2) and a suggestion to consider updating that to include publication on a firm's 

Web site or for trustees to create a Web site. Another example concerns references to getting 

stock price quotes from The Wall Street Journal (p. 5-2), which does not publish the 

comprehensive list it once did, and suggesting updating that to reference reputable online sources 

like Yahoo Finance or E-Trade. 

A few otber minor questions or suggestions concerning technology arise. The Trustee's 

Guide references (p. 5-1) short retention periods by clearing brokers for computer tapes. I 

wonder whether that is still true. Page 1 J -4 refers to a SIPe spreadsheet formatted in Quattro 

Pro; it says that will be sent to the trustee on diskette, but now that's probably sent bye-mail 

attachment. There are references to the NASD that should be updated to FINRA (examples 

appear on pages 5-2 and 18-1). Also showing signs of age is the reference on page 8-1: "If there 

will be a distribution of a large block of securities, review Exhibit 26 and consult with SIPC's 

legal staff." Exhibit 26 is a 1972 document and I wondcr whether it is still current. For the 

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avoidance of doubt, I suggest updating the 1972 document by rewriting it in the form of a 

currently dated memorandum. 

Statements on page 17-1 should also be updated. These refer to R.M. Smythe & Co., 

Inc., at 170 Broadway, New York, New York, as in the business of appraising non-marketable 

securities. Smythe was acquired in 2008 by Spink and is now called Spink Smythe, and its 

current address is 145 West 57th Street (18th floor), New York, New York 10019, telephone 800-

622-1880, and its internet address is www.spinksmythe.com. The Guide adds that Smythe 

publishes a reference book called "Robert D. Fisher Manuals of Valuable and Worthless 

Securities 1926 to 1971." It appears that the suffix (referring to years) has been dropped from 

that volume's title. The Trustee's Guide also says that Smythe will research whether seemingly 

worthless securities actually have value and, if so, will sell them through Herzog and Company, 

taking a fee. It's worth veritying whether Spink Smythe still does that through Herzog. The 

Guide says that Smythe is the "only firm in America which performs this type of research." An 

SEC web site page suggests there may be others, including Financial Information, Inc., publisher 

of Financial Stock Guide Service. 

As a question of style, this edition of the Trustee's Guide invariably uses masculine 

pronouns, which is no longer the norm for corporate documents in America. (An exception 

appears on page 11-4 where reference is made to "his or her." Related pages, discussing 

reviewing fee applications of trustees and counsel, were obviously updated around 2003 after the 

SEC made related policy suggestions on that subject.) Of minor importance, but worth doing if 

updating the Trustee's Guide: the Guide's dozens of exhibits are referenced out of order, with 

Exhibits 27, 28, and 29 referenced on page 1-4, and references to other exhibits, beginning with 

exhibit I, appearing on page 2-1 and later pages. Similarly, the Guide's index of exhibits as they 

appear in the accompanying CD presents them in a random order; the list should be revised to 

appear in alpha-numeric order. It would also be helpful to include in the list of exhibits a crossreference to pages in the Guide where exhibits are referenced or discussed. 

3. Operations Manual (August 2004). The Operations Manual offers a clear and 

comprehensive guide of great utility to examiners within SIPC and to consultants they may retain 

from time to time. It is clearly written and makes the process easy to understand. The 

Operations Manual manifests a valuable repository of accumulated practical wisdom essential to 

the liquidation process. I understand that it was last updated in August 2004, in a project led by 

an examiner recently recruited at that time. It could now use some updating, though its content 

and style makes it appear less outdated than the Trustee's Guide (including its routine use of both 

masculine and feminine or neutral pronouns). For example, the Operations Manual should be 

updated to reference the internet as a resource in several places (an example appears on page 16 

when discussing dealing with a debtor's office space) and to change occasional references from 

the NASD to FINRA (e.g., p. 27). 

Concerning the Operating Manual's style, there is some duplication of text in the 

Trustee's Guide. (Examples appear on p. 12, Public Relations; p. 15, Immediate Actions of 

Liquidation Proceedings; and p. 23, Bank Loans.) This duplication may be intentional and 

desirable, to the extent that the two resources are of primary value to different professional 

groups, lawyers and examiners, who may not be assumed to read both documents. But that may 

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be doubtful and in any event worth noting. In addition, the paragraphs on page 40 (concerning 

allocation in connection with an account transfer) and page 41 (on final housekeeping matters) 

span nearly a full page each. They should be broken up into multiple paragraphs. Once broken 

up, the discussion of final housekeeping may warrant unpacking and expansion, as it seems to 

condense important steps into dense prose unlike the clarity in the rest of the Manual. It 

compresses topics I would expect to see spelled out in an operations manual. 

As with the Trustee's Guide, of like minor importance but worth doing if updating the 

Operations Manual, the exhibits are referenced out of order. (For example, exhibit 3 is first 

referenced on page II while exhibit 2 is first referenced on page 15; and on page 32 a series of 

exhibits appears in this confusing order: 4, 5, 8, 9, II, 7, 10, 6). Also as with the Trustee's 

Guide, it would help to include in the list of exhibits (p. 42) a cross-reference to pages in the 

Manual where they are referenced or discussed. 

Page 25 of the Operations Manual says: "The Trustee should bring any Repo transactions 

to the attention of the SIPC attorney assigned to the case." This reads as if it was inserted as a 

one-off addition when a more comprehensive approach may be warranted. I can see why this is 

not delineated, given the potentially uncertain classification of such transactions as securities or 

not. But there are likely other instruments that defy easy classification that may warrant similar 

direction too--as discussed next. 

B. Expand Document Wealth 

I. Current Practices. The Trustee's Guide and Operations Manual cover substantial 

territory and may have been comprehensive when originally published and most recently 

updated. Since then, however, developments may have occurred that warrant considering 

additional documentary support, either as parts of those documents, as exhibits, or as stand-alone 

resources. In the spirit of the modernization motif, it's clear that many of today's brokerage 

firms and securities products differ substantially from those that existed during the first several 

decades of SIPC's existence. That is certainly true of larger firms, like Lehman, and is also 

likely true of many other SIPC members. 

The sheer volume of brokerage and securities activity has led to firms that are more 

decentralized and have staffs with more specialized tasks and assignments. The pace of 

innovation in securities products has accelerated rapidly and results in a variety of securities well 

beyond stocks, bonds, shorts, options, and even repurchase agreements, to include a bewildering 

array of structured products, derivatives, advanced forms of options, like long-term equity 

appreciation securities (LEAPS), and other instruments, held in additional kinds of accounts, like 

portfolio margin accounts. These developments and how examiners and trustees may be 

expected to handle them-when, whether and how to close tllem out, under the Series 300 rules 

of the CFR, for example--may warrant capturing in documentary form, as a repository of 

collective and accumulated wisdom and experience among SIPe's staff, both in the Legal and 

Operations Divisions. 

In some ways, the two groups have different needs and may have different interests. 

Examiners are interested in clarity concerning such matters as whether particular financial 

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instruments are securities within the meaning of that term of art or not, and how to handle them; 

some lawyers may desire like clarity, though others may be more willing to leave contestable 

classification issues like that to particular contexts when they arise. Even so, some effort to 

synthesize the variety of firms and products could be fruitful. That may be particularly useful to 

enable staff with more recent maturation points to share cutting edge knowledge with veterans 

for whom the pace of innovation and change may seem overwhelming. It's a way to consolidate 

knowledge that likely would prove useful to new recruits to both Divisions, whatever wealth of 

experience they may bring with them to SIPC. 

That can also provide an organizational road map for dealing with problems that can be 

foreseen though faintly. A comparative historical example may illuminate. SIPA was amended 

in 1978 to require trustees to replace customer securities with open market purchases. That 

change was made without any advance planning and there was no written reflection or guidance 

about what that would involve or how a trustee should proceed. Within SIPC, a consensus 

emerged merely to muddle through the process without formally stating policy in a manual or 

otherwise. 

As it happened, that approach worked reasonably well and trustees developed procedures 

and practices informally and case by case over time to implement that statutory requirement. But 

it remained true that advance written guidance would have been helpful in many cases. In 

today's world, with greater complexity, and a more conscious tendency for organizations to 

adopt formal written manuals on various subjects concerning operations, attempting to articulate 

aspects, issues, and resolution procedures concerning brokerage firms and securities products 

may be warranted, all in the spirit of modernization. 

2. Consultants/Trustees Data Base. Despite considerable internal expertise, it's common 

for SIPC staff to engage outside experts on various matters, including when examiners engage 

accountants, consultants and others for discrete tasks, and when lawyers retain external trustees 

and trustee's counsel. The Vice President Operations maintains a data base of consultants and 

this is reportedly available to examiners. That list includes information they supply about 

themselves and capabilities. There are as many as eight to ten based in New York and others of 

smaller size scattered nationwide. For trustees (and counsel), a dozen easily-recognized large 

New York based firms are available for most cases (with about four tapped regularly throughout 

SIPe's history); for smaller cases elsewhere in the country, the legal team finds local counsel in 

local areas when needed using customary techniques for identifying legal professionals. 

But it was not obvious in my review that all examiners or lawyers are aware of such data 

bases, access them regularly, or can readily identify required expertise quickly. I understand that 

this may be due to how retention of external professionals is determined at SIPe's officer level 

and in accordance with other policies recommended in the 2004 Corporate Review Services 

report. Even so, given the varying complexities and needs of different liquidation cases and the 

value of consultants having just the right expertise for a job, and familiarity with SIPC (see 

Operations Manual, p. 14), it may be desirable to provide staff-wide access to data bases of 

consultants and trustees on whom examiners and lawyers can call as needed. Ideally, the data 

base would include not only information the external professionals supply but notes on previous 

SIPC assignments completed, and brief notes on its value and cost. This could simply involve 

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incorporating into the data base evaluations of external consultants made at the conclusion of 

cases. That may be helpful to relatively newer SIPe staff and may also formalize a pool of 

potential future employees SIPC may from time to time wish to recruit. 

C. Human Resources Investment 

I. Recruiting and Training. It's vital to SIPe's continued success that it be able to recruit 

capable professionals in all its Divisions. Among staff in the Legal Division and Operations, it's 

essential that professionals be familiar with ongoing securities brokerage business developments 

and practices, able to work toe-to-toe with trustees and their counsel and outside accountants and 

other consultants. Ideally, the professional staff would consist of persons across the career 

ladder, to enable the team as a whole to possess the range of value that comes from a 

combination of veteran experience along with energetic new perspectives. That facilitates the 

transmission of senior knowledge down the career ladder and mutual education about evolving 

trends and practices. 

The Legal Division's current composition approximates that ideal, with its members each 

separated roughly by a decade of seniority and representing all cohorts. The Operations 

Division, in contrast, tends to be congregated among more senior personnel, making it, as one 

noted, "a bit long in the tooth." It could be desirablc to plan a recruitment program to address 

that imbalance. One reason for the difference in the Divisions may be due to the required skill 

set or recruiting philosophy. Recruiting of lawyers at SIPe emphasizes academic achievement 

along with some securities litigation experience. Lawyers younger and older will qualify and 

find the job offer strongly appealing. 

The Operations Division emphasizes back office brokerage experience, with less 

emphasis on formal education. And in today's brokerage environment, with highly specialized 

tasks, there are simply fewer people towards the earlier career stages who have seen the broader 

range of back office operations. The result may be a natural and rational propensity to recruit in 

the more senior ranks. That's may be optimal, so long as a continuing supply of talent is 

available. But it does reduce the particular and overall length of service examiners have with 

SIPC. Onc solution is continuing to recruit examiners for SIPe from among the group of outside 

consultants used in other customer protection proceedings. Another would be a combination of 

accepting less experienced applicants with beefed up training may be useful. That said, it's 

notable that kindred recruiting challenges seem to appear at cousin organizations in Washington, 

such as the FDIC and SEC. 

2. Officers. SIPe's existing organizational structure is coherent, essentially dividing the 

corporation into two Divisions, Legal and Operations/Finance, with one officer overseeing each 

and each of them reporting to the President, the only other officer. The Operations/Finance half 

of the corporation is further segmented into those two components, each overseen by an 

Assistant Vice President, plus a technology sub-division. SIPe's By-Laws don't exactly map 

onto that reality, though. They contemplate as officers a Senior Vice President - Finance, a 

position that's not presently occupied, along with a Vice President for each of Finance and 

Operations, positions currently combined and held by a single individual (as the By-Laws 

authorize). Given existing governance realities, however, it seems that if SIPC wished, for 

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promotion, retention, or recruitment, to name a Senior Vice President, the role would be at least 

as desirable overseeing Operations as Finance. Adding such an authorized officer to the ByLaws, a Senior Vice President Operations, may thus be desirable. 

It's also notable that two other officer positions authorized in the By-Laws, Controller 

and Treasurer, are not presently occupied. Instead, the current Vice President Operations and 

Finance oversees the non-officer Assistant Vice President - Finance, who discharges related 

functions. This comparison of the By-Laws to existing entitlement indicates that there is room 

within the organizational structure to recognize achievement and provide advancement, should 

that be desirable. It's not possible to make any particular recommendations in this regard, as 

nothing has come to my attention that would justify any, but the built-in flexibility and other 

points warrant noting. 

3.~LQfessional Development. Tbe Trustee's Guide contains as exhibits two law review 

articles published by SIPC lawyers, one by its current President and former General Counsel 

when he was Assistant General Counsel (1982) and one co-authored by its current General 

Counsel when sbe was Associate General Counsel (1990) (her co-autbor was then SIPC's 

Deputy General Counsel and later its President). These are excellent, and oft-cited, overviews of 

mucb of wbat SIPC docs and its statutory mandate. They were undoubtedly valuable exercises 

for those authors and useful contributions to the field when published two and three decades ago. 

It may be desirable to encourage current SIPC lawyers to consider undertaking similar 

contemporary endeavors, as suggested by a more recent (2006) shorter piece by its President 

(and former General Counsel) and Associate General Counsel appearing in the American 

Bankruptcy Institute Journal. It could be particularly interesting and valuable to provide case 

studies of the customer protection proceedings arising out oftbe Lehman insolvency and Madoff 

fraud. 

More broadly, it could be desirable to increase support for external training of tbe 

professional staff. Tbat certainly includes maintaining existing support for periodic professional 

development events. More important, it would include tuition support to complete unfinished 

college degrees and for advanced specialized degrees relevant to the field. Four of SIPC's six 

examiners (not the Vice President or Assistant Vice President) attended college but did not 

complete it or earn the degree. For any of those who may find it desirable, and have the time, it 

would be a wonderful employer outreach to support that, as many other modern corporations do. 

That may be an especially appealing tool to help address the recruiting challenge discussed 

earlier. Likewise, all SIPC lawyers obviously earned their J.D. degrees, and one bolds an 

advanced law degree, the LLM (in tax law). If any of those sbould wish to pursue an LL.M., 

especially one focused on securities law or other related specialty, it would be an appealing show 

of professional support for SIPC to back that, again as many other modern corporations do.' 

I Corporate examples include large corporations like JC Penney and Northrop Grumman; quasipublic agencies like the Port Authority of Ncw York and New Jersey; and smaller enterprises 

like WaWa Corp. Human resource management firms like Cerdian can help. See 

www.ceridian.comlemployee_benefits_nav/I.6267.15689.00.html. There are tax-advantaged 

and tax- limited ones. See www.finaid.org/otheraid/employertuitionassistance.phtml. 

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D. Substantive Document Updates and Highlights 

I. Compensation P()licyJQ[ Outside Consultall.ts. Aside from employee salaries and 

benefits, SIPC's largest category of operating expenses, important expense line items reflect 

legal, accounting, and other professional fees. Though obtaining excellent professional services 

is the paramount concern, SIPC maintains policies designed to contain those costs and SIP A 

addresses this by requiring court approval of certain fees. Policies include those emphasized in 

the 2004 Corporate Review Services report addressing controls to prevent improprieties in 

retaining and paying external consultants. They include policies such as the Legal Division has 

of asking for litigation budgets from retained outside counsel. They include suggestions the SEC 

made in 2003 concerning requesting invoices at least quarterly and, for large cases during great 

activity periods, monthly. SIPC policies also speak to requesting discounts for services and 

assurance that quoted rates will remain in effect for at least one year. 

They also routinely reference language such as the following. Concerning fees of 

trustees and trustee's counsel, the Trustee's Guide states: "Tasks which can be competently 

performed by an associate should not be performed by others whose time commands higher 

rates." Trustee's Guide, pages 1-3 and II-I. The Trustee's Guide and the Operations Manual 

amplifY that point for compensation of all external consultants, whether trustees, counsel, 

accountants, or others, seeking an "understanding that the firm will use persons with the lowest 

grade who are qualified to perform the tasks required." Trustee's Guide, page 12-1; Operations 

Manual, page 13. These expressions and others reflect a commitment to compensation based on 

hourly rates. The SEC's intervention clearly contemplated fees for legal services based on 

hourly rates, suggesting that hours be classified in designated categories, and the Trustee's Guide 

requires fee statements to provide detailed record of time expended, including the number of 

hours and the hourly rate. Trustee's Guide, pages 1-2 and 12-1. 

Though hourly rates, performed at lowest-priced competent levels, may contribute to 

ideal cost containment policies, it's important to appreciate that SIPC's practices do not adhere 

rigidly to this model. They are more congruent with current developments in professional fee 

practices that increasingly depart from both the hourly rate and the formulation about least-cost 

competent providers. This is especially so in the legal profession, though extends to other 

professional service providers too. 

Law firms traditionally grew through associate leverage for profitabi lity. The business 

model admitted large numbers of young associates, paying $80 per hour (say $160,000 for a 

2000 hour year) and billing them at $180 to $250. Firm partners made money and enticed some 

associates to make partner. Today, corporate clients have become stronger, with in-house 

counsel wielding more power. Many don't accept the leverage pyramid structure anymore or 

fund it. They say something like: ''I'll pay $750 per hour to get advice and representation from a 

true expert, but won't pay $250 per hour for an associate learning what they're doing." 

Examples abound. The "Value Challenge" issued by the Association of Corporate Counsel calls 

for corporate clients to move away from hourly billing altogether2 Some ACC members are 

refusing to pay anything for work done by anyone without at least two years practice experience. 

1 See www.acc.com. 

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75077.101

SIPe's own practices reflect these developments and, of course, even its written policies 

about external compensation are not inconsistent with it. Significant discounting occurs, 

including a considerable discount for the trustee and its counsel in the Lehman case. The law 

firm has reduced its monthly billings for hourly rates significantly and isn't charging, as other 

firms do, for the cost of meals and transportation. SIPe pursues such flexibility in other ways, 

including negotiating to adjust for the value of services rendered without slavish adherence to 

hourly billings or rates. When feasible, contingency fees are used, especially for collection 

cases, though that's only feasible for matters with discrete outcomes. Accordingly, it may be 

desirable to update SIPe's written policies to reflect its flexibility in practice as a way to assure 

that this knowledge is communicated to newer SIPe staff and to external consultants, trustees, 

and trustees' counsel. 

Modest adjustments to the existing language may be all that's warranted. Examples may 

include: "Though SIPe is accustomed to accepting proposals and fee applications based on 

hourly rates using the least-cost competent personnel, overall cost for outstanding professional 

value is what's sought. SIPe is interested in discussing alternative billing arrangements, which 

may include fixed pricing for discrete assignments and/or involving higher-cost personnel to 

perform assignments in less time so that, on balance, least cost is achieved with greatest 

professional skill." 

2. Highlighting Vital Statements. Modern corporations, including those of SIPe's size, 

tend to have adopted several specific manuals or statements. Standard examples are mission 

statements; codes of corporate ethics; and policies concerning internal control. SIPe already has 

versions of materials like these scattered in various governing documents but it could be 

beneficial to highlight these vital statements differently. Doing so should not result in complex 

documents or foster bureaucracy within SIPe or diminish its nimbleness and family spirit. They 

should embrace a positive sense of mission, ethics, and compliance. 

A mission statement may seem like a redundancy within SIPe, given the clear and often 

repeated directive derived from SIPA to promote investor confidence by providing protection to 

customers of securities brokers and dealers. Yet that would also render the task of producing a 

mission statement easy, and the statute doesn't exactly use those phrases. There is a widespread 

view among SIPe personnel, and among outsiders, that SIPe's mission and their jobs are 

particularly noble. They are to protect customers by returning cash or securities in failed 

brokerages, and "within statutory limits, to replace such cash or securities when they are missing. 

That's an easy mission statement to write and would both cement and build morale. It can 

certainly help get through difficult days or cases and can have other salutary effects. 

SIPe has a code of conduct set out in its By-Laws and restated verbatim in its Personnel 

Guide, along with additional statements concerning seeking employment elsewhere and 

whistleblower procedures and protections. These are provided to all employees, who are also 

asked to attest to receiving and understanding them. In the past, that attestation exercise was 

repeated for all employees whenever the documents were amended; in the future, this will be 

done annually whether amendments were made during the year or not. These policies reflect 

prevailing best practices among corporate employers, a norm reflected in the Sarbanes-Oxley 

Act of 2002, which requires public companies either to adopt a code of ethics or explain why 

they don't. 

A-IS 
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75077.102

SIPC's By-Law and Guide provisions are important statements of core values and 

warrant just a few suggestions. The code of conduct appears in the By-Laws in a penultimate 

Article labeled "Miscellaneous" (pp. 17-20). While substantively unobjectionable, that 

classification may wrongly signal a triviality to the provisions that should not be sent. 

Accordingly, it may be desirable to revise the By-Laws to add a separate newly named article 

containing the code of ethics. In tum, the Personnel Guide reiterates those provisions and adds 

material, including whistleblower policy. 

It's not obvious why the additional material appears in the Guide but not in the By-Laws. 

Perhaps this is because the Board adopts the By-Laws, subject to SEC approval, and SIPC's 

officers adopt the Guide. Yet that procedural point doesn't diminish the substantive value of the 

full combined code of conduct and other statements of ethics. Consideration should be given to 

giving both sets of standards equal prominence in both the By-Laws and the Guide. (As with the 

Trustee's Guide, these materials also invariably use solely the masculine pronoun, something to 

edit when updating them.) I understand that even such reformatting of the By-Laws would 

require SEC involvement and approval. It still may be worth doing. 

A parallel example, may help. SIPC's By-Laws also contain vital provisions concerning 

member advertising. This is seen as so vital that SIPC has separately created a stand-alone 

document presenting it, republishing it on its CD-ROM accompanying its 2009 Annual Report. 

A similar separate presentation of the By-Law concerning the code of ethics, combined with the 

additional material from its Personnel Guide, could be prepared. (As with the code of conduct, 

this advertising By-Law appears in the Article called "Miscellaneous." (pp. 13-17). That 

heading isn't proportional to the topic's vitality, which would be reflected by giving the topic its 

own ArticleJ ) 

Sarbanes-Oxley imposes specific requirements for internal control over financial 

reporting, and most corporations maintain extensive systems for that and to assure compliance 

with law. SIPC maintains internal control over financial reporting on substantially, though not 

exactly, the same basis as prescribed by Sarbanes-Oxley and related standards promulgated by 

COSO and adopted by the PCAOB. Those are reviewed annually by SIPC's outside independent 

auditor, Grant Thornton in recent years, though only for the purpose of auditing SIPC's financial 

statements---·not as a separate audit of internal controls as Sarbanes-Oxley requires. Such audits 

are costly and there is no obvious justification for SIPC to follow that practice. Indeed, SIPC 

occasionally has requested its outside auditor to conduct particular tests of certain controls, 

including whether employees received and understand SIPC's Personnel Guide, especially its 

whistleblower provisions. That may be sufficient. Accordingly, I do not necessarily recommend 

expanding the annual audit to include internal controls, but this report wouldn't seem complete 

without mentioning it. 

* * * * 

3 If revising the By-Laws, it may also be good housekeeping to relocate another item classified 

as miscellaneous, limiting corporate capital expenditures, to Article 8, which likewise limits 

corporate borrowing, making assessments, and pledging security. 

A-19 
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75077.103

j:e\l·r:B.CM\,$,;' 

i'lu;r:.l;.hC.,lld',\,-n; 

Testimony Before the 

Ho Broad S1reN 

Fifth floor 

New York. :-,iY 10004 

('fIX 

www Investorprotection.com 

United States House of Representatives Committee on Financial Services 

Subcommittee on Capital Markets, lnsu.-ance and Government-Sponsored Entcrpl'iscs 

"The Securities Investor Protection Corponltion: Past, Present & FutUl'c" 

Wednesday, March 7,2012 

By 

Steven B. Caruso 

Maddox Hargett & Caruso, P.e. 

Chainmm Gan·ett. Ranking Member Waters and members of the Subcommittee: 

I am Stcycn B. Caruso. the resident partner in tbe New York City office of Maddox 

Hargett & Caruso, p,c., a 1m\' finn \\'hose practice is almost exclusively devoted to the 

representation of public investors in connection \\'i\h thcir disputes with the securities 

industry, I am a past President and 3 past member of the Soard of Directors ortlle Public 

Investors Arbitration Bar Association ("PIASA"), which is the largest national 

association of anorneys whose individual law practices foclls on the representation and 

protection of public investors in securities arbitration proceedings, and 1 am also the 

current Chairman of the National Arbitration and Mediation Committee ("NAMe") of 

the Financial Industry Regulatory Authority, Inc. C'rINRA"J. which is the advisory 

groLlp that provides recommendations on the rules, regulations and procedures govel11ing 

secllrities arbitrations, mediations and disputc resolution acti\'ities. 
161 


75077.104

Testimony of Steven B. Caruso 

March 7, 2012 

Page -2-

In June 01'2010. I was asked to serve as one of the Iwcl\'c (12) members of the SIPC 

Modernization Task Force ("'SIPC Task Force"), a group which consisted of investor 

advocates, representatives oJ'the securities il1llustry. go\'crnment regulators and 

acadcmia. from across the nation, as \\ell as one international member. 

The stated mission of the SIrC Task Force \\3S 10 undertake a comprehensive review of 

both the Securities Inycstor Protection Act ("SIP;\") and the Securities Investors 

Protection Corporation' s ("'SIpe"') operatiolls and policies, and to propose reforms to rhe 

Board of Directors of S1 PC and other interest"d parties, \\ith respect to statutory 

Clm.;ndments and other operational and/or procedural relincments, as may he appropriate. 

giwn the passage or time since: thc original enactll1cnt of SIPA changes thal we have all 

"xpcrienccd in the securities industry and judicial precedents and/or interpretations 

thereof 

1 am honored to be able to have the opportunity to share with you my thoughts and 

perspectives on the SJPA and SJPc. frolll the point or vi"w of both 111)' professional 

experienccs as an investor advocate and, of "qual importane". as a mcmber of the SIrC 

Task Force, 

Historical Overview of SIP A & SIPC 

When the United States Congress enacted SIPi\ in 1970. and created the SIPC. its stated 

purpose was to promote: inH:stor confidence in the nmion's securities markets through the 

extension of certain protections against certain losses to customers resulting from the 

financial difficulties and/or failures of their broker-dealer tirms, 

SIPe is a nonprofit membership corporation whose membcrs arc, with certain limited 

statUlory exceptions. all persons registered as brokers or dealers under S"ction 15(h) of 

the Securitics Exchange Act of 1934 and all persons \\'ho arc mcmbers of a national 

securities cxchange, ;\s of December 31, 2010. it is rcp0l1ed that there \v"re 4.773 

members ofS1PC. 

Since lh" inception of SIPC in 1970 through thc end or 20 1 0, it has been reported that 

SIPC had commenced 322 customer protection proceedings, in accordance with the 

requirements that arc set fixth in SIPA. and, during Ihat same period of time, it is 

estimated that SIPC distributed cash and securities to an estimated 739.00() customers of 

those failed brokerage iirms in the approximate aggregate amount oJ' $1 09.3 billion, 
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75077.105

Testimony of Steven B. Caruso 

March 7,2012 

Page -3-

"rh~ monetary resources that arc required to protect and reimburse cListomers of nliled 

broker-dealers are derived from three (3) primary sources - the assets in the possession of 

the trustee for the estate oCtile lailed broker-dealer. assessments that are collected Crom 

Sirc members and imerest that is eamcd on SJrCs investmcnt in United States 

government securities (collec(ively tile "SIrC fund"). As a supplement to the SIre fund. 

the United States Securities & Exchange Commission (""SFC") has the authority to lend 

SII'C up to $1 billion which it, in turn. would borrow directly from the United States 

Treaslll'J'. 

The SIPC Modernization Task Force 

I belie\'e that the objective of the SIPC Task Force was clear and unequivocal (0 

modernize SIPA and SIPC so as to ensure that its role in the protection of investors and 

thc promotion of investor confidence: in the nation's securities markets remains viable. 

Beginning at the inaugural meeting of the SJPC Task Force in June of20 I 0 and 

continuing thereafter at a number of subsequent meetings and through numerous 

telephone conferences, the members oCthe SIPC Task Force discussed and debated a 

number of issues thn! were applicable 10 OUl' mission statement and objective. 

Among the topics that were re\ie\ved by the SIPC Task Force wcre SIPes corporate 

governance. adequacy of cxisting SIPC protection. the ongoing viability of the S[1'(, 

fund. inherent limitations ()n il1\'Cstor protection. investor education, the misnomer of 

\\hat has commonly been referred to as excess SIPC "insurance" and the relationship of 

all oCthese initiatives in the context orthe international arena. 

It is nowble that. in connection with the efforts that were undertaken by the SIrC Task 

Force. an interactive website \vas established (www.SIPCModernization.org) through 

which the general public was given thc OPPOt'llillity to prO\'ide comments and 

recommendations (0 sirc and each of (he membcrs of the SIPC Task Force. It is also 

notable that. in the course or the review that \vas undertaken by the SIPC Task Force. 

several public forums were held through which investors ancl other interested parties were 

given the opportunity to provide comments. thoughts and suggestions on the process that 

was undertaken. 

In February of 20 12, the slPe Task Force presell1ed its tindings. conclusions and 

proposals for retorm in a written report that was submitted to the SIPC Board of 

Directors ("SIPC Task Force Report'} 1'01' (heir consideration, and a complete copy of 

our report \Vas made publicly available on both SIPC's \\'ehsitc and the dedicated website 

of the SIPC Task Force. 
163 


75077.106

Testimony of Steven B. Caruso 

March 7,2012 

Page -4-

Focus on Specific SIPC Task Force Topics 

In my role, as a member oi"thc slPe Task Force. and based on my O\VI1 personal 

experience with SIPA and SIPC. as an attorney who has provided representation to 

numerous investors in SIPC proceedings. it is my personal belief that there are a number 

of recommendations, til at arc included within the SIPC Task Force Report. which should 

be immediately adopted by SIPes Board ol'Directors and remain a focus of the 

oversight responsibilities of the members ofthis Subcommittee. 

These recommendations include. but arc nolneccssarily limited to. the follo\\'ing: 

1. First and tLll-emost is the SlPC Task Force reeolllmendation that the limitation on the 

maximum amount of protection that is provided by SIPC in a SIPA proceeding. which is 

cLlITcntly $500.000 per customer. should he increasea to $1.3 million and that. moving 

forward, the level of protection should be indexed to the rate of inJ1ation. 

The rationale of the SIPC Task Force. with respect to this recommendation. \vas 

predicated on a number of factors \\hieh included. li)r example. that $1.3 million would 

represent [he current indexed value oJ'what $500.000 in 1980 would be worth today: that 

the $1.3 million level of protcetion \vould be sufficient to protect more than 90'),~) of all 

retail customer accounts: and that this increased level ofprolection would more 

adequately reflect the economic realities of the securities industry today and the amount 

of investable assets that investors entrust to their finuncial advisors. 

2. The second SIPC Task Force recommendation is the recommendation that would 

eliminate the current distim:tiol1 in the SII'A level of protection between "claims for 

cash" and "claims for securities'" 

The rationale oCthe SIPC Task Force. with respect to this recommendation. was 

predicated on a number of f~lctors which included. for example. lhat the distinction is 

arbitrary and has, in the past. kd to the disparate treatment of clistomers in SIP A 

proceedings: it has generated an atmosphere of confusion on behalfofthe investing 

public who simply do nol understand the distinction between the nature oftlle protectiol1s 

that are provided by SIPC when their broker-dealer firms encounter financial difficulties 

and/or fail; and it is a distinction that is no longer grounded in reality giwl1 the \vay that 

cash and securities are held at bmker-ckalcrs. 

3. The: third SIPC Task Force recommendation that I would like to highlight is the 

recommendation that would require amendments to SIP A so as to provide pass-through 
164 


75077.107

Testimony of Steven B. Caruso 

March 7,2012 

Page -5-

SII'C protection to individual investor pal"licipants in ddined bendit pt'nsion plans. 

defined contribution plans and deterred profit sharing plans. 

The rationale oethe slPe Task force, \Iith respect to this recommendation, was 

predicated on a Ilumber or factors whieh includcd. for example. that there are an 

estimated 40 million participants who have their assets invested in privately sponsored 

pension plans who, under the current SJP!\ limitations, are exposed to catastrophic losses 

in the event that their broker-dealers should [~lil: and that these investments typically 

represent the retirement accounts and life savings orman), indirect inlestors \vho do not 

h3\'e a choice as to where tllCir assets are held. 

4. And the fourth SIPC Task Foree recommendation that I would like to mention in my 

C0111ments today is the recommendation that \\ould impose a minimum ICc assessment or 

at !east $LOOO on every SIPC broker-dealer member. 

The rationale of tbe SIPC Task Force, \\i1h respcetto this recommendation. was 

predicated on a number of factors \\'hieh included, lor example, a recognition of the fact 

that prior SIPC member assessment Je-\cls - which were historically $150 per year Ivere 

unjustifiable ti'om an economic perspective: tllc amendments that \\we incorporated 

\\ithin the Dodd-frank Act had the unintended consequence of rcdueing SIPC member 

assessment levels to amounts that were even lower than S150 per year or. in some 

instances, those assessments \\'ere eliminated in their entireties: and the continuing 

concerns as to the economic viability orthe sIre Fund itself given the potential adverse 

ramifications that could be associated with recent liquidations - and the potential l-iJture 

liquidations- of major broker-deakrs. 

Conclusion 

Thank you for providing me with tbe opportunity. as a member of the SIPe Task Force. 

to share with you Illy thoughts and perspectives on both SIPA and SIPe. 

[ would be happy to entertain any questions thut the members of'thc Subcommittee may 

have. 
165 


75077.179

TESTIMONY OF IRA D. IIAMMERMA:'-I, 

SENIOR MANAGING DIRECTOR AND GENERAL COUNSEL, 

SECURITIES INDUSTRY AND FINANCIAL MARKETS ASSOCIATION 

BEFORE THE 

U.S. HOUSE OF REPRESENTATIVES 

FINANCIAL SERVICES COMMITTEE 

SUBCOMMITTEE ON CAPITAL MARKETS AND GOVER:'oIMENT SPONSORED 

ENTERPRISES 

HEARING ON: 

THE SECURITIES INVESTOR PROTECTION CORPORATION: 

)'AST, PRESENT, AND :FUTURJ<: 

MARCH 7, 21H2 

I. Introduction 

Chairman Garrett, Ranking Member Waters, and members of the Subcommittee: 

My name is Ira Hammerman, and I am Senior Managing Director and General Counsel 

of the Securities Industry and Financial Markets Association CSIFMA")! and a member of the 

SIPC Modernization Task Force (the "Task Force") formed by the Securities Investor Protection 

Corporation (,'sIPe) I am appearing here today as an individual member of the Task Force 

and I am not speaking on bchalf of my fellow Task Force members. Thank you for allowing me 

to submit my full statement for the record. 

The Task Force undertook a comprehensive review of the Securities Investor Protection 

Act ("SIPA") and SIPC's operations and policies and proposed reforms to modernize SIPA and 

SIPC. The Task Force worked hard for approximately a year and a half. and recently presented 

its official Report and Recommendations to the Board ofSIPC Directors. I would like to thank 

my fellow members of the Task Force, and SIPes dedicated staff, for their hard work. 

commitment. and willingness to consider a variety of proposals. My testimony will focLls on 

several of the Task Force's recommendations regarding appropriate revisions to SIPA. 

II. Report and Recommendations of the Task Force 

I want to begin by highlighting some of the important pro-investor changes recommended 

by the Task Force. The Task Force recommends expanding and increasing the protection 

available to customers of broker-dealers in three important ways. As you know, when a brokerSfFMA brings together the shared interests of hundreds of securities firms, banks and asset managers. 

SIF\1A's mission is to support a strong financial industry, investor opportunity, capital formation. job creation and 

economic gro\vth, v.'hilc building trust and confidence in the financial markets. SIFMA, with offices ill New York 

and Washington D.C .. is the U.S. regional member of the Global Financial :V1arkets Association. (More information 

about SIFMA is available at http://www.sifma.org.) 
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75077.180

dealer is liquidated and thc cListomer property marshaled by the trustee is inadequate to return to 

the broker-dealer's customers all funds and securities they entrusted to the custody of the brokerdealer, SIPC makes advances from its own funds to assure the return of the cllstomers' property. 

Since 1980, these advances have been capped at $500,000 per customer. The Task Force 

recommends increasing the maximum advance amount from $500.000 to $1.3 million to adjust 

the limit to reflect inflation since 1980. SIPA also currently distinguishes between claims for 

cash and claims for securities, setting a lower $250.000 limit on advances to customers based on 

claims for cash entrusted to the broker-dealer. The Task Force recommends eliminating the 

distinction in lcvels of pwtection between investors' claims for cash and claims for securities. 

which has been a subject of controversy and a source of expensive and unproductive litigation. 

Finally. the Task Force also recommends a limited "pass through" ofSIPC protection to make 

individual pension plan participants eligible for SIrC advances with respect to their share orthe 

plan's account at a failed broker-dealer. These recommendations appropriately rdlect SIPA 's 

purpose of promoting investor contidence in the U.S. capital markets by protecting investors 

against a loss of cash or securities in a failure of the broker-dealer holding their property. They 

also reflect positive progress in the efTort to modernize SIPA and SIPe. 

While 1 support these recommendations. 1 wish to note that they were made without any 

real consideration of their cost to SIPC. This cost will be funded by the members ofSIPC and. 

ultimately. by the investing public. Before implementing these recommendations. I urge 

Congress to obtain a reasonable estimate of the costs of the expanded protection and consider 

whether thesc costs would be justified by the increased investor confidence. As of this date. 

there has been no such analysis, and I believe an adequate analysis of the modernization of SIP A 

and SIPC is not possible without it, so as to ensure that well-intentioned investor protection and 

modernizatioll measures do no inadvertently undercut SIPC's overall effectiveness in protecting 

investors. 

Ill. SIFMA's Recommendations Not Fully Addressed by the Task Force 

1 am disappointed by the Task Force's failure to take action with respect to several 

critical areas previollsly identified by SIFMA. In particular, SIFMA believes it is essential to 

ensure consistency between SIPA and the SEC's Customer Protection Rule (Rule 15c3-3). 

When a broker-dealer fails and enters liquidation under SIPA, SIPA provides tor the distribution 

of the customer property held by the failed broker-dealer to its customers,pro rata. based on the 

nct value of the securities and cash in their respective accounts. known as their '"net equity:' 

Any mismatches between the Customer Protection Rule's reserve and segregation requirements 

and customers' net equity claims in a SIPA proceeding can result in an insolvent broker-dealer 

holding insufficient customer prope.1y to satisfy all customers' net equity claims. The current 

discrepancies between the Customer Protection Rule and SIPA were briefly addressed by the 

Task Force's report. which recommended further study. I believe the Task Force missed an 

opportunity to identify the specific discrepancies that currently exist and recommend resolutions. 

I also believe, however. that additional discrepancies are likely to arise as the SEC promulgates 

rules for the protection of securities-based svvap customers, unless the SEC is given the power to 

make rules under SIPA that will harmonize the customer protection scheme and the liquidation 

process. 

2 
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75077.181

A. Need For Consistcncy bctween SIPA and the SEC's Customer Protection Rule 

SIPA and the Customer Protection Rule must work together. The Customer Protection 

Rule requires each broker-dealer to maintain possession or control of its customers' fully paid 

and excess margin securities and deposit into a reserve account an amount generally equal to its 

net monetary obligations to customers or in respect of customer securities positions. When a 

broker-dealer enters liquidation under SIPA. the customer securities and the reserve account are 

available for distribution to customers. IfSIPA and the Customer Protection Rule are 

harmonized (and the broker-dealer had complied with its obligations). the failed broker-dealer 

should have sufficient customer property to fully satisfy the net equity claims of all customers. 

Unfortunately. the t\\O are not fully harmonized. 

Perhaps the most significant divergence between SIPA and the Customer Protection Rule 

is the status of proprietary accounts of broker-dealers. A broker-dealer's net equity claim based 

on its proprietary account is a customer claim eligible to share in the pro rata distribution of 

customer property Linder SIPA (although not eligible for SIPC advances), but the proprietary 

account of a broker-dealer is not treated as a customer account for purposes of the Customer 

Protection Rule. As a consequence. there may be net equity claims entitled to share in the pro 

rata distribution of customer property for \\hich no assets were sct aside. In the liquidation of 

Lehman Brothers, Inc. C·LBI"). for instance. Lehman Brothers International (Europe) eLBIE"). 

an English broker-dealer affiliate of LBI, has filed cllstomer claims for approximately $10 billion 

based on its proprietary positions. but the Customer Protection Rule did not require LB I to 

maintain possession or control ofLBIE's securities or make deposits into its reserve account in 

respect of obligations to LBIE. LBI's trustee has challenged the "customer" status of these 

claims. but if they ultimately are allowed as customer claims, the gap between SIPA and the 

Customer Protection Rule may cause a sizeable shortfall in the customer property available for 

distribution to LBl's customers. 

The SEC has proposed to nan'ow this divergence by requiring broker-dealers to fund a 

separate reserve account with an amount generally equal to its net monetary obligations with 

respect to proprietary accounts of other broker-dealers or in respect of securities positions in sllch 

accounts. (The possession or control requirement. however. would not be applied to securities 

positions in these accounts. provided that written permission to usc the securities is obtained.) 

While a step in the right direction - SIFMA has filed a generally j,worable comment on this 

proposal other divergences between SIP A and the Customer Protection Rule continue to exist 

and should be reconsidered. For example, a similar difTerence exists in the treatment ofprincipal 

officers and directors of a broker-dealer. who are non-customers under the Customer Protection 

Rule but are eligible for customer status under SIPA. 

B. Clarity and Consistencv in the Treatment of Securities-Based Swaps 

SIFMA is also concerned that. as the SEC develops the customer protection requirements 

applicable to broker-dealers that act as securities-based swap dealers, the divergences between 

the SEC's customer protection requirements and SIPA will only increase. The Dodd-Frank Aet 

amended the stockbroker liquidation provisions oflhe Bankruptcy Code to treat accounts holding 

securities-based swaps as "securities accounts'· (to the extent of any applicable customer 

protection or segregation requirement) but no similar amendment was made to SIPA. leaving 

3 
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75077.182

unclear the treatment in a SIPA liquidation of customers' securities-based swaps (and related 

cash and securities margin). Although this issue was not addressed by the Task Force. SIFMA 

believes that customers who have securities-oased swaps in an account at a broker-dealer 

generally should have a net equity claim calculated based on the value of the securities-based 

swaps. any cash or securities in the account. and the vallie of any other positions (e.g.. securities 

or commodities futures or non-securities-based swaps) in the account at least to the extent of 

any applicable customer protection or segregation requirement. 

SIFMA is concerned. however. that maintaining a single class of customers. which 

encompasses cash account customers. margin account customers. portfolio margin customers. 

and securities-based swap customers. may unfairly impose risks of the newer and more complex 

types of accounts and transactions (i.e., portfolio mal'gin and securities based swaps) on the 

customers who have simpicr accounts (i.e., cash accounts). Accordingly. SIFMA recommends 

that consideration be given to dividing broker-dealer customers into separate account classes, 

tailoring customer protection rules to each specillc account class and activity in a way that 

provides for a separate pool of customer propCl1y for each separate account class, and. in a 

liquidation under SIPA or the Bankruptcy Code. distributing the customer property for each 

accollnt class solely to members of that account class based on net cquity calculated based on all 

positions in the customers' respective accounts of that class. It may be appropriate to separate 

customer accounts into at least the following three classes: 

• Cash account~. Cash account customers hold only fully-paid long securities positions 

and cash credit balances. The customer protection rules would require the broker-dealer 

to maintain possession or control of all securities belonging to these customers and fund a 

reserve account in the amount of all of their credit balances. In a liquidation of the 

broker-dealer, accounts in this class and the related customer property should be easily 

and efficiently transferred to a solvent broker-dealer or a bridge financial company (either 

in bulk or individually at the direction of the relevant customer). 

• Margin accounts. More sophisticated margin account customers could have long and 

short positions and debit or credit balances in margin accounts subject to Federal Reserve 

Board Regulation T. This account class could generally be subject to the current 

customer protection rules relating to possession or control of certain securities (which 

allow some margin securities to be used by the broker-dealer to obtain financing related 

to customer positions) and requiring a reserve account to be funded on a formula oasis. 

POl1folio Margin and Swaps Accounts. The most sophisticated customers havc portfolio 

margin accounts and/or swaps accounts. containing long and short securities and options 

positions. securities-based and non-securities-based swaps. credit or debit balances and 

possibly also futures positions. This account class should also be subject to customer 

protection requirements relating to possession or control of customer securities and to the 

funding of a reserve account. but those rules would need to take into account the brokerdealer's use offunds or securities to carry swaps that hedge the customer swaps 

positions. 

It may also be appropriate to develop additional account classes. or to modify the classes 

outlined above: the precise delineation of the separate account classes should be the subject of 

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further review and careful study and should only bc adopted after 0pp0l1unity for public 

comment. 

C. .Rule-Making Power 

The best way to accomplish the harmonization ofSIPA. the Bankruptcy Code and the 

SEC's Customer Protection Rule is to grant rule-making authority to the SEC similar to the 

authority that the Commodity Futures Trading Commission (the "CFTC',) has under Section 20 

of the Commodity Exchange Act to make rules regarding the comt11odity broker liquidation 

provisions of the Bankruptcy Code. and to instruct the SEC to make rules under both the 

Bankruptcy Code and SI PA regarding the scope of customer property. the determination of a 

customcr's net equity and the method of liquidation of a broker-dealer that are consistent with 

the customer protection rules applicable to operating broker-dealers. In carrying out this 

instruction. the SEC could follow the CFTC in creating different "account classes" as outlined 

abovc, cach with rights in separate pools of customer property that may be created by customer 

protection rules adapted to the circumstances of the account class. (The SEC has already starteu 

uown the path of creating separate account classes by proposing different customer protection 

requirements for prorrietary accounts of broker-dealers. including the creation of a separate 

reserve deposit for these accounts. but the separation is meaningless if these accounts are lumped 

together with the securities accounts of public custolllers in a liquidation of th" broker-dealer.) 

IV. The Fundamental Purpose of SIPA Protection 

Turning to the question of fraud committed by a broker-dealcr. I would like to address 

two dilTercnt but interrelated issues. As members of this Subcolllmittce know. SIPA's 

fundamental purpose is to promote investor confidence in the U.S. capital markets by protecting 

customers against the loss of cash or securities entrustcd to the custody of the broker-dealer 

holding such property. To the extent the customer property held by the failed broker-dealet· is 

not sufficient to satisfy the net equity claims of all of the customers of the failed broker-dealer. 

SIPC funds arc advanced f()t' each customer in order to replace the missing securities and funds. 

As intended by Congrcss. however. SIPC's funds arc available only to replace missing customer 

property; they are not used to protect investors against any other risks. 

1 share in the sympathy with, and outrage on behalf oL the many innocent victims of 

massive frauds by the likes of Madoff and Stanford. Financial fraud undermines confidence in 

our markets and our regulatory system. However. SIPA is not intended to protect investors 

against losses on their investments, only against losses of their investments in the event of a 

broker-dealer failure. Investing in securities inherently exposes the investor to market 

fluctuations in the value of the securities. Investors who lose money because ofa decline in the 

value of the securities purchased for their accounts are not protected by SIPA against such losses. 

whether the decline is due to market forces or even due to fraud. SlPA, for instance. would have 

provided no protection to investors who purchased Enron stock or bonds against the losses they 

realized through Enron's fraud and resulting hankruptcy (although it would have provided them 

protection against the loss of their Enron securities if their brokers failed). Under this principle, 

investors who purchased certificates of deposit in Stanford International Bank (an Antiguan bank 

that was allegedly operated as a Ponzi scheme) are not protected by SJPA against the possibility 

that those certiticates of deposit are worthless. As sllch. SIFMA opposes efforts to extend 

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SIPCs protection to cover. for the first time. fraud by the issuer of certain securities (in this case. 

ccrti ficates of deposit) purchased by the customer which are neither lost nor stolen but in fact in 

the holders' possession. This extension would likely deplete SIPCs recently increased targeted 

reserves 01'$2.5 billion (up from SI billion) and even exhaust the additional $2.5 billion that 

SlPC is able to borrow from the SEC (and, indirectly, from the U.S. Treasury), leaving SIPC 

unable to protect securities investors until its funds are replenished. Even more importantly, this 

extension would be an unprecedented expansion of the protection provided by SIPC and is in 

direct connict with the fundamental purpose and intent ofSIPA. 

SlPA's protection for broker-dealer customers difTers from the Federal Deposit Insurance 

Corporation's ("FDIC's") insurance for bank depositors in the samc way that securities 

investments differ from bank deposits. Bank deposits represent a debt of the bank to the 

depositor. They are generally intended to be a safe use of funds and to provide only a limited. 

but low-risk return. The FDIC insures the payment of the bank deposit, including accrued 

interest, in the event of a bank failure (up to the limits of the insurance coverage). Securities 

accounts at a broker-dealer, by contrast. hold investments of the customer in securities (and 

related cash amounts). Customers invest in securities to benefit from increases in the value or 

the securities (and Irom dividends. interest or other distributions 011 the securities), but also take 

the risk that the value of the securities may drop, potentially to zero. SIPA is not intended to 

protect customers against declines in the value of their accounts due to changes in the value of 

their securities investments, but only against the loss of their actual securities due to a f~1ilure of 

the broker-dealer. SIPC's advances are therefore only available to customers who do not receive 

their cash and securities investments, not to customers whose investments go sour or turn out to 

be fraudulent. 

V. "Net Equity" Calculation in the Context of a Fraudulent Scheme 

In a SJPA liquidation. customers have claims for their "net equity" that are satisfied by a 

pro rata distribution of the failed broker-dealer's "customer property:' plus, if that distribution is 

inadequate. up to $500.000 of SIPC advances. A customer's "net equity" is calculated by taking 

the value of the long securities and cash in the customer's account and subtracting the value of 

the short secllrities positions in the account and any indebtedness of the customer to the failed 

broker-dealer. In the ordinary course, a SIPA trustee looks to a customer's account statements 

and the books and records of the failed broker-dealer to cstablish the securities positions and 

cash balances used to compute the customer's net equity. When a broker-dealer is operated as a 

Ponzi scheme, however. the cllstomer account statements will themselves be fraudulent it is the 

essence of a Ponzi scheme that the perpetrator reports false profits to the investors - and 

therefore thc statements do not truly represent positions in the customers' accounts. 

Instead ofrclying on ti'audulent account statements to determine the net equity of the 

customers of Bernard L. Madoff Investment Securities LLC ("Madofr'), the trustee appointed by 

SIPC to liquidate Madoff has used the "nN investment" method. Under the net investment 

method, the fraudulent customer account statements are disregarded and a customer's net equity 

is determined solely by reference to the amount of money the customer entrusted to the Ponzi 

scheme operator and the amount of money the customer received from the Ponzi scheme. The 

customer's net equity is his or her net investment in the fraudulent scheme -the excess (if any) 

of the amount entrusted over the amount received. This method was originally developed with 

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respeclto fraudulent schemes outside of the SIPA conte~t as far back as the 19205 and has been 

regularly applied by sevcral trustees and courts in SIPA liquidations (including the Madoff 

liquidation, where it was rccently upheld by the Court of Appeals for the Second Circuit). 

When a failed broker-dealer was operated as a Ponzi scheme, SIFMA believes that, as a 

matter offundamental fairness, this net investment method should be lIsed to determine net 

equity for purposes of the distribution of customer property held by the failed broker-dealer. Thc 

propeliy held by a Ponzi scheme and used to make distributions to the '"investors" in the scheme 

is simply the pooled property ofal! victims of the scheme, and making distributions based on 

anything other than their net investment would be fundamentally unfair - at best it would result 

in sharing the losses unevenly among the victims, and in some cases it would result in 

perpetuating the scheme by taking money from some victims and paying it to others to satisfy 

their claims for false profits. 

VIII. Conclusion 

In conclusion. SIFMA appreciated the opportunity to participate in the work of the Task 

Force and is committed to working constructively to modernize SIPA to better protect investors 

and thereby increase investor confidence in the financialmarkcts. SIFMA looks forward to 

continuing to work with the Subcommittee on these il1lpol1ant investor protection issues. 

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Statement 

of 

Stephen P. Harbeck, President and Chief Executive Officer 

Securities Investor Protection Corporation 

Before the 

Capital Markets and Government Sponsored Enterprises Subcommittee 

ofthe 

House Financial Services Committee 

March 7, 2012 

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 ("SIPC"). My name is Stephen Harbeck, and I am the 

President and CEO of SIPC. I am pleased to appear before you today with Ms. Sharon Bowen, 

the Acting Chair of SIPC, who will address the recommendations of the SIPC Modernization 

TaskForce. 

Since the collapse of the Lehman Brothers entities in the fall of 2008, SIPC has been at 

the center of the subsequent financial crisis. I would like to provide an overview of SIPC's role 

in the major events that have arisen fi'om 2008 through the present day. 
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I. 

Ongoing SIP A Liquidation Proceedings of Note. 

A. Lehman Brothers Inc. 

The Chapter 11 proceeding for Lehman Brothers Holdings Inc. CLBHI"), and the 

Securities Investor Protection Act ("SIPA") liquidation of its subsidiary broker-dealer, Lehman 

Brothers Inc. ("LBI"), is the largest bankmptcy, of any kind, in history. SIPC is extremely proud 

of its role in protecting investors in that unprecedented case. 

Distributions to Customers in the I,BI Liquidation 

On September 19, 2008, within hours of his appointment by the United States District 

Court for the Southern District of New York, the Trustee, James W. Giddens, applied for and 

received permission from the United States Bankruptcy Court for the Southern District of New 

York to transfer customer accounts to a solvent brokerage firm. The hearing in the Bankmptcy 

Court that afternoon, which extended into the early morning ofthe following day, was described 

in the American Bankruptcy Institute Journal as the most important bankruptcy hearing in 

history.l Over the vigorous opposition of some creditors, the Trustee, supported in court by 

SIPC, sought and obtained authority to transfer the accounts to Barclays Bank and Ridge 

Clearing. As a result, control of approximately 110,000 customer accounts at LBI, containing 

approximately $92.3 billion in assets, was returned to customers, fully satisfying their claims, 

within days after the start of the SIPA proceeding. The Trustee and SIPC overcame substantial 

logistical problems to effect that transfer, and that achievement was critical to maintaining 

1 S. Lubben, The Sale of the Century and Its Impact on Asset Securitization: Lehman Brothers. 

American Bankruptcy Institute Journal, December/January 2009 ("Lubben"). Id., fu 4. 

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customer confidence in not only the American securities markets, but also the securities markets 

across the globe during the 2008 fmancial crisis.2 

The satisfaction of claims in LBI addressed SIPC's primary mission ... the protection of 

small investors ... virtually immediately, and none of the related entities were nearly as complex 

as LB1.3 Every investor with an account and a valid claim ofless than $500,000 in assets owed 

in connection with the account has been fully satisfied. 

Other Accomplishments in the LBI Liquidation 

Some other significant facts and major achievements in thc LBI case include: 

The magnitude and complexity of the LBI liquidation is apparent from the fact 

that the size of the estate marshaled and administered by the Trustee exceeds $117 billion. 

The Trustee has defended against, and pursued, high stakes litigation in the 

liquidation proceeding and he has done, and is doing, so successfully. As just a couple of 

examples -- the Trustee prevailed in his recovery against Barclays Bank of $2.3 billion in a 

dispute over margin assets seized by Barclays. That matter continues to be litigated on appeal. 

Likewise, the Trustee recovered $757.4 million cash, and $106 million in physical securities, in 

settlement of a dispute with JP Morgan Chase. Moreover, the Trustee has prevailed in other 

2 Lubben noted as follows, fn 4: "See proffered testimony of BalTY W. Ridings at Transcript, p. 

146 - ("Any failure to consurmnate [the Barclays's sale] may potcntially cause a major shock to 

the financial system") and the remarks of Judge Peck, Transcript at 171 ("in unrebutted 

testimony [Mr. Ridings J indicated through proffer that the markets, in effect, would tank [if the 

sale was not approved].") 

3 In enacting SIPA, Congress intended to protect the small investor. SIPC v. Morgan, Kennedy 

& Co., 533 F. 2d 1314, 1321 (2d Cir. 1976); McKenny v. McGraw an re Bell & Beckwith), 104 

RR. 842, 855 (Bankr. N.D. Ohio 1989),.<lID!. 937 F.2d 1104 (6th Cir.1991) (Congress was 

primarily concerned with protecting small investors). 

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litigation matters involving complex securities issues such as the proper valuation of Sholt 

positions or the determination oftri-party set-off rights. 

The claims that remain for resolution by the Trustee ale neither small nor easily 

resolved. Remaining claims involving the LBI U. K. firm, LBI's parent company, and numerous 

hedge funds will involve a dispute over approximately $42 billion. 

Approval ofthe Chapter 11 Plan for LBHI 

On December 6, 2011, the United States Bankruptcy Court for the Southern District of 

New York approved a liquidating Chapter 11 plan for LBHI. In doing so, Judge James Peck sald 

that the case represented the most "overwhelming outpouring of creditor consensus in the history 

of insolvency law. What a differenee three years makes." The packed courtroom applauded after 

Judge Peck's remarks.4 

Judge Peck, who presided over the Lehman case, took a moment at the confirmation 

hearing to offer his views on the challenges in restructuring debts of this magnitude and 

complexity: 

My world changed when the Lehman cases were assigned to me and so did 

yours. For me, it has been a once in a lifetime experience. To have worked 

across the bench from so many outstanding professionals in promoting conflict 

resolution and helping to bring these truly extraordinary one-of-a-kind cases (0 

this culminating substantive moment, superlatives abound. And we have heard 

them all and probably used them all. This is the biggest, the most incredibly 

complex, the most impossibly challenging international bankruptcy that ever 

was. 

But the greatest superlative of all is reserved for today. This largest ever 

unplanned bankruptcy that started in chaos, accelerated the financial crisis and 

eroded confidence in the global financial system also has yielded the most 

overwhelming ontpouring of creditor consensus in the history of insolvency 

4 Lehman Closes a Chapter: As $65 Billion Bankruptcy Plan is Approved, Cheers and Tears 

Color Courtroom" 

http://online.wsj.com/articie/SBI0001424052970204770404577082451546013514.html 

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law. What a difference three years can make. Never before have divergent 

holders of 450 billion dollars in claims recognized the benefits of pragmatic 

compromise and come together as one in support of a single Chapter 11 

plan. This is a monumental achievement in our field, awe-inspiring, really, 

that, to me, represents the highest and best use of Chapter 11 in the public 

interest. 

For myself, I'm cxtremely proud to have presided over this transparent, fair 

and the remarkably successful process that stands out as perhaps the finest 

example of the flexibility, power and utility of the United States bankruptcy 

system. Our system is not perfect. But together we have shown the world that 

it can work very well indeed. Lehman may once have been a too-big-to-fail 

systemically significant global financial institution. But it was not too big to 

resolve in Chapter 11. 

I congratulate each and every professional in every single law firm and 

advisory firm here and in foreign jurisdictions that contributed in ways 

recognized and unrecognized, large and small, to this historic confirmation of 

Lehman's plan. You should all feel great pride in what has been 

accomplished.5 

SIPC concurs with Judge Peck's remarks and will continue to move the ease to 

conclusion. 

Litigation success in the United Kingdom 

I am pleased to report that last week, the Supreme Court, the highest appellate court in 

the United Kingdom, has ruled in a way that greatly assists the customers of LBI, the United 

States SIPC member. The Court held that cash sent by customers to LBIE, a British entity, is 

deemed to be segregated for customers immediately upon receipt by LBIE, rather than at the 

point where LBIE actually placed the funds in a segregated account. Thus, if funds found their 

way to a "house" account, these funds will be deemed segregated. (This is the rule in cases 

under SIP A as well.) 

5 Weil Bankruptcy Blog: _ 

http://business-finance-restructuring.weil.com/chapter-ll-plans/confirmedi#axzzl14PJ5URO 

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This result in this Lehman matter also has very positive ramifications for the American 

customers ofMF Global. 

B. Bernard L. MadoffInvestment Secnrities LLC 

While Lehman Brothers is the largest bankruptcy of any kind in hiStOlY, the Madoff case, 

initiated three months later in December 2008, is the largest Ponzi Scheme in history. The 

Madoff case presented a completely different sct of challengcs. 

Claims Determination and Satisfaction 

The first major challenge for SIPC and Irving Picard, the Trustee in the Madoff case, was 

to determine who was eligible to share in "customer property" and advances from SlPC in this 

massive fraud. WIllie the scope and duration of the Madoff fraud was unprecedented, SIPC had 

dealt with similar, albeit smaller Ponzi Schemes, in the past. SIPC and the Trustee took the same 

positions taken by SIPC and other trustees in prior SIP A cases involving fictitious pricing, and 

used a "net investment" methodology. This is also consistent with how virtually all other Ponzi 

Scheme claims are calculated. Persons who withdrew more than they deposited were thus 

ineligible to share in "customer property" or SIPC advances. The position taken by SIPC and the 

Trustee was affirmed by the United States Bankruptcy Court, and the United States Court of 

Appeals for the Second Circuit, and the latter Court refused to review the decision en banco The 

matter is now the subject of three petitions for certiorari to the United States Supreme Court. 

In other claims related matters, the Bankruptcy Court and the United States District Court 

upheld the Trustee's Determinations concerning persons who invested in hedge funds which, in 

tum, invested with Madoff. The Courts held that cach of the hedge funds was a customer but the 

limited partners who owned the respective hedge funds were not entitled to "customer" status. 

That matter is on appeal to the Second Circuit. 

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Asset Recovery 

The Trustee and his counsel have made enonnous progress in recovering assets for 

ultimate distribution to the most impaired class of creditors, to wit, those claimants who have not 

recovered all of their original investments with Madoff. The Trustee's website summarizes the 

more than $9 billion in such recoveries to date, and that summary is attached as Exhibit A. This 

represents approximately half of the amount originally invested by claimants with Madoff. 

This is an extraordinary result. The tools available to the Trustee under SIPA and the 

Bankruptcy Code made these recoveries possible. 

Certain hedge funds had valid claims against the Madoff estate, but were required to 

return the proceeds of preferential and fraudulent transfers before sharing in any distribution. In 

entering into settlement agreements in these situations, the terms of the settlement agreements 

typically specify (at the insistence of the trustee and SIPC) that the proceeds of any subsequent 

distributions to the hedge funds flow directly to investors, without management receiving any of 

the money. Because SIPC knows this issue to be of concem to many members of the 

Subcommittee, a more detailed discussion of this issue is attached as Exhibit B. 

C. MF Global Inc. 

SIPC was called upon to initiate the liquidation of MF Global on virtually no notice. 

Unlike bank failures, brokerage firm failures typically take place with very little advance 

warning. The initiation of the liquidation for MF Global is very instructive. It provides insight 

into how SIPC responds immediately in a crisis situation. 

On Monday moming, October 31, 2011 at 5:20 a.m., I received a telephone call from a 

representative of the SEC's Division of Trading and Markets who was then in New York. The 

purpose of the call was to inform SIPC that a SIPA proceeding was necessary for MF Global. 

This was the first notice to SIPC that such action was required to protect investors. I immediately 

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telephoned SIPC's Chairman, Orlan 10hnson, and sent the Chairman an email, indicating the 

need to start the case. The Chairman is authorized by SIPC's Bylaws to approve the initiation of 

a proceeding. I also telephoned other officers and senior members of the SIPC staff, who 

convened at SIPC's office at about 7:00 a.m. SIPC's legal staff drafted pleadings to begin the 

liquidation. SIPC received a formal written notification from the SEC that a liquidation 

proceeding was appropriate under 15 U.S.C. section 78eee(a)(l) via email from an SEC official 

at 7:29 a.m., stating the basis for commencing the casco 

While four members ofthe SIPC staff flew to New York, the relevant personnel at SIPC 

made simultaneous inquiJies to a number of professionals as to whether those persons, and the 

law f!Ims with which they were associated, were presently engaged in the MF Global matter. 

This was done so as not to designate a person 01' firm with an irreconcilable conflict of interest 

which would have prevented their serving nnder the "disinterestedness" test. Approximately ten 

possible trustees and connsel having the requisite bankmptcy experience, skill and resources, 

were considered. Some were not called because it was public knowledge that those prolessionals 

were indeed involved in the MF Global case. Approxilnately five persons were contacted. Of the 

five, only two law firms were eligible to serve; three had conflicts. Of the two remaining law 

f1Iffis, one had never served in a previous SIP A case. MF Global presented the nnprecedented 

situation of a large brokerage failure that did not only have a securities, but a multi-billion dollar 

commodities, business. Because this matter would not be the appropriate case for a firm with no 

prior experience, SIPC then determined that James W. Giddens, perhaps the most experienced 

individual in dealing with SIP A cases, having served as counselor trustee in such cases since the 

early 1970s, was best suited for this complex case. After discussions with Mr. Giddens to assure 

SIPC that he and his firm had sufficient available resources and that they were disinterested, 

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SIPC designated him as Trustee, with Hughes, Hubbard & Reed as his counsel. All of those 

decisions had to be made within hours; SIPC filed its legal papers in New York, obtained a court 

order in New York, and Mr. Giddens took control of the MF Global premises the afternoon of 

October 31. 

SIPA places the responsibility for choosing a Trustee and counsel on SIPC. In the MF 

Global case, the wisdom of this statutory provision made it possible to have a fiduciary in place 

less than 12 hours after SIPC was notified of the necessity to protect investors. Further, r am 

pleased to report that the Trustee transferred over $1.5 billion in investor assets in the MF Global 

ease within one week. Choosing a veteran Trustee made this possible. 

Presently, the Trustee has distributed 72% of assets to 27,217 commodities account 

holders, and 60% plus up to $500,000 to 300 securities account claimants in the casco The 

trustee's most reccnt status update of the case, dated February 6, 2011, is attached as Exhibit C. 

D. Stanford Group Company 

SIPC declined to initiate a liquidation proceeding for the Stanford Group Company 

because the SEC bad not demonstrated that any investors left assets at the SIPC member 

brokerage finn. The investors voluntarily purchased certificates of deposit issued by the 

Stanford Intemational Bank in Antigua. In the words of the SEC those certificates of deposit 

paid "excessive and perhaps impossible" rates of return. Each investor, under SIPA, either (a) 

has his or her certificate or (b) is entitled to the delivery of that certificate or its value, namely, 

the value of a CD issued by a bank under the control of liquidators in Antigua. 

Let me be very clear: in the forty year history of SIPA, SIPe has never been interpreted 

to permit SIPC to refund the purchase price of a bad investment. This is true even when the 

investment was induced by the fraud of a SIPC member firm. If there is to be a change in the 

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law, Congress should change the law only after rigorous debate about the wisdom and 

implications of such a policy. The SEC should not usurp legislative authority and expand the 

role of SIPC far beyond Congressional intent or the plain words of SIPAIf SIPC is to be revised to afford the protections of the SIPA statute to allow SIPC to pay 

claims based upon the rescission of fraudulent transactions, this is a task for Congress, after 

deliberation on the significant consequences of such a change. 

II. 

SIPe and the Dodd-Frank Act 

The Dodd Frank Act made a number of changes to SIPA. First, the Act made changes to 

the minimum assessment charged to SIPC members. Ms. Bowen's testimony on the Task Force 

Report will mention a potential new amendment which should prevent an unintended result, to 

wit, that some SIPC members now pay no assessment. 

Second, SIPe's credit line with the Treasury was increased from $1 billion to $2.5 

billion. 

Third, SIPC now protects cash up to $250,000 in each customer's account. 

Fourth, the Dodd-Frank Act criminalized certain misrepresentations about SIPC 

membership, and increased criminal fines for misconduct. 

Since the enactment of the Dodd-Frank statutory regime, there has been no instance 

where SIPC has been called upon to step in with respect to a financial conglomerate that would 

be wound down under that statute. While the Act authorized the FDIC to liquidate systemically 

significant fmancial firms, including those with broker-dealer subsidiaries, Congress set up the 

regime to be used sparingly. The fact that the Dodd-Frank statutory program was not brought to 

bear on the MF Global situation is a case in point. According to the filings in the Chapter 11 

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proceeding of MF Global' s parent company, the overall bankruptcy is the eighth largest 

bankruptcy in history, measured by assets. Y ct the wind down of the business, and the 

satisfaction of claims, is proceeding under the Bankruptcy Code and SIPA, as Congress intended. 

III. 

n.R.757 

SIPC does not support H.R. 757. While SIPC is aware of the significant financial distress 

wrought by Madoff and that the intent of the bill is to provide for a more equitable distribution 

under SIPA, the provisions of the bill would actually: 

(a) Result in a less equitable distribution, 

(b) Have the unintended consequence of rewarding, encouraging, and perpetuating Ponzi 

Schemes, 

( c) Allow a fraudulent actor to establish the distribution criteria in the subsequent liquidation 

proceeding. 

(d) Pledge the assets of SIPC, and, indeed, the American taxpayer, to guarantee the fictional 

profits invented by fraudulent actors. 

An analysis illustrating the inequality of distribution under the proposed legislation is 

attached as Exhibit D. 

The bill would reverse long standing judicial precedents which arc specifically designed 

to enforce equitable distributions. SIPC urges the Committee not to disturb the existing statutory 

scheme. By limiting the ability of a trustee to use preference and fraudulent transfer provisions 

of the Banlauptcy Code, the distribution to claimants is less equitable, by any objective standard. 

Further, the bill would reverse some of the salutary results achieved in the Madoff case, in that it 

would apply to ongoing cases. Such a result would cause chaos in the case, literally changing 

the law mid-stream. 

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H.R. 757 also removes SIPe's authority to designate a trustee and counsel in a SIPA 

case. 

SIPC and trustees, in the words of the Second Circuit Court of Appeals, both vindicate 

important public interests. It would indeed be odd if trustees and SIPC disagreed often. That 

said, no one can make the remotest claim that SIPC chooses anyone other than extremely 

qualified fiduciaries. I submit that the track record of trustees in the cOUlis demonstrates that 

trustees uphold the SIP A statute as Congress wrote it. That is the criteria upon which trustees 

should be judged. 

It is true that SIPC has returned to proven experts when it is appropriate to do so. But 

SIPC does not choose from a "SIPC alumni" list. Out of 324 customer protection proceedings, 

only 2 former employees have served a total of 4 times as a trustee or counsel in a SIPA case. 

There is no revolving door. 

IV. 

H.R.1987 

SIPC does not support H.R. 1987. To the extent that bill seeks to limit the use of 

bankruptcy avoidance powers in a SIPA case, this bill presents the same problems as H.R. 757. 

H.R. 1987 also changes SIPA by making a very broad category of individuals 

"customers" of a defunct brokerage firm, even where those individuals had no relationship 

whatsoever with the brokerage. Thus, individual limited partners in a hedge fund would be 

individual "customers" of a brokerage firm if the hedge fund itself held an account. This is at 

odds with the basic concepts of corporate ownership (that is, the hedge fund, not the paliners, 

owns the account). To the extent H.R. 1987 would change this concept in ongoing liquidation 

12 
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75077.120

proceedings, it would also reverse judicial opinions in the Madoff case, and reverse other 

precedents dating to 1976. 

As Ms. Bowen indicates in her testimony, the SIPC Modernization Task Force 

considered this issue and proposed that only a very nalTOW subset of "indirect" investors be 

covered in future cases. Of course, the potential costs of such a legislative change requires 

further study. 

The bill also makes a significant change in how "customer" accounts are cvaluated by 

introducing an "inflation adjustment" concept which does not appear in SIPA as cUlTently 

enacted. This would have the effect - demonstrable in the Madoff case - of increasing the return 

to claimant~ who have already received all of their own investment proceeds at the direct 

expense of persons who have not received less than they inv~sted. SIPC does not SUppOlt that 

result. A Ponzi Scheme is a "zero sum" situation. While well intended, this provision damages 

those who have lost the most. 

V. 

H.R.4002 

The bill appears specifically designed to deal with the Stanford Ponzi Scheme, discussed 

above. 

For the following reasons, SIPC does not support the bilL 

At the outset, let us stipulate that the victims of the Stanford Antigua Bank fraud are truly 

victims. Nevertheless, cxisting law does not protect them, and H.R. 4002 cannot be reconciled 

with the basic policy of the existing law. It is important to understand that his approach would 

fundamentally change the nature ofSIPC. 

13 
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75077.121

The bill proceeds from a premise that radically alters the fundamental protection 

available under the Securities Investor Protection Act (SIP A). 

As we discussed infr!b the reason SIPC has declined to start a proceeding in the Stanford 

case stems from the essential nature of the dispute. SIPC protects the "custody" function 

brokerage firms perform. This means that customers are protected against the loss of the cash 

and securities held for them by their broker-dealer when the broker-dealer fails financially. In 

Stanford, after literally years of factual investigation, the SEC has not produced a single 

customer who left assets in the custody of the SIPC member brokerage at Stanford. Indeed the 

SEC's then General Counsel specifically concluded that SIP A protection did not extend to the 

Certifieate of Deposit (CD) purchasers in the Stanford case. 

The persons who bought CDs in Stanford purchased CDs issued by a bani, chartered 

under Antiguan law for which two liquidators have been appointed. The CDs have declined in 

value. Fraud was involved. But SIPA does not permit SIPC to repay thc original purchasc price 

to other investors who purchase fraudulent investments in Enron, or any other security, including 

the CDs here at issue. SIP A does not pClmit SIPC to rescind transactions that result in losses. 

The investors have their CDs. The CDs have a value, but that value depends upon what the 

Stanford Antigua Bank liquidators can distribute to them. The risk of loss never leaves an 

investor just as thc prospect of profit never leaves thc investor. 

Other facts bear out the Stanford CD purchasers' ineligibility for protection. In buying 

the CDs, the investors were requircd to open accounts at the Antiguan Bank, not at the 

brokerage. Moreover, in making the purchase, each investor was required to sign a subscription 

agreement/investor questionnaire in which the investor acknowledged having received a 

Disclosnre Statemcnt. More than once, thc Disclosure Statement cautions the CD purchaser that 

the CDs ru:e not protected by SIPC. 

14 
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75077.122

The only time SIPC would decline to initiate a customer protection proceeding is where 

SIPC has concluded that there is no investor who fits within the "customer" definition. That is 

what is apparent here. The reason the SEC did not immediately refer this matter to SIPC in 2009 

is because the SEC knew then that there were no "customers" that fit within the SIP A statute. 

Indeed, there is only one instance in 42 years where SIPC has declined to start such a 

proceeding, to wit, the matter involving the Stanford Financial Group. Thus, although the bill 

refers to "customers" of a debtor firm, there are no such persons, as that term is statutorily 

defined in SIP A, 

The bill presents SIPC with the worst of both worlds. 

Payment of a settlement is typically designed to terminate legal proceedings, or the 

prospect of legal proceedings. Here, the bill contemplates that SIPC would proffer certain 

payments to persons SIPC believes are not eligible for SIP A's protections ... and still proceed 

with a lawsuit. To extend a realistic hypothetical: If SIPC wins the lawsuit initiated by the SEC, 

that wguld mean that the persons who had received funds were ngt customers cntitledJo receive 

anything. The bill literally provides for payments .... and the prospect of more payments, not the 

end of the proceeding. 

There is a clear inconsistency in the amounL~ mentioned in the bill and SIP A 

protection. 

Assuming solely for purposes of argument that it made sense for SIPC to name .!!!!y 

"settlement proffer" to claimants, section 2(c)(3)(A) of the bill makes reference to a possible 

limit of $500,000 for such proffer, but section 2(c)(6) treats the CD claimants as claimants for 

cash. The limit of protection for cash claims is $250,000. 

Unless and until Congress clearly assigus SIPC the task of paying fraud claims, both 

the bill, and the SEC's legal position, run counter to clearly established Congressional 

policy. 

15 
187 


75077.123

Consider the following hypothetical dialogue: 

Salesman: My brokerage film offers Certificates of Deposit issued by an offshore Bank 

in Antigua. The Bank pays extraordinarily high rates of return on CDs. 

Investor: That sounds suspicious to me. What if this is a fraudulent investment that is 

discovered after I receive the CD? 

Salesman: Not a problem. SIPC will pay you up to $500,000 in such an instance. That 

is more than the FDIC offers! 

Under the SEC's legal position in SEC v. SIPC, and under the bill, the Salesman's last 

statement would be true. While the Stanford victims are sympathetic, this is a fundamental 

depruiure from existing law. The consequences for persons who buy legitimate investments, and 

the potential costs of rescinding all such fraudulent investments made through SIPC members 

firms have not been considered. Indeed, federal taxpayer funds are implicated because SIPC has 

a line of credit with the Treasury, through the SEC. Thus, taxpayer funds could be used to 

restore the purchase price of a bad investment. That is a very big departure from protecting the 

"custody," or "safekeeping" function perfonned by brokerage firms, as the law provides for 

today. Moreover, persons who invest in fraudulent investments would be better off than those 

who make legitimate investments. They bear no market risk, profit from the fraud until it is 

uncovered, and once the fraud is uncovered, they get their money back from SIPC. 

VI. 

The Adequacy ofthe SIPC Fund 

The SIPC Fund currently stands at $1.4 billion. Under SIPC's Bylaws, most recently 

updated in 2009, the "Target Balance" for the SIPC Fund is $2,5 billion. Absent a decision by 

the SIPC Board to change the rate, SIPC will continue to assess its members Y. of 1 % of each 

16 
188 


75077.124

member's net operating revenue until the Target Balance is reached between 2016 and 2017. 

This issue is always under review by the SIPC Board. 

SIPC has sufficient funding to handle any foreseeable calion its resources under SIP A as 

currently constituted. I caution that if SIPC's mission is expanded by legislation to refund the 

purchase price of fraudulent securities transactions, judicial expansion of SIPC's clearly defmed 

limitations, or otherwise, neither the SIPe Fund nor the Treasury line of credit will be adequate. 

Conclusion. 

In conclusion, the period from 2008 to 2012 has been unlike any prior experience in 

SIPC's history. I believe SIPC has responded effectively to the challenges presented. That is not 

to say that, as we look to the future, the SIP A program cannot be refined or improved. 

I would be pleased to answer any qucstions you may have about SIPC's work. 

17 
189 


75077.125

Exhibit A 
190 


75077.126

RECOVERY STATUS TO DATE 

RECOVERIES AND SETIlEMENT 

AGREEMENTS 

$9.067 Billion 

AMOUNT UNAVAILABLE DUE TO 

APPEALS AND RESERVES 

$6.444 Billion 

AMOUNT IN CUSTOMER FUND 

$2.297 Billion 

AMOUNT DISTRIBUTED FROM 

CUSTOMER fUND 

$325.7 Million 

SIPC COMMITMENT 

$798.4 Million 

Afl amounts approximote 

Page 1 00 

RECOVERfES TO DATE 

As of February 15.2012 and in the 38 months since his appointment, the SIPA Trustee has: recovered or entered into 

agreements to re<::over morc than $9 biITion. representing approximately 52 percent of the approximately $17.3 billion 

in principal estimated to have been lost in the Ponzi scheme by BLMIS customers who filed claims. These recoveries 

excf'.ed prior restitulion efforts related to Ponzi schemes both in terms of dollar value and percentage of stolen funds 

recovered. 

SIgnificant Rec.overies to Date 

lRS 

Oil December 21, 2011, a $326 million settlement with the Uniterl States of America. on behalf ofthe Internal 

Revenue Service, was approved by t.he United States Bankruptcy Court for the Southern District of New York.. TIle 

SIPA Trustee detem1ined that BLMJS falsely debited the accounts of 14:5 foreign Ilccountholders for alleged income 

tax withholding and paid to the lR..'l SUdl withheld amounts related to alleged dividends, However, because no 

securities were purchased on which the alleged dividel)ds were paid, no taxes should have been withbeld. 

MOllntCa{lital Fuud 

On October 4. 2011, the United States Bankruptcy Court for the Southcm District of New York appm'led II settlement 

with Mount Capital Fund, a BLMIS Feeder l<und, which is in liquidation in the British Virgill Islands, whicb returned 

$43.5 million to the Customer Fund, 

Tremont Group 

On July 28, 2011, theSIPA Trustee announced a settlement with Tremont Group Holdings Inc< and related entities 

under the tenns of which the Defendants will deliver cash payments into escrow totaling more than $1 billlon. which 

will ultimately be placed into the Customer fund and distributed, pro rata, to BLMIS cuslOlners with allowed claims. 

On September 22. 2011, the agreement was approved by the United States Bankruptcy Court for the Southern District 

of New York. but the settlement is currently under appeal. 

Greenwich Funds011 May IS, 201 J> a settlemcn1 agreement was rumounced with Greenwich Sentry L.P, and Greenwjch Sentry Partners, 

L.P. (combined, the "Greenwich Funds"), domesticBLMIS feeder funds operated by the Fairfield Greenwich Group 

("-FOG") that were 100 percent invested in BLMIS. Tenns oflhe settlement, whicll was structured very similady to the 

~:ettlement with the Fairfield Funds. included a reduction in the Greenwich Fund customer claims which will ultimately 

benefit BLMIS customers with approved claims. Under the agreement, the Greenwich Funds also Ilgreed to assign all 

of their claims against FGG management oompanies. officers and partners to the Trustee and to the enby of judgment 

for the full amount ofllie Trustee's claims, approximately $212 million. TIle settlement was appro'lcd on June 21. 

201 I by the United States Bankruptcy Court for the SOUlhcm District of New York. 

Fairfield Funds 

On May 9, 2011, a settlement agreement was announced with the Joint Liquidators ofFairfieJd Sentry Limited, 

Fairfield Sigma Limited and Fairfield Lambda Limited (collechvciy, the "Fairfield Funds"). Terms of the settlement 

include an immediate and penn anent reducli01l- of nearly $1 billion - in the lotal amount of claims against the 

BLMIS Customer Fund by the Fairfield Funds, which would effectively increase future payments to custOJnC'.rs with 

allowed claims. In addition, the settlement agreement aligned the interests ofthe SIPA Trustee and his counsel witb 

the Joint Liquidators ofFairfie1d Sentry, strengthening both parties' abilities to pursue and recover bilHons of doUaT'S 

in additional claims: against the owners and manllgt".ment of the Fairfield Funds, as well as hundreds of subsequeJlt 

frnnsferees of stolen customer property. TIle United States Bankruptcy Court for the Southern District of New York 

approved this settlement agreement on June 7, 201 1. 

Hadassah 

On March 10, 2011, the United States Ha.nkruptcy Court for the Southem District of New York approved 11 settlement 

betwet'.n the SIP A Trustee Dnd Hadassah in the amOlli1t of $45 million 

Union Bancsirc Plivce 

On January 6, 2011, the United States Bankruptcy Court for the Southern District of New York approved a ptelitigation settlement between the SIP A Trustee and Union Ballcajre Privee tilet resulted in the recovery of$470 

million. 

Cad J, Sbapiro, ct .d. 

On December 21, 2010, the United States Bankruptcy Court for the Soulhem District of New York approved a prelitigation settlement betweC!l the SIP A Trustee aJld ('..art J. Shapiro. Robert Jaffe and related entities in the amount of 

$550 miHiOll. As PSit onlle agreement, the Shapiros also forfeited $75 million to the U.S. government 

Estate of Jeffry Picower 

On December! 7,2010, the SIPA Trustee and the U.S. Govemmcnt announced a groundbreaking $7.2 billion recovery 

agreement with the estate of Jeffry Picower;. $5 billion of the seUlement to go. to the SJPA Trustee for equitable 

distribution to BLMlS customers with allowed claims and $2.2 billion forfeited to the U $, govenmlent. 

http://www.madoff.comlrecoveries-04.html 3/212012 
191 


75077.127

Page 2 of3 

On January 13,201 I, the United States: Bankruptcy Court for lhe Southr.m District of New York approved this 

settlement, bUl the settlement is currently under appeal by third parties. The government forfeiture order also is being 

appealed 

Norman l? uvy. et 01. 

On February IS, 2010, the United States Bankruptcy Court for the Soulhcm District of New York approved a prelitigation settlement between the SIP A Trustee and the estate ofNonnan F. Levy. 111is settlement resulted in the rctum 

of $220 million (the "Nonnan Levy Settlement'). Certain customers moved to selaside the Court's Order approving 

the Nonnan Levy settlement. The Bankruptcy Court denied the motion. and (he claimants filed an appeal in United 

States District Court on April 11.201 L On February 16. 2012, 1he District Court upheld the Bankruptcy Court's 

esrlier ruling approving the SIPA Trustee's settlement with the Levy family. 

Optimal 

On June 16,2009. the United States Bankruptcy COUIt for the Southem District of New York approved a pre-litigation 

settlement between the SI.PA Trustee and Optima! Strategic U.S, Equity Ltd. and Optimal Arbitmge Ltd. This 

settlement resulted in the recovery of more than $235 million. 

Total Rccoverieg by fnterim Report Periods 

Amounts shown do 1101 include COIll'i-approl'ed seitlemenls under appeal or not yet collected 

SIXTH , FIFTH INTERIM INTERIM 

REPORT REPORT 

SIXTH INTERIM REPORT 

FOURTH 

INreRlM 

REPORT 

Petiod ended September 30, 2011 

Tolal received $2.1 billion 

THIRD 

INTERIM 

REPORT 

DESCRIPTION 

SECOND 

INTERIM 

REPORT 

FIRST 

INTERIM 

REPORT 

AMOUNT 

Transfers from Debtor's Estate - Securities $291,203,371.40 ---------_ ... _-------_._-------_._- Transfor from Dabtor's Eslata - BNY account $336.660,934.06 

Transfers ffUm Debtor's Estate -. Chase account $235,156,309,36 

_TC_""_'f_e"'_f_co_m_De_bt_O(_'_E,_,,,_"_-_o_~e_c _____________ . _______ $4_,03_6_,1~5:~_ 

Interest and Dividends 

------------------------ $1,713,881.88 

____ ""_',:.-273,87723 

$21.783,082.40 

Cioseout Proceed!> - Broker Dea!ers ----._-------.. --------- Closeout Proceeds - NSCC 

$11,304,329.91 

SponsTlck_e'_' ____________ ._._____ $89,690.80 

Bank Dept Participation _____ $4,755,690.63 

DTCCti/lares 

Market Making Business 

$204,170.51 

$1.389,4/3,18 

-'--'-----_ lib'''''' .. _-_._------ $495,000,00 

Admln!slralive Subtenant Rant Revenue 

Adjusting Admln!sfraf!1Ie Subtanant Rent Revenue 

Refunds - BlM Air Charter 

Refuwjs - Deposits --------"-----,-,-

Refunds - DueslSubscriptions 

RefUnds- Car Regisfratfoos 

Refunds - Vendors 

Refunds - Transit Cams 

$511,390.79 

$752,963.00 ~-""----

______ $9,841.45 

$117,247,15 

$157.00 

$61,581.20 

$793.61 -------_ .. --------- Refunds - IORllrancefoNorkers Comp ____ • _______ -.::.~4Q.2,B59.58 

Refunds - Politir.al Contrlbutlons _. _______________ :.c"-'-44c:::,5:.c OO=.OO::.. 

Refunds - Otha-r $50.84 

Recoveries - Customer AV<lldances $139,209,034.46 

Recoveries - Pre-UUgaUon Settlements $1,521,631,048,00 

Recoveries - Utigation SeH!ements 

Recoveries - Donation Selliemonts -------------_ .. _---_. Recoveries - Vendor Prefareru:es 

Recoveries - Employees 

Recoveries - Taxing Authorities 

http://www.madofI.comll.ecoveries-04.html 

___ --'$40-'-,60...:9,297.32 

_____ -'-'500_,000.00 

_____ -'--_ ,850.39 

$10,674.74 

$12,771,56 

3/212012 
192 


75077.128

Recoveries - Class Actions 

Recoveries - NASDAQ 

Recovefles" NYSE 

Recollelies -- Transaction Fees 

Recoveries - Other 

MlsceUaneous 

Earnings on Trustee's Investments 

Interest on Truslee's SaVings Accounts 

http://www.madoff.comlrecoveries-04.html 

Page 3 of3 

$380,488.99 ~--~---~-----

$308,948.49 

$183,683.79 

$98,816.23 

$296,298.73 

$1136 

_______________ $1_5,_23_9,_62_5.~ 

3/2/2012 
193 


75077.129

Exhibit B 
194 


75077.130

stpc SECURITIES INVESTOR PROTECTION CORPORATION 

805 FIFTEENTH STREET, N. W., SUITE 800 

WASHINGTON, D. C. 20005-2215 

(202) 371-8300 FAX (202) 371-6728 

WWW.SIPC.ORG 

The Honorable Ed Perlmutter 

Congress of the United States 

1221 Longworth House Office Building 

Washington, D.C. 20515 

September 30, 2011 

The Honorable Gary Ackerman 

Congress of the United States 

2111 Raybum House Office Building 

Washington, D.C. 20515 

RE: Bernard L. Madoff Investment Securities LLC ("BLMIS")j 

Settlement Agreement Between Trnstee and Tremont Group Holdings Inc., et al. 

Dear Congressmen Perlmutter and Ackerman: 

This is in response to your letter of September 26, 2011 to Chairman Shapiro and me 

regarding the settlement ("Settlement") between Irving H. Picard, Trustee for the liquidation of 

BLMIS under the Secmities Investor Protection Act ("SIP A") and Tremont Group Holdings, 

Inc., ("Tremont") and a large number of other related defendants. You raised questions about the 

SIPA Trustee's Settlement with Tremont, including how the procccds of the Settlement will get 

into the hands of the Tremont investors who in the BLMIS liquidation proceeding are indirect 

investors with BLMIS. You also requested comment on prospective amendments to SIPA 

regarding this topic. 

This response will address yom questions regarding the Tremont Settlement. I will defer 

on your requests for comment on prospective amendments to SIP A, as the SIPC Modernization 

Task Force has these patticular issues under its review and will present its report to the SIPC 

Board later this year. 

I am pleased to respond to your questions on the SIPA Trustee's Settlement with 

Tremont. First, the SIP A Trustee included a provision in the Tremont Settlement Agreement (at 

SIPC's suggestion) whereby Tremont Managcment agreed not to receive any money. That 

provision stated that the "Tremont Defendants covenant that they will cause all payments 

received fi'om the Trustee in respect of the Total Allowed Claims Amount to be fairly and 

equitably allocated among Broad Market Fund, Portfolio Limited, Rye Insurancc, and their 

respective partners and/or invC:'ltQr~." As a result, all of the funds received by Tremont through 

any BLMIS customer fund distribution made by the SIPA Trustee will be available to the 

investors of the various settling Tremont funds. The SIPA Trustee had also included the same 

provision in the Fairfield Sentry and Greenwich Sentry settlements that were approved by tlle 

Bankruptcy Court. 
195 


75077.131

I-Ions. Perlmutter and Ackerman 

September 30,2011 

Page Two 

Second, all of the funds received by Tremont· through any BLMIS customer fund 

distribution by the SIP A Trustee is being placed in the Tremont Investor class action settlement 

fund to be distributed to the Tremont investors under a plan to be determined by U.S. District 

Judge Griesa in the Southem District of New York. At the hearing on the Tremont settlement 

before Bankruptcy Judge Lifland on September 22, 2011, the investors class counsel spoke in 

favor of the Settlement and made clear that there are conflicts among the Tremont investors as to 

the allocation of the class action settlement fund but that District Judge Griesa will detelmine 

how to resolve those conflicts after all the Tremont investors have had the opportunity to be 

heard in that court. In Fairfield Sentry and Greenwich Senny, the funds are in liquidation or 

Chapter 11 and the allocation of funds received by each tlu'ough any BLMIS customer fund 

distribution by the SIP A Trustee will be directed by the court overseeing the liquidation or 

Chapter 11 proceeding. 

Third, as shown by the foregoing, the Trustee and SIPC are keenly aware of the 

importance of getting funds into the hands of so-called "indirect investors." But ultimately, the 

SIP A Trustee cannot coutrol contractual relationships among parties which are not BLMIS 

customers. 

Fourth, at the September 22 hearing on the Settlement, Bankruptcy Judge Lifland noted 

that the SIP A Trustee had acted to protect the indirect investors by preventiilg any payments 

from being used by management and further by requiring Tremont to allocate fairly and 

equitably any customer funds distributed by the SIPA Trustee among the investors in Tremont. 

Bankruptcy Judge Lifland also made it clear that the internal Tremont distribution process was 

an issue squarely before District Judge Griesa to be decided in the Tremont class action. 

Fiftb, the SIP A Trustee and SIPC are committed that, whenever possible, a similar 

equitable distribution process will be in force for all settlements with other feedcr funds. 

Finally, as I testified before the Subcommittee on Capital Markets, avoidance actions 

under the Bankruptcy Code and the Securities Investor Protection Act are designed to permit the 

most cquitable distribution possible under the circumstances where a Ponzi Scheme has 

victimized investors. The results in the MadofI case to date demonstrate the wisdom of those 

legislative provisions. 

Respectfully, 

?~ len P. Harbeck '. 

President and CEO 

SPHlrec 

cc; Chairman Shapiro 
196 


75077.132

Exhibit C 
197 


75077.133

Status Update from the Office of James W. Giddens, Trustee for the Liquidation ofMF 

Global Inc., Concerning the Trustee's Investigation 

Media Contact: Kent Jarrell, 202-230-1833 

February 6, 2012 ~ New York, New York~ James W. Giddens, the Trustee for the liquidation of 

MF Global Inc., today filed a preliminary report on the progress of his investigation into the 

failure of the broker-dealer with the United States Bankruptcy Court for the Southern District of 

New York, the Honorable Martin Glenn, presiding. The Trustee's investigation has 

preliminarily determined that MF Global Inc. had a shortfall in commodities customer 

segregated funds beginning on Wednesday, October 26,2011, and that the shortfall continued to 

grow in size until the bankruptcy filing on Monday, October 31, 2011. 

The Trustee's investigators have now traced a majority of the cash transactions, totaling 

more than $105 billion, made in and out ofMF Globallnc. in the last week before bankruptcy 

and are completing the process of tracing the remaining transactions. MF Global also executed 

securities transactions totaling more than $100 billion during its final week of operations. These 

included liquidation of customer securities, proprietary positions and other items. The securities 

included complex instrmnents, such as off~balance sheet repurchase transactions involving 

sovereign debt securities al1d derivative structures. 

"For three months our investigative team has worked to understand what happened 

during the final days of MF Global when cash and related securities movements were not always 

accurately and promptly recorded due to the chaotic situation and the complexity of the 

transactions," Giddens said. "With these preliminary investigative conclusions in hand, we will 

analyze where the property wired out of bank accounts established to hold segregated and 

secured propeliy ultimately ended up. We will then determine whether there is a sound and legal 

basis for recoveries against third parties that will help make customers whole. These will be 

very complex legal and factual determinations, which we will make consistent with our duty as 

the advocate for the fonner customers ofMF Global Inc." 

The investigation to date has found that transactions regularly moved between accounts 

and that funds believed to be in excess of segregation requirements in the commodities 

segregated accounts were used to fund other daily activities of MF Global. In the past, such 

transfers were in amounts of less than $50 million, but as liquidity demands increased and could 

not be met from internal sources, much larger amoUl1ts were used, apparently with the 

assumption that funds would be restored by the end of the day. By Wednesday, October 26, as 

tl1e result of increasing demands for funds or collateral throughout MF Global, funds did not 

return as anticipated. As these withdrawals occurred, a lack of intraday accounting visibility 

existed, caused in part by the volume of transactions being executed, and the 4(d) U.S. 

1 
198 


75077.134

segregated commodity customer account appears to have reached a deficit condition on 

Wednesday, October 26 that continued through to MF Global's bankruptcy. 

The Trustee has identified most of the parties that were the immediate recipients of 

transfers from MF Global Inc. during the final days and weeks of operation. These transfers 

were largely effected through the clearing banks acting on behalf of MF Global Inc. The 

ultimate recipients of these transfers included banks, exchanges and clearing houses, MF Global 

Inc. affiliates, counterparties, and customers of the futures commission merchant and the brokerdealer. 

The number of transactions executed by MP Global during the last week prior to the 

bankruptcy escalated to unprecedented volumes. The rush to meet funding needs for collateral, 

margin and customer liquidations led to billions of dollars in securities sales, draws on credit 

facilities, and a web of inter-company loans across affiliates, some foreign. The company's 

computer systems and employees had difficulty keeping up with the unprecedented vohune of 

transactions. A number of transactions were recorded erroneously or not at all. So called "fail" 

transactions - where either the buyer or seller fails to deliver the cash or the security, 

respectively - were five times the normal volume during the firm's final week. 

The investigation has revealed that a confluence of factors contributed to the deterioration 

ofMF Global's liquidity position. The exposure to European sovereign debt, coupled with the 

announcement of disappointing quarterly results, triggered credit downgrades by Moody'S, Fitch 

and S&P. This escalation in credit risk mandated substantial margin calls and increased 

demands from counterparties and exchanges for collateral. As an example, the additional margin 

paid to support only the sovereign debt positions exceeded $200 million during the final week of 

operations. This was a significant drain on available cash and securities. The sovereign debt 

investments undertaken on a repo to maturity basis allowed some immediate gains to be booked, 

but these were purely paper profits gencrating negligible cash while the underlying transactions 

resulted in calls for substantial additional margin. 

The heightened risk and apparent loss of confidence drove customers to close their 

accounts and withdraw funds, resulting in even greater demands on a relatively limited amount 

of available cash. The Trustee's investigation has revealed that, while personnel may not have 

been immediately aware of it, MF Global Inc. experienced a shortfall in 4(d) customer funds 

beginning during the day on Wednesday, October 26. The MF Global parent company struggled 

to continue to operate and even to sell the business, but MF Global Inc. appears to have remained 

in a shortfall of commodity customer segregated funds viliually continuously until its parent 

filed for Chapter 11 protection on Monday, October 31 and the Securities Investor Protection Act 

(SJPA) proceeding was commenced against MF Global Inc. later that afternoon. 

2 
199 


75077.135

'111e Trustee's investigators, including the legal and forensic accounting teams, have 

conducted over 50 witness interviews, preserved secure access to thousands of boxes of hard 

copy documents, imaged over 800 computer drives, and are maintaining over 100 terabytes of 

data. 

To understand where the money went during October 2011, the analysis conducted by the 

Trustee's professionals has included 840 cash transactions in excess of $10 million that total 

$327 billion, and an ongoing analysis of related securities transactions involving a value of over 

$100 billion, These large cash transactions alone span 47 bank accounts across eight financial 

institutions. An additional 20,000 cash transfers that total $9 billion involve transfers of less 

than $10 million, 

The Trustee's investigation is continuing to correlate cash transfers to relevant 

movements of securities used as collateral or loaned to counterparties. To that end, the Trustee is 

now working with various third parties to further define these securities transactions and obtain 

more complete infOlmation about the extent and basis for transfers to' select parties. The Trustee 

continues to investigate the complex factual and legal questions to determine how best to pursue 

possible recoveries and the extent to which applicable law would SUppOlt claims against 

particular recipients of funds, affiliates, and possibly to other parties, including employees of MF 

Global. 

The Trustee's investigation will continue, in coordination with the regulatory and law 

enforcement investigations that are being conducted by the Department of Justice, the CFTC, 

and the SEC on an ongoing basis. The Trustee will seek to release additional infOlmation related 

to his investigation in the future, but cannot prematurely release information that might 

compromise the integrity ofthose investigations or the Trustee's own efforts to recover funds for 

customers and the estate. 

CLAIMS PROCESS AND ACCOUNT TRANSFERS 

The Trustee's staff is continuing its analysis of customer claims after the claims filing 

period for commodities customers closed on January 31, 2012. 

Once a claim is reviewed by the Trustee's staff on as expedited a basis as possible, a 

detennination letter will be issued to tI1e claimant. These determination letters are being issued 

on a rolling basis. The determination letter will acknowledge the claim and provide a 

determination as to whether the claim has been allowed, denied, reclassified, or is subject to 

further reconciliation or information requests. 

The Trustee is eager to make additional distributions to former MF Global Inc. customers 

as soon as possible. However, the Trustee is required by law to hold an appropriate reserve of 

3 
200 


75077.136

funds until disputed claims are resolved either through negotiation or by the COlllt. At this time, 

the Trustee anticipates significant disputed claims against the MF Global Inc. estate by MF 

Global Holdings Ltd., MF Global UK Limited, and other entities. The Trustee will move to 

attempt to resolve these claims as quickly as possible, but it is uncertain how long resolution will 

take. Therefore, it is not known at this time when the Trustee will be legally able to make 

additional distributions. 

The Trustee has already distributed nearly $4 billion to fOlmer MF Global Inc. retail 

commodities customers with US futures positions via three bulk transfers: 

Within days of the bankruptcy, the Trustee received court approval for the transfer of 10,000 

commodities customer accounts with three million open positions, along with approximately 

$1.5 billion in collateral associated with those positions at the time of the bankruptcy. These 

open positions had a notional value of $1 00 billion. It is estimated that 40% of all 

commodity futures exchange activity in United States markets came from MF Global Inc. 

trades and a serious disruption in markets was avoided by the transfer. 

A transfer of 60% of the cash attributable to approximately 15,000 customer commodity 

accounts with cash only in the accounts, totaling approximately $500 million, was completed 

in November. 

• And in December and January a third transfer occun-ed that moved approximately $2 billion 

to restore 72% of US segregated customer property to all former MF Global Inc. retail 

commodities customers with' US fntures positions. 

In addition, the Trustee has received COUli approval to sell and transfer approximately 318 

active retail securities accounts, which is substantially all of the securities accounts at MF Global 

Inc. Nearly all securities customers have received 60% or more of their account value and 

already 194 of former MF Global Inc. securities customers have received the entirety of their 

account balances because of a Securities Investor Protection Corporation guarantee. 

The information in this statement does not apply to any other M]<' Global entity, including 

separate insolvency proceedings involving the parent company, MF Global Holdings Ltd. 

4 
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75077.137

Exhibit D 

75077.138

EQUITABLE TREATMENT OF 

INVESTORS: 

AN ANALYSIS 

Prepared for the House Financial Services Comm

Capital Markets Subcommittee 

," u SI:PC 

-

, -. 

Stephen P. Harbeck 

President and CEO 

The Securities Investor Protection Corporation 

March 7,2012 

75077.139

The Fad§ 

DATE INVJE§TOR. A INVJE§TOR. B ][NVE§TOR. C 

01101110 Deposits $2 Million Deposits $2 Million Deposits $2 Million 

01/01/12 Receives Statement $4 Million Receives Statement $4 Million Receives Statement $4 

02/01112 Withdraws $3 Million Withdraws Nothing Withdraws Nothing 

03/01/12 Receives Statement $1 Million Receives Statement $4 Million Receives Statement $4 

04/01112 Ponzi Scheme Exposed and Investors Are Innocent of Knowledge 

Broker's Assets and Other Customer Property Completely Dissipated on Filing Date 

•..•. ' ... ' ..... . . . ::.', .':, ': .. 
204 


75077.140

75077.141

Hypothetical 1: Assume total of $6 million deposited and no

available to distribute. 

Results Under the Equitable Treatment of Investors Act 

Amount Withdrawn 

Pre Liquidation 

Amount Received 

From SIPC Advance 

Total Amount Received 

Based on $2 Million 

Deposit 

IIiLU 

Investor A 

$3,000,000 

$ 500,000 $3,500,000 

Investor B Investor C 

-0- -0-

$500,000 $500,000 

$500,000 $500,000 

75077.142

Hypothetical 1: Assume total of $6 minion deposited 

nothing available to distribute. 

Results Under Current Law 

Customer's Net Equity 

After $3 Million 

Withdrawal by "N' 

Is Avoided 

Customer Property 

Distributed After 

Avoidance of 

Transfer to"A" 

Amount Received From 

SIPC Advance 

Total Amount Received 

Based on $2 Million 

Deposit 

liD 

Investor A 

$2,000,000 

$1,000,000 $ 500,000 

$1,500,000 

InvestorB Inv

$2,000,000 $2

$1,000,000 $1

$ 500,000 $ 

$1,500,000 $1

75077.143

COST TO SIPC 

® Identical in Each Instance 

® Which is More Equitable? ® The Avoidance Powers Are Exactly W

Makes the Distribution Equitable 

,...". .. ' ....... . I&U&II 

75077.144

Hypothetical 2: Assume Subsequent Recovery From 'l.JVrongdoer of$l,OOO,O

Results Under the Equitable Treatment of Investors Act 

Investor A Investor B Inves

Customer's Net Equity 

Based on Last Statement $1,000,000 $4,000,000 $4,00

Amount Withdrawn 

Pre-Liquidation $3,000,000 -0- -

From SIPC $500,000 $500,000 $50

From Wrongdoer $111,111 $444,444 $44

TOTAL AMOUNT 

RECEIVED BASED ON 

$2 MILLION DEPOSIT $3,611,111 $944,444 $9

liD 

75077.145

Hypothetica12: Assume Subsequent Recovery From Wrongdoer of $1,000,000 

Results Under Current Law 

Investor A InvestorB Inv

Customer's Net Equity 

After "AS" $3 Million 

Withdrawal is Avoided $2,000,000 $2,000,000 $2

Customer Property 

Distributed After 

Avoidance of Transfer 

To "A:' $1,000,000 $1,000,000 $1

FromSIPC $500,000 $500,000 $5

From Wrongdoer $333,333 $333,333 $3

TOTAL AMOl.JNT 

RECEIVED BASED ON 

$2 MILLION DEPOSIT $1,833,333 $1,833,333 $1

liD ' ' 

75077.146

SECURITIES INVESTOR PROTECTION CORPORATI

.... __ . __ .. _ 

805 15th ST NW, SUITE 800 

DC 20005=2215 

(202) 371=8300 

WWWoSlpCeorg " 
211 


75077.147

Network for Investor 

Action and Protection 

TESTIMONY OF RON STEIN, CFP 

President, The Network for Investor Action and Protection 

Before the Subcommittee on Capital Markets, Insurance, 

and Government Sponsored Enterprises ofthe 

Committee on Financial Services 

United States House of Representatives 

March 7, 2012 

www.investoraction.org 

P.D Box 2159 Halesite NY 11743 Phone (800) 323-9250 Fax (631) 421-5701 
212 


75077.148

Chairman Garrett, Ranking Member Maxine Waters, Vice Chairman David Schweikert, 

Members of the Subcommittee, and Fellow Congressional Members: 

My name is Ron Stein, President of the non-profit Network for Investor Action and 

Protection ("NIAP"). I am both a registered investment adviser and Certified Financial Planner 

and over the years have seen all too often how a fraud such as Madofrs can ruin the lives of 

thousands of innocent victims. 

On behalf ofNIAP and myself, I appreciate the opportunity to appear before this 

Committee and explain why it is essential that Congress enact H.R.7S7, legislation that reaffirms 

and restores the vital investor protections that Congress intended for investors under SIP A and 

that until recently, investors rightfully understood was already provided to them. 

Since its formation, NIAP and its membership of over 1200 individual investors have 

worked diligently to prescrve and expand investor protections against the wide array of potential 

investor frauds anyone of which could financially devastate the victims and their families and 

tum their lives upside down. Our primary constituency and concern is the individual noninstitutional investor, the person most in need of assistance. Unlike the large hedge funds and 

other institutional investment entities, these individual investors are frequently unable to fend for 

themselves in the wake of a fraud and lack the awareness and tools to obtain relief that is, or at 

least should be, available to them as investor fraud victims. 

Although NIAP was formed in response to the Madoff scandal and the devastation it has 

caused, our mission and our focus is not limited simply to the Madofffraud, but enhancing 

protections for all investors. We have devoted significant time and effort working toward 

meaningful regulatory reform. The regulators, whether they be govermnental agencies such as 

the SEC or quasi-governmental self-regulatory entities such as SIPC or FINRA are the threshold 

gatekeepers; unless they do their jobs diligently and vigorously, the likelihood of future wide 

scale fraud is increased. NIAP is therefore deeply involved with reform efforts and measures 

designed to enhance proper regulatory functioning. Our work thus includes oversight and 

investor education to prevent the erosion of existing investor rights by those such as SIPC which 

should be working vigorously for the victims but all too frequently operate instead in their own 

self-interest. 

It is widely known that the regulatory oversight and investigatory functions failed 

abysmally in the Madofffraud, which should have been stopped years ago. But even after it was 

discovered, during the inordinately lengthy SIPC Liquidation process that has followed, there has 

been a continuation of the past failures to protect the victims of this massive fraud. 

1 
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75077.149

For these and other reasons, we fully support H.R.7S7. It is a vital reform measure and 

reaffirmation of core investor protections. It must be enacted to protect the reasonable and 

legitimate expectations of Mad off victims and as a necessary step toward rebuilding investor 

confidence in our capital markets, already shaken by the events of recent years. 

In considering H.R.7S7, it cannot be over-emphasized that the Madofffirm - BLMISwas not an un-regulated, fly-by-night investment firm, offering outrageous returns. It wasa high 

profile, highly regarded broker-dealer, and SIPC member, led by a scion of Wall Street, 

theoretically subject to the full range of regulatory scrutiny, and offering, at times, below-market, 

albeit steady returns. As documented in great detail in the Report of the SEC's Inspector 

General, however, during the lengthy period that the fraud persisted, the SEC failed, for many 

years, to identify and stop the massive investor fraud despite repeated opportunities to do so, and 

despite possessing full authority and the necessary tools to do so. I Compounding the SEC's 

regulatory failures, the SEC Inspector General's report also documents the shocking fact that 

despite learning information strongly suggesting to them that Madoffwas engaged in a fraud, 

highly regarded financial institutions and insiders chose to keep silent and not report that 

information or their suspicions to the regulators. In essence, the failed oversight of the SEC, 

NASD, and the blind eye of other professionals in the field is what fueled the explosive growth 

of this crime, perhaps more even than the fraudster. 

Unfortunately, the failure to inform or protect investors has continued even now, three 

years even after Madoffwas caught. The manner in which the Madoff Liquidation has been 

mishandled reveals with painful clarity the gross inadequacy of the current SIPC liquidation 

process and the vital need for reform. Throughout the liquidation process, SIPC and its handpicked trustee have been allowed to make crucial decisions which favored their own substantial 

financial interests to the detriment of the Madotf victims, even though the statute -- entitled, 

ironically for many investors "The Securities Investor Protections Act" -- was specifically 

enacted to protect investors. The core failures arising from SIPC's conflict-based, self-interested 

decision making could not have continued but for the parallel failure of the SEC to exercise in 

any meaningful way oversight over SIPC's operations, as mandated by the SIPA statute. Rather 

than exercising its authority, the SEC has abdicated its responsibility and allowed SIPC and its 

Trustee free rein to twist and mangle the statute almost beyond recognition. The consequence is 

that vital investor protections enacted by Congress have been compromised or ignored, in flat 

defiance of the clearly expressed Congressional intent to thc contrary. 

It is undisputed, for example, that the majority of Madoff victims will receive none of the 

monetary relief promised them in the SIP A statute -- not one penny in SIPC advances2

• 

Moreover, and in devastating fashion, SIPC and its Trustee have dramatically added to investors' 

I INVESTIGATION AND FAILURE OF THE SEC TO UNCOVER BERNARD MADOFF'S PONZI SCHEME, 

OIG Report No. 507. August 31, 2009 

2 According to the Trustee's web site, 2,703 claims were denied entirely and 2,426 claims were at least 

partially allowed. 

2 
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75077.150

tinancial and emotional distress by bringing almost 1,000 individual clawback lawsuits against 

victims although each of these defendants, according to the Trustee, are innocent victims with no 

knowledge of the Madoff fraud. Thus, not only have these innocent victims been deprived of 

their SIPA benefits but they have now been forced, at considerable cost, to defend themselves 

against clawback actions in which the Trustee seeks to compel victims to pay SIPC monies 

legitimately withdrawn trom their own Madoff accounts over decades -- money long spent to pay 

taxes, mortgages, education expenses, and all of their other costs of living incurred over the 

course of many years. Investors took redemptions in good faith, reasonably believing that they 

were taking their own funds based on statements that reflected positive account balances. For 

SIPC and its Trustee now to seek to take those monies from already devastated victims of this 

fraud is, quite simply, unconscionable - as is the failure of SEC to exercise its oversight powers 

to prevent it - even though the SEC had been told previously that there would not be clawback 

against innocent victims.3 

In the process, the SIP A statute has been a total failure and fraud for these innocent 

Madoffvictims.lt has been transformed from a remedial, investor protection statute, into an 

instrument of investor oppression and harm. Most of these victims are small non-institutional 

investors who were devastated by the Madoff fraud to begin with. It is morally indefensible that 

these victims should now also be subjected, to further victimization by SIPC through the 

misapplication of the SIPA statute. 

The historical context makes obvious both Congress' intent and SIPA's meaning. SIPA 

was enacted in 1970 in the wake of massive insolvencies that had rocked the broker-dealer 

industry and seriously undermined investor confidence.' iiAt the time, the securities industry 

operated on the basis of registered physical stock certificates rather than the current book entrystreet name system. Each time stock was bought or sold, the seller's shares had to be physicalJy 

delivered to be cancelled and a new certificate had to be issued by the Company in the name of 

the buyer, to be physically delivered to that buyer. The back office logjams - often referred to as 

the "paper crisis" -- were monumental as were the attendant costs and delays, particularly as the 

number of shares traded exploded throughout the 60's. Stock certificates literally piled up in 

back offices from floor to ceiling waiting to be transferred. Certificates were frequently lost and 

theft of securities, and even counterfeit was rampant. in Brokerage firms resorted to all types of 

devices, including fraudulently "cooking their books" to mask their detcriorating financial 

condition from the regulators and their customers. iv Embezzlements and Ponzi schemes were 

routinely in the headlines. Chaos was the norm. 

It was in that context that Congress sought to reform the system in order to assist the 

The SEC's Inspector General's report on the David Becker contlict issue quotes Chairperson Mary Shapiro 

to the effect that she (and presumably the other SEC commissioners and staff) understood from SIPC and the trustee 

that no clawback actions would be brought against innocent victims of the Madoff fraud. But even when that proved 

to be false-when such actions were later brought by the trustee in the name of SJPC- the SEC remained silent and 

took no action to prevent this obvious wrong from continuing. 

3 
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75077.151

industry, while at the same time protecting the investing public and maintaining the integrity of 

the capital markets. Following extensive hearings through 1969 and 1970, legislation was 

introducedv

, patterned on the FDIC model to provide necessary structural change and investor 

protection. Although initially the tinancial industry stalled the legislation, as broker-dealer 

insolvencies mounted (including several major firms that threatened the very existence of the NY 

Stock Exchange), and commission income plummeted with the increased loss of investor 

confidence, the industry soon reversed course and urged the creation of a federally-based 

insurance entity that could help stave off financial disaster. Thus SIPA was enacted and SIPC 

was born. The old system of registered investor possessed stock certificates migrated to the book 

entry-street name system and in 1975 Congress enacted modifications to the Securities Exchange 

Act of 1934 and additional changes to SIP A in 1978 to continue to improve protections, and 

affirm that investors would know that they were protected (up to the statutory limits) if the shares 

they owned were not available to them from the brokerage firm for whatever reason. 

Through the enactment of SIP A, Congress created a multi-legged investor protection 

regime that dramatically stepped up oversight of broker-dealers and exchanges, and further 

empowered both NASD (now FINRA) and the SEC. It also mandated that the securities industry 

form and fund SIPC, a not-for-profit entity, to act as the funding vehicle to insure customer 

accounts against brokerage firm failure up to the statutory limits (currently $ 500,000).4 In doing 

so, Congress looked to the structural protection offered by the banking industry through FDIC, 

with necessary modifications to accommodate for the industry differences. With the change to a 

book entry/street name system, securities ownership would be demonstrated by trade 

confirmations and account statements in the same manner as the banking industry'S customers 

knew what they were owed by their bank account statements and pass books. Under both 

systems -- FDIC for bank customers and SIPC for brokerage customers -- there were specific 

dollar protection limits providing customers with clarity and, most critically, the certainty so 

central to a pillar of the economy. Just as all FDIC bank depositors, whether net savers or those 

now withdrawing savings for living income, enjoy equal status and FDIC protection, Congress 

sought to provide similar certainty for all brokerage customers. While bank and brokerage 

customers could choose to exceed those protected limits, they would do so knowing that those 

excess balances were at their own risk,s But they were never told that even the basic SIPC 

covcrage would be withheld from them by a rogue quasi- governmental agency and its 

designated Trustee. 

Richard Nixon. "STATEMENT ON SIGNING THE SECURITIES INVESTORPROTECTION ACT OF 1970". 

December 31. 1970. 

To the banking industry, which during the Great Depression had seen innumerable failures, had even 

witnessed the Hanover Trust Banking Ponzi theft, FDIC insurance coverage based on the customer's account 

statement was seen as an essential component of restoring customer faith in the banking system and to encourage 

investor to feel confident leaving their money on deposit in banks. That same need existed in the Securities system 

and with the change ITom registered physical stock certificates to book entry street name, the same need existed for 

the account statement representations to be given full force and effect Otherwise. customer confidence could not be 

restored and our capital markets would have suffered. 

4 
216 


75077.152

While the SEC and industry pressed intensely for the keeping of securities in street name, 

the public was not in full support. As one study indicated, "the public appears to lack confidence 

in street name registration as a substitute for the customer named certificate." vi It made sense, 

therefore, that Congress, the SEC and the industry, given the already dismal public opinion, 

would do nothing further to undermine investor confidence, or weaken the new protections. 

But SIPA's laudable goals and protections have now, for all practical purposes, been 

eviscerated by SIPC and its Trustees, as the following undisputed facts from the Madoff 

liquidation all too clearly demonstrate. 

FACT: A majority of the Madoff customers have been denied any SIPC coverage 

or advances, will receive none in the future, and will not be entitled to participate in the 

distribution of the SIPC customer property;6 

Many investors who have received some SIPC relief under the 

Trustee's Net Investment method. have received less in SIPC advances than they should have 

based on their account statements and the amount of their allowed claim has similarly been 

improperly reduced. 7 

FACT: According to the Trustee, at least 75% (and perhaps as much as 90%) 

of the anticipated pool of SIP A customer property will be distributed to institutional entities 

hedge funds and the like -- leaving only a small percentage for the small, non-institutional 

individual investor, the person who was supposed to be the primary beneficiary of 

SIPA protection. Included in this group oflarge institutional customers are some of the very 

hedge funds and other professionals whom the Trustee says facilitated the rapid expansion of the 

fraud by virtue of their substantial funding of Madoff' s investment cash and lack of due 

diligence.s 

FACT: For more than 40 years, SIPC has aggressively marketed the familiar SIPC 

Logo to investors and to the industry, to persuade the investing public that their investments are 

protected even if the brokerage firm should fail or be unable to deliver what should have been in 

an investor's account. During this same 40 year period, the industry experienced explosive 

growth due, in part to the ability of a brokerage firm to advertise its SIPC membership and the 

fact that their customer accounts would be protected by SIPC as a result of that membership. 

See Footnote 2. 

This occurs because under the Trustee's methodology, all investors have their allowed claims reduced by 

the amount of so-called fictitious profits. This results in a reduced allowed SIPe claim which impacts on the size of 

the SIPe advance and the participation in the distribution of customer property. 

8 Included in this group of large institutional customers are some of the very hedge funds and other 

professionals who the Trustee himself has stated allowed for the rapid expansion of the fraud by virtue of their 

substantial funding of Madofrs investment cash flow; See slPe responses to Rep. Kanjorksi and Rep. Garrett on 

917120 I 0 and lI24/20 II respectively. 

5 
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75077.153

Until SIPe's recent arbitrary revision of the statute, the investing public understood that there 

was only one meaningful exclusion from SIPC coverage: SIPC would not protect against market 

place loss (i.e. if an investor purchased stock which then declined in value in the marketplace, 

that loss belonged to the investor, not SIPC and properly so). But other than that, investors were 

informed of the coverage, and of no other exclusions to that coverage. Theft, embezzlement or 

other theft fraud (including "Ponzi" theft) were never perils exempted from SIPC protection. 

Critically, the financial services industry, with SIPe's support, including thousands of trained 

practitioners in my field, repeated these same assurances of SIPC insurance protections to 

millions of investors for these past forty years. To change the rules now, just when the SIPC 

coverage is so needed amounts to a bait-and-switch campaign, having deliberately misled the 

American investing public, and abandoning them during their time of greatest need. Frankly, it 

should be dealt with as such. 

The Trustee has already received legal fees in the hundreds of 

millions of dollars and has publicly projected that these legal fees and expenses ultimately 

exceed $1 billion 9 Ironically, if that same amount of money had instead been allocated to paying 

SIPC advances to innocent Madoffvictims, based on their final account statements, every 

Madoffvictim -- so called net winners and net losers alike -- would have received a full SIPC 

advance, without diminishing by even one penny the amount of customer property available for 

distribution to Madoffvictims with allowed SIPC claims. Instead, more than three years after the 

MadotT fraud surfaced, the Liquidation process remains bogged down interminably in complex 

litigation, and victims remain without their SIPC financial relief, despite the explicit SIP A 

requirement that relief to victims be paid "promptly". 

FACT: Although acknowledging that each victim was factually innocent and 

unaware of the Madoff fraud, the Trustee has nevertheless brought almost 1000 clawback actions 

against Madoffvictims to recover withdrawals they made years and even decades earlier. They 

did so from their own MadotT accounts in good faith, with every reason to believe it was their 

own money. Although couching these clawbaek actions as necessary to accomplish an equitable 

result, it is hardly fair or equitable to require people to pay moneys they have long since spent 

believing -- for good reason -- that they were spending their own money. 

FACT: Despite repeated representations to the contrary, under the Trustee's Net 

Investment Methodology, SIPC will be being reimbursed for all SIPC advances and for all legal 

fees and expenses before the majority of the Madoff victims receives even first dollar from the 

Madoffbankruptcyestate. 

FACT: The Trustee's Net Investment methodology will save SIPC approximately 

one billion dollars, the additional amount that SIPC would have paid out to victims in SIPC 

advances under the final account statement method (the historical norm). This financial windfall 

As reported in above reports to Kanjorski and Garrett. 

6 
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75077.154

for SIPC comes at the direct expense of the innocent Madoffvictims. 

FACT: Moreover. the Trustcc's Nct Investment methodology, while saving SIPC 

nearly $1 billion as stated above, has transferred thc cost instead to all US taxpayers. Had SIPC 

paid the Madoffvictims their proper SIPC advances as Congress intended, that would have 

reduced the amount of the allowable theft loss deduction and would have reduced the tax refunds 

the IRS would have paid out based on the theft loss. Conversely, when SIPC withheld SIPC 

advances from these Madoffvictims which increased the deductible theft loss, and increased the 

amount the IRS had to pay in refunds on the allowed theft loss. In other words, under SIPC 

everyone loses -- except SIPC and thc financial services industry -- which get a 

$1 billion windfall and reduced fees (amounting to a bailout) respectively. 

F ACT: Although SIP A, by its express terms, requires the registered brokerage 

industry to fund SIPC at sufficient levels to enable SIPC to pay all required statutory advances 

and benefits, for many years each brokerage firm paid only $150 dollars per year for the 

privilege of proclaiming SIPC membership by the firm and protection for the customers, despite 

the enormous increase in the size (and risk to clients) of brokerage firm failure. This left the 

SIPC fund woefully underfunded when the Madoff fraud surfaced and led the Chairperson of the 

SEC Mary Shapiro to acknowledge in her Congressional testimony that the "problem" was that 

there was just not enough money to provide SIPC relief for all of the Madoff victims as SIPA 

required. 1O This, however, should not have bccn a surprise to anyone, least of all the SEC. 

SIPe's underfunding has been questioned for years by Congress, with no remedial actions taken 

until the Madoff scandal came to light. 

SIP A expressly requires SIPC to make advances from the SIPC Fund 

"promptly" to relieve the financial distress of customers while the Trustee seeks to recover 

customer property from complicit third parties. But in addition to denying any protection, 

whatsoever, to over half ofBLMIS' customers, the actual disbursement of funds to even eligible 

customers has been delayed more than three years, with no end in sight -- and without any hint 

that compensatory interest will ever be paid to compensate for the delay. 

FACT: The SIP A statute contains a specific definition of Net Equity and further 

provides it may not be changed by SIPC, reserving that right exclusively to Congress. I I 

Despite this Congressional prohibition, SIPC and the Trustee have acted as though they have 

Carte Blanche to adopt whatever "definition" of Net equity suits their interests. This not only 

violates the statute but is inherently dangerous. Since SIPC chooses the trustee and SIPC alone 

decides how much to pay that Trustee, it is hardly surprising that, as in Madoff, a trustee will, 

consciously or otherwise, choose a definition that benefits and protects the interests ofSIPC (and 

10 . The OIG report also reported the Chairman's concern about the ability of the SIPC fund to handle the 

impact of the Madoffinsolvency. Left wlexplained by Chairperson Shapiro is how then there was enough money to 

pay the Trustee and his law firm a projected BILLION DOLLARS in fees and expenses 

11 See, 15 U.S.C.§78ccc(b)(4)(A) & 15 US.C.§78111. 

7 
219 


75077.155

the securities industry), relegating the needs of the victims to secondary status. This is a 

universal problem and what has happened to the Madoff victims here can happen to other 

victims of future brokerage firm failures and fraud. 

FACT: The Congressional history of SIPA confirms that it was intended to 

provide protection for brokerage customers when their securities "have been lost, improperly 

hypothecated, misappropriated, never purchased, or even stolen". 12 However, in its zeal to 

protect the SIPC fund in the Madoff debacle, SIPC and the Trustee have effectively written this 

core protection out of the law and, in the process, have de tied the will of Congress. 

FACT: Despite what will invariably be SIPe's protestations to the contrary, SIPC 

has a longstanding history of denying valid customer claims, forcing victims to undertake years 

of costly and contentious litigation. The SEC, despite statutory responsibility for overseeing 

SIPC, has essentially allowed SIPC free rein to do as it pleases, without restraint or effective 

oversight.v ;; 

***** 

With these facts as a backdrop, no investor can ever comfortably feel protected by SIP A; 

they should no longer believe that if their brokerage firm fails, they will at least receive their 

promised SIPC coverage to partially reduce their loss. If the Madoffliquidation is any indicator, 

SIPC coverage will effectively be non-existent for most securities fraud victims, a result which is 

antithetical to fostering investor confidence. 

After Madoff, what informed or prudent investor can ever feel safe withdrawing .!illY 

money from a brokerage account for fear that years, or even decades, later, a future SIPC trustee 

will sue to take back those funds. How can anyone be expected to invest with any degree of 

confidence under such circumstances? 

And who is most affected by this? Clearly, it is the small non-institutional investor -- the 

elderly, the retiree, the sick - all of whom need to access their brokerage account profits 

regularly in order to live and pay their bills. These victims have already lost their life savings to a 

fraudster. It is unthinkable to subject them to yet another devastating confiscation. 13 

12 H.R. Rep. 95-746, 95'h Cong., I" Sess. (1977) at 21. See also, S.Rep. 95-763, 95'" Cong.2d Sess. (1978) 

Sess.(I978) at 2 

13 Imagine if similar procedures were adopted by the banking industry under FDIC? 

Imagine the uproar if after years of living on interest earned from a bank account, the bank 

suddenly became insolvent due to the bank president's Ponzi scheme fraud and instead of 

receiving FDIC coverage, customers were told they had to repay the bank the interest previously 

withdrawn. As inconceivable as that sounds, that is precisely the underlying rationale for 

denying Madoffvictims SIPC coverage and for the reprehensible c1awback actions brought 

against these innocent victims. 

8 
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75077.156

If SIPe' s current self-serving approach is left in place, a further loss of investor 

confidence will inevitably follow. Responsible financial advisors and brokers will have to 

explain to their clients that SIPC protection is replete with caveats that will not be known to the 

investor until their investments may be in jeopardy. They may be informed that SIPC has 

recently decided that profits may not be protected, that funds withdrawn from an account may 

reduce SIPC protection, or worse, they may be clawed back. A responsible practitioner may tell 

their customer what their true account value their net equity really is, and that it may be far 

lower than their account statement values. The public hazard, particularly to those living on 

income and thereby reducing their potential SIPe protection, is clear and beyond belief. 

No one is asking SIPe to provide insurance against a market place decline in a 

customer's investment. That is an investment risk that is not covered by SIP A, and properly so. 

Again, it is the primary factor distinguishing SIP A coverage from FDIC coverage; in all other 

material respects, SIPA was patterned after FDIC coverage and was intended to provide that 

same degree of comfort and protection against institutional failure, despite recent insistence by 

SIPe and its supporters to the contrary. But what is needed is the basic SIPC coverage promised 

to investors for more than forty years. 

As applied in Madoffby SIPC and its Trustee, we are left with a statute enacted by 

Congress to protect investors and foster investor confidence accomplishing precisely the 

opposite result. Coverage is riddled with uncertainty and without any clarity as to what SIPe 

will, or will not, protect. Further, investors are now faced with the prospects of staggering 

c1awback actions against them, ostensibly under the guise of SIPA itself. This is a perverse and 

untenable circumstance. It brings into sharp focus the urgent need for Congress promptly to pass 

H.R.7S7, to restore SIPA to what Congress intended and to eliminate the ability ofSIPC or any 

future trustee to craft artful techniques to deprive investors of the protections mandated by 

Congress. 

H.R.7S7 addresses squarely and unambiguously a number of the more glaring 

deficiencies that have emerged during the process ofSIPe's mismanagement of SIP A and the 

SEe's failure to rein in SIPe's wrongful activities. 

• First, it will require SIPe and all future Trustees to determine Net Equity of an 

innocent non-institutional customer using the customer's final account statement, i.e. on the basis 

of what the customer reasonably understood and expected he is owed by the brokerage firm. At 

the same time, it will provide no comfort or protection to any customer who is found to have 

been complicit with the broker's fraud since those customers will clearly not qualify as 

"innocent" . 

9 
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• It will also protect an innocent non-institutional customer from the costs, 

emotional toll and potential financial devastation of clawback actions. Again, H.R.757 will not 

shelter those who acted with wrongful knowledge of or complicity in the fraud. Again, they will 

not qualifY as "innocent" and will thus fall outside of the safe harbor ofH.R.7S7. 

• H.R. 757 will impose a more stringent standard for registered professionals 

relating to what they knew or should reasonably have known and will provide meaningful and 

practical incentives for them to report perceived fraudulent conduct to the appropriate regulators 

in order for them to be protected from liability. 

• It will eliminate the unseemly practice -- and the obvious conflicts of interestinherent in allowing SIPC to choose the Trustee and then to determine how much that Trustee 

can charge for his and his law firm's services. Under H.R. 757, the SEC will create an 

panel of independent potential trustees and the Court will select the trustee from that panel. 

Moreover, the Court, not SIPC will determine the trustee's compensation consistent with the 

manner in which non-SIPC bankruptcy trustees are compensated 

• Critically, H.R. 757 will make clear to all investors already shaken by the events 

since 2008, and further frightened by the high-profile failures of major brokerage firms, that 

account statements will be honored in the event of a brokerage firm failure and will not be 

ignored at the whim of some future SIPC Trustee based on some amorphous and subjective view 

of fairness. At this critical juncture, certainty and clarity is needed, now more than ever, if our 

capital markets are to continue to grow and if investor confidence is to be restored and nurtured. 

Passage of H.R. 757 will reaffirm the type of protections Congress mandated for 

victimized brokerage customers when SIP A was enacted. It will end the insanity of allowing 

clawbacks against innocent victims a process that virtually criminalizes the victim and 

dramatically erodes investor confidence. H.R.7S7 will also correct some of the more significant 

deficiencies in the administrative operations of the current SIP A statute, including, most 

significantly ending the conflict of interest inherent in allowing a quasi-governmental agency to 

hand-pick its own trustee, a person who has a vested interest in catering to the needs and wishes 

of the paymaster. It will help restore investor confidence in the securities markets and, hopefully 

eliminate -- or at least minimize -- the extreme investor cynicism that currently exists. It will 

provide necessary clarity and certainty in place of the uncertainty and chaos which currently 

exists. It will reiterate to investors, that Congress intends to stand by its promises of investor 

protection now, and in the future. 

In sum, H.R.757 is desperately needed to restore the protections mandated by Congress to 

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victims of frauds such as Madoff and the desired confidence in our capital markets that our 

economy needs and requires to grow. We urge the swift passage ofH.R.75i 4 

14 Passage ofH.R.757 is the beginning not the end ofa necessary refonn process Further improvements and 

changes to our investor protection system are needed. My prior testimony submitted to this committee, along with 

materials submitted to the SIPC Modernization Task Force articulate some of those thoughts. Clearly, protections 

are needed for other victims of this type of fraud as well, including victims in qualified plans and other indirect 

investors. But a first step is essential. Future promises will mean nothing, if we don't follow through on the promises 

already in place. 

11 
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• ENDNOTES 

, Joel Seligman, The Transformation of Wall Street, Third Edition, p450 + 

"Wyctt Wells, Certificates and Computers: The Remaking of Wall Street, 1967-1971: Harvard Business History 

Review, 2000: p 204 + 

'" SEC, Study of Unsafe and Unsound Practices of Brokers and Dealers, Report and Recommendations; pursuant to 

SIPA Act of 1970; for Committee on lnsterstate and Foreign Commerce, Washington, D.C. 1971; p20, 44,145-146. 

" I.e. Ira Haupt & Co, a mid-sized Wall Street brokerage was closely tied to the Tino DeAngelis "Salad Oil Man" 

Ponzi theft scheme; Robert Vesco, and his financial scandal and political connects was major news through 1970. 

, Legislation introduced, S 2348, The Federal Broker-Dealer Investment Corporation Act, 1970, This was stalled 

and subsequently superseded by HR19333, which became the SIPA law, 

Joo, Thomas W" Who Watches the Watchers? The Securities Investor Protection Act, Investor Confidence, and the 

Subsidization of Failure, Southern California Law Review, Vol 72:1071,2000; p1080+ 

,j Sidney Robbins, The Paper Crisis in the Securities Industry, Lybrand, Ross, 1969; p6 

'" Gretchen Morgenson, Investor Beware; Many Holes 711reaten Safety Nelfor Investors o(Failed Brokerages, NY 

Times, Sept 25, 2000 

12 
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75077.160

RICHARD NIXON XXXYlI Pre5ident.j'tl){' UNiudSfIlm: 1969-1974 

481 - Statement on Signing the Securities Investor 

Protection Act of 1970. December 30, 1970 I AM SIGNING today the Securities 

Investor Protection Act of 1970. This legislation establishes the Securities Investor Protection Corporation 

(SIPe), a private nonprofit corporation, which will insure the securities and cash left with brokerage finns by 

investors against loss from fmancial difficulties or failure of such flIms. Protection is provided up to an 

aggregate of$50,000 per account, with a limit on coverage of cash of $50,000. 

In my message on economic policy and productivity on June 17, 1970, I urged the formation of a corporation to 

afford protection to small investors, backed first by industry payments and then by funds from the U.S. 

Treasury. The bipartisan efforts of the Congress, the administration, and the industry have now resulted in this 

legislation--a vitally important advance in the consumer-protection field. 

Just as the Federal Deposit Insurance Corporation protects the user of banking services from the danger of bank 

failure, so will the Securities Investor Protection Corporation protect the user of investment services from the 

danger of brokerage finn failure. 

This act protects the customer, not the broker, since only the customer is paid in the event of finn failure. It does 

not cover the equity risk that is always present in stock market investment, but it will assure the investor that the 

solvency of the individual finn with which he deals will not be cause for concern. It protects the small investor. 

not the large investor. since there is a limit on reimbnrsable losses. And it assures that the widow. the retired 

couple. the small investor who have invested their life savings in securities will not suffer loss because of an 

operating failure in the mechanisms of the marketplace. 

Virtually all brokers and dealers in the securities industry will be members of SIPe. These members will 

provide $75 million from assessments, trust fund transfers, and lines of credit from commercial banks within 

120 days. The industry will continue to pay assessments based on a percentage of their gross revenues until the 

fund reaches $150 million. If, contrary to expectations. this fund at any time should prove inadequate, SlPC may 

also call upon a $1 billion line of credit from the U.S. Treasury. Any funds provided by the Treasury will be 

recovered from subsequent assessments. 

This legislation contains a specific statutory mandate to the Securities and Exchange Commission to promulgate 

rules and regulations with respect to lhe financial responsibility and related practices of brokers and dealers. The 

SEC is given flexibility in establishing those rules and regulations. 

The functioning of the securities industry is a key element in providing the means for continued growth of 

American business and the economy of this country. Protection for the customer is essential, and has been 

provided here, as in the mutual fund bill [Public Law 91-547] which I recently signed. The Government and the 

industry must work together on seeking prompt solutions to the problems of the securities business. While those 

problems are being defined and resolved. the user of investment services, the small investor. will be protected. 

Note: As enacted, the bill (HR, 19333) is Public Law 91-598 (134 Stal. 1636). 

Citation: Richard Nixon: "Statement on Signing the Securities Investor Protection Act of 1970.," December 30, 1970. Online by 

Gerhard Peters and John T. Woolley, The American Presidency Project. http://www.presidency.ucsb.edu/ws/?pid=2B70. 
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Statement of 

United States Senator David Vitter 

Before tbe Capital Markets and Government Sponsored Enterprises Subcommittee 

of tbe House Financial Services Committee 

Marcb 7,2012 

TIlank you, Chainnan Garrett and Ranking Member Waters and members of the Capital Markets 

and Government Sponsored Enterprises Subcommittee, for inviting me to testify here today. 

Congress has given the Securities Investor Protection Corporation (SIPC) incredible 

responsibility for protecting investors, and for that reason, it's vitally important and appropriate 

that we point the spotlight at SIPC to understand the ways that it is and is not working. 

If there is one common cause between Stanford and Madoffinvestors, it's the way SIPC fought 

investors every step of the way and has absolutely refused to protect the victims of fraud. For 

three years the Stanford victims have been fighting just to have their day in court - and 

unfortunately, it's SIPC that they have to fight. 

I fear we are in a situation where, if SIPC were a true financial regulator, we would call it 

regulatory capture. The actions of SIPC are dictated by the member companies rather than by 

the law. SIPC is functioning more like a trade association and advocate than a quasi-regulator. 

I first became involved in the Stanford case because it has affected thousands of victims in the 

United States, and many of them live in Louisiana. Allen Stanford was adept at preying upon the 

savings of retired oil and gas workers in Louisiana in particular. Many of the victims have told 

me their entire savings has been lost because of the Stanford fraud, and that they have been 

forced to sell their home and re-enter the work force. 

I want to be absolutely clear. I don't believe there is any need to change to the Securities 

Investor Protection Act in order to provide coverage for the Stanford victims. These victims are 

entitled to coverage under the law as it is currently written. 

In the actual criminal case against Allen Stanford, he is accused of stealing customer funds. 

Instead of purchasing Stanford International Bank (SIB) "certificates of deposit" (CDs), the 

Stanford Group Company (SGC) which was a SIPC member, acquired control of its customers' 

funds and the funds were stolen by Allen Stanford. The Securities Exchange Commission (SEC) 

and courts have taken the position in litigation related to the receivership of Stanford's estate, 

that the Stanford companies operaled as a Ponzi scheme and, "a Ponzi scheme is, as a matter of 

law insolvent from its inception." And, just yesterday, ajury convicted Allen Stanford on 13 of 

14 counts related to this case. 

In Old Naples Securities, Inc. the U.S. Court of Appeals for the 11th Circuit held that customers 

of an introducing broker-dealer who thought they were purchasing bonds through the brokerdealer were "customers" of an introducing broker-dealer within the meaning of SIPA and 

entitled to coverage under the statute. The court held whether a claimant deposited cash with the 

debtor "does not... depend simply on to whom the claimant handed her cash or made her check 

payable, or even where the funds were initially deposited." Rather, the issue was one of "actual 
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75077.162

receipt, acquisition or possession ofthe property of a claimant by the brokerage firm llllder 

liquidation." 

Previously, the SEC has argued that "a customer's legitimate expectations" ought to be protected 

"regardless of the fact that the securities were fictitious." It is impossible for an insolvent entity 

issue legitimate securities. In re New Times Securities Services, Inc., the owner sold fictitious 

mutual funds, as well as bona fide mutual funds to investors via a register broker dealer that was 

a SIPC member and a non-broker-dealer entity. 

Forensic accounting, which was done by the court appointed receiver, shows that the SIB CDs 

were not purchased by SGC for its customers, and therefore they are not worthless securities 

with zero value as argued by SIPC. Instead, these CDs are fictitious. The SGC customer funds 

were never transferred to the Antiguan bank and there was never any money standing behind the 

CDs. 

On June 5, 2011, the SEC Commission voted on a determination that SIPC should provide 

coverage for the Stanford victims. In the analysis of the case provided by the SEC to SIPC, the 

SEC explains that on the specific facts of this case, investors with brokerage accollllts at SGC 

who purchased the CDs through the broker-dealer qualified for protected "customer" status 

llllder SIP A. 

In reaching its determination, the SEC cited the conclusions in the report of the court appointedreceiver for SGC, who noted that the many companies controlled and directly or indirectly 

owned by Stanford "were operated in a highly interconnected fashion, with a core objective of 

selling" the CDs. Among other things, the receiver also noted that "[c]orporate separateness was 

not respected within the Stanford empire ... Money was transferred from entity to entity as 

needed, irrespective of legitimate business need. Ultimately, all of the fund transfers supported 

the Ponz! scheme in one way or another, or benefited Allen Stanford personally." 

A SIPA liquidation proceeding would allow investors with accounts at the SGC to file claims 

with a trustee selected by SIPC. The trustee would decide whether the investors have 

"customer" claims that are protected by the statute, and an investor who disagreed with the 

trustee's detennination could seek court review. 

However, the ultimate roadblock to the victim's day in court is SIPC. 

During the eight months since the SEC made its determination instructing to provide protection 

to the Stanford victims, SIPC has tried every conceivable idea to drag out making a final 

determination. 

After the SEC's determination, SIPC ran up $200,000 of charges in June and July oflast summer 

in reviewing the court appointed receiver's documents - a cost that will be ultimately be paid for 

with the money set aside for the victims. When asked about these charges, SIPC claimed that it 

was in order to do research into a settlement offer to the victims. However, an official settlement 

offer never materialized. 
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75077.163

During the time between the SEC's determination and the SEC ultimately tiling an application 

with the DC Circuit Court to compel a SIPA liquidation, I had many calls and meetings with 

Orlan Johnson, then Chairman of SIPC and his staff, including Stephen Harbeck. Concerns were 

raised by both Mr. Johnson and his staff on a reoccurring basis, as far back as OUf first meeting 

on this issue, about the cost to the SIPC fund of covering Stanford victims and how SIPC 

member companies would react to the need for SIPC to increase its assessments. I stressed in 

our discussions that I believe the only focus should be on providing the victims with swift 

resolution under the law in a manner that takes into account the complex nature of the fraud and 

uses the forensic accounting that had already been undertaken. 

In these meetings and on these calls, it seemed to me, that SIPC was more interested in the cost 

of the resolution and protecting its Wall Street member companies than it was in doing their 

duty, doing the right thing, and immediately initiating a formal liquidation proceeding in the 

Stanford matter as ordered by the SEC. In fact, I was told that SIPC felt they would be sued no 

matter what they ultimately decided to do. SIPC was certain they would either be sued by the 

SEC or sued by their member companies 

During the course of these meetings and phone calls it also became obvious that SIPC hired 

lawyers to defend itselffrom the SEC while still negotiating a settlement offer, and SIPC has 

shown every indication it will continue to litigate this matter in court. 

Currently, SIPC is fighting the SEC in court trying to avoid being compelled to file a protective 

order which would ultimately allow individual victims to get a judicial review of the merits of 

their claims against SIPC. While this judicial review is certainly part of the SIP A process, it was 

intended to be more of a summary proceeding, and I think everyone would be surprised at some 

ofSIPC's tactics they are willing to use in order to avoid compensating the victims. 

In a filing on February 16th, despite the fact that SIPC has run up a charge of $200,000 dollars 

with the court-appointed receiver, SIPC asked the judge to allow a discovery of documents 

related to who the customers were, the certiticates of deposit and the corporate structure of the 

Stanford Companies. In addition, on Monday of this week, SIPC asked the judge for approval to 

review all of emails and documents of the SEC's legislative affairs team in a fishing expedition 

in an attempt to find a past instance where a statTer at the SEC might have said something that 

disagreed with what the SEC ultimately voted on months or years later. 

The SIPA statute is 41 years old, and SIPC has never challenged the authority of the SEC in 

court the way it is now. SIPC has decided to test the SEC's authority to compel SIPC to protect 

investors. If SIPC persists on this pat, SIPC will undermine the faith investors have in markets 

and in SIPC coverage itself. Although I hope SIPC will see the error of their logic, r realize that 

ship has already sailed. I will continue to work on behalf of Stanford victims and all of 

Louisiana victims of securities fraud. 

Chairman Garrett, I want to close by once again commending you on this timely hearing. I hope 

that my testimony shows that though no additional legislative action is needed to provide SIPC 

coverage for the Stanford victims, they are facing what amounts to regulatory capture and are in 

a desperate search for ways to hold SIPC accountable. Hearings like this one are a very 
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75077.164

important step in that process. I encourage you to bring them back before this committee on a 

regular basis to answer for their actions. 

I hope at some point to hear Mr. Harbeck and Ms. Bowen tell the victims why they feel 

comfortable running up a $200,000 tab at the expense who have lost everything. 

Thank you again Chairman Garrett, Ranking Member Waters and Members of the Subcommittee 

for the opportunity to speak on behalf of the victims. 
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75077.165

BJ)\ Bond 

Deale~sof 

Amenca 

Statement of William Daly 

\\'\\\\.\)(\;tmcri(;I.org 

Senior Vice President, Government Relations 

Bond Dealers of America 

House Committee on Financial Services 

Subcommittee on Capital Markets and Government Sponsored 

Enterprises 

The Securities Investor Protection Corporation: Past, Present, 

and Future 

March 7, 2012 
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75077.166

Chairman Garrett, Ranking Member Waters and members of the Capital Markets and 

Government Sponsored Enterprises Subcommittee, thank you for the opportunity to 

submit this statement from the Bond Dealers of America (the "BDA"). 

The BDA is the only trade association exclusively focused on U.S. fixed income 

markets and represents middle-market brokers and dealers who are headquartered 

in cities all over the country, doing business throughout the United States coast to 

coast. 

Our members are the "Main Street" firms, not the Wall Street firms. They help 

communities around the country finance their schools, roads and bridges. They also 

provide investment opportunities and liquidity for the investors in those 

communities. 

The Securities Investor Protection Corporation (SIPC) plays an important role in the 

American financial markets, providing investors with the assurance that if their 

broker gets into financial difficulty the investor's cash and securities in possession 

of the broker will not be lost. 

We appreciate this opportunity to comment on the Report and Recommendations of 

the SIPC Modernization Task Force. The Task Force clearly spent a great deal of 

time on this project and gave serious thought to the issues before it. We commend 

them for their efforts. 

We believe, however, that the challenges to modernizing SIPC go far beyond the 

incremental recommendations of the Task Force and that some of the 

recommendations would increase the challenges. As the Task Force recognizes, 

several of its recommendations will have the effect of increasing claims. 

SIPC was created approximately 40 years ago and for most of its history the 

demands on its resources were relatively low. However, since 2008 the demands 

have become larger by several orders of magnitude. Its expenses increased from 

virtually zero in 2007 to over $1.3 billion in 2008 and have remained very high by 

historical standards ever since. Obviously, the liquidation of Lehman Brothers was 

due to the financial crisis, but other liquidations - notably the Madoff ponzi scheme 

and the liquidation ofMF Global- were not. There is also the case of the Stanford 

International Bank Ltd., where SIPC and the SEC differ over whether the case is 

covered by the Securities Investor Protection Act (SIPA). As with the other very 

large cases, the Stanford case would involve major claims on SIPe's resources if the 

SEe's view prevails. And it would clearly represent an expansion of SIPe's role as 

currently interpreted by the SIPC Board. 

It does not appear that after a short period of time, SIPC will return to "business as 

usual" as it was before 2008 and any discussion of modernization should take that 

into account. 
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75077.167

As a result of the demands put on SIPe, member assessments have had to increase 

dramatically, and will increase further if the SEe prevails in the Stanford case. In 

2007 and 2008 (and for many years previously) members' assessments were 

virtually zero. They now exceed $400 million a year. The effect on individual firms 

has been dramatic, with the assessments for some BOA members increasing 1000 

fold. Increases of that magnitude in a short period can and do affect firms and the 

services they provide to investors. Such a sudden and large increase in assessments 

strains firms' budgets and forces adjustments and curtailments in plans and projects 

to provide services and investment opportunities to the firms' clients. 

In this context, the recommendations of the Task Force, while perhaps good policies, 

seem to us to have missed the mark. In a situation where the scope and activity of 

slPe have dramatically changed and may change further, there is no recognition of 

that fact in the Task Force's report or recommendations. The challenges facing slPe 

and how it can fulfill its role in the financial system going forward is simply not 

recognized nor dealt with in the report's recommendations. 

In fact, the Task Force makes a number of recommendations that would increase the 

claims on slPe without any discussion of the magnitude of the increases nor any 

cost/benefit analysis. 

The Task Force does recommend that the slPe Board undertake its own 

examination of the recommendations. We would go farther. We believe that the 

slPe Board should examine SIPe's role in a more fundamental way. We believe that 

before the slPe Board takes up these recommendations that it should examine 

SIPe's role currently and what it likely will be in the future, what the magnitude of 

claims will be, whether the current increase in claims is solely due to the financial 

crisis and will abate or whether there may be a permanent increase in SIPC claims, 

what the capital needs of SPIC will be and finally, how to equitably finance those 

capital needs. 

Thank you again for the opportunity to present our views. 
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75077.168

VOICE OF lNDEPEtWENT FINANCIAL SERVICES F'RMS 

AND INDEPENDENT FINMKfAl ADVISORS 

STATEMENT FOR THE RECORD 

On 

The U.S. House Committee on Financial Services, 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

"Securities Investor Protection Corporation: Past, Present, and Future" 

March 7, 2012 
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75077.169

VOiCE OF INDEPENDENT fF~ANCIAL SERVICES F;RI'15 

AND INDEPENDENT F1NANCAL ADVISORS 

Statement of the Financial Services Institute 

To the Subcommittee on Capital Markets and Government Sponsored Enterprises 

For Oversight Hearing on the Securities Investor Protection Corporation 

The Financial Services Institute (FSI) represents independent financial services firms and 

the independent financial advisors affiliated with them. We are pleased that the 

Subcommittee is holding this hearing to explore the issues facing the Securities Investor 

Protection Corporation (SIPC). We wish to register our concerns regarding proposed 

changes to the structure of SIPC assessments, particularly our strong opposition to the 

disproportionate financial impact that independent broker-dealer (IBD) firms will be forced 

to bear under revised SIPC assessments and the SIPC Modernization Task Force's 

recommendations. 

Independent Broker-Dealer Firms were not part of the problem and are Disproportionately 

Impacted by Increased Assessments 

It is clear that IBD firms were not part of the problems that created the most recent 

financial crisis. Yet, these same firms are disproportionately bearing the burden of the 

failures that resulted in the crisis through the imposition of significant and unanticipated 

increases in SIPC assessments. The failure of Lehman Brothers and the Ponzi scheme of 

Bernie Madoff, as well as others, have placed an enormous burden on IBD firms. Prior to 

2009, SIPC assessments were at the very minimum, $150 per year. In fact, this had been 

the practice for so long that our members had developed a reasonable expectation that the 

cost would remain at that level for the foreseeable future. 

Instead, since 2009 SIPC assessments have increased exponentially and without warning. 

The result has been a significant blow to IBD firms, making already difficult economic 

circumstances even more challenging. To wit, the following is a brief list that demonstrates 

the impact: 

A small FSI member firm located in the Southeastern United States, with 

approximately $20 million in revenues in 2011, had the following SIPC assessments 

from 2008 to 2011: 

o 2008 - $150.00 

o 2009 - Approximately $10,000 - a 6566.67% increase from the prior year 

o 2010 - $22,417 - a 124.17% increase from the prior year 

o 2011 - $34,891 - a 55.65% increase from the prior year 

A mid-size FSI member firm in located in the Southwestern United States, with 

approximate revenues of $65 million in 2011, had the following SIPC assessments 

from 2008 to 2011: 

o 2008 - $150.00 

o 2009 - $32,107 - an increase of 21,304.67% from the prior year 

o 2010 - $84,660 - an increase of 163.68% from the prior year 

o 2011 - $71,595 

A large FSI member firm in the Northeastern United States with approximately $170 

million in revenue in 2011, had the following SIPC assessments from 2008 to 2011: 

o 2008 - $150.00 

o 2009 - $486,714 - an increase of 324,376% from the prior year 
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75077.170

o 2010 - $795,174 an increase of 63.38% from the prior year 

o 2011 $835,763 an increase of 5.1 % from the prior year 

o 2012 - projects near $1,000,000 

Profit margins for IBD firms are generally very small. From 2004 to 2010, the average 

annual profit margin for IBD firms was 1. 7%. SIPC assessments are likely to remain high for 

the foreseeable future, especially with recent developments involving a court battle between 

the SEC and SIPC to determine coverage for victims of the R. Allen Stanford Ponzi scheme 

and the failure of MF Global currently progressing through SIPC liquidation. 

These assessments are having a disparate impact on small IBD firms which don't have the 

resources to absorb the large and unexpected increase in fees. Furthermore, many IBD 

firms operate as dual registrants conducting both investment advisory and securities 

brokerage operations under a single corporate entity. Small firms are organized in this 

manner to reduce costs and simplify their bUSiness operations. This structure results in 

additional complications due to the fact that when investment advisory services are 

segregated into a separate corporate entity they are excluded from SIPC assessments, but 

are included when they occur under the same corporate entity as the brokerage services. 

IBD firms should not be penalized simply for choosing a more efficient business structure 

that helps lower their costs. 

Another reason IBD firms are shouldering a disproportionate share of the burden is that IBD 

firms present a significantly lower risk of causing SIPC payouts due to the fact that they 

operate as introducing brokers. As such, they are prohibited from obtaining custody of 

investor funds and securities, and therefore receive no cash or securities from investors 

other than for transmittal purposes. Instead checks are made payable directly to the 

product sponsor and accounts are held, and securities transactions are processed, through 

clearing firms. The risk to investors is significantly less in this model and, thus, the risk of 

an adverse event requiring SIPC liquidation is also lower. 

In addition, the vast majority of IBD firms do not sell proprietary securities or insurance 

products. Those IBD firms who do engage in proprietary product sales are usually 

subsidiaries of large, heavily regulated insurance companies and typically do not offer their 

financial advisors preferential compensation for the sale of those products. Proprietary 

products are often the vehicle through which those who perpetrate financial fraud, like R. 

Allen Stanford, gain access to investor funds. Once again, the structure of the typical IBD 

firm lowers the risk of SIPC payouts. 

Effects of Increased SIPC Assessments to IBD Firms 

The results of excessively high SIPC assessments will continue to be predictable: failure of 

small IBD firms. In 2008 there were more than 5,000 broker-dealer firms. By 2012 that 

number has fallen to just over 4,500, with approximately 175 broker-dealer firms failing in 

2009 alone, the first year of the increased assessments. 

The failure of small IBD firms will have a significant impact on the securities industry. 

Smaller IBD firms are a significant source of industry innovation. With profit margins 

generally very slim, small IBD firms have incentives to conSistently develop new methods of 

efficiently and effectively meeting their regulatory obligations, while at the same time 

providing the financial advice and services that Main Street Americans need and demand. 

These innovations often are adopted by others in the industry and become industry best 

practices. The excessively high SIPC assessments will lead to not only failures of small IBD 

firms, but also to reduced investment in new resources and innovation - including the hiring 
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75077.171

and training of new employees, acquisition of new equipment and development of software 

- among remaining IBD firms. 

Beyond industry innovation, there is a more significant impact that the loss of IBD firms will 

have: decreased access to financial advice, services and products for Main Street Americans 

seeking to save for retirement and their children's education. Small IBD firms and the 

independent financial advisers associated with them typically provide financial services and 

products to middle-class investors that are not served by larger firms. These investors need 

access to quality financial advice, products and service every bit as much as wealthier 

investors. However, many of these investors are unable to access these products and 

services through large wire house firms, which often find servicing smaller accounts 

unprofitable. Without the small IBD firms and their associated independent financial 

advisors providing local access to financial advice, less affluent investors will be left to their 

own devices to achieve their financial goals. 

Implementation of the SIPe Modernization Task Force Recommendations will perpetuate 

these problems 

Should the recommendations of the SIPe Modernization Task Force be adopted, the 

problems outlined above will only be perpetuated. The Task Force has recommended, 

among other things, the following: 

Increase the minimum assessments, 

Increase the caps on coverage to $1.3 million indexed for inflation, and 

Eliminate the distinctions between cash and securities to allow larger recoveries. 

Unfortunately, the Task Force failed to make major reforms that would more equitably 

distribute the costs. We believe that this is a result of failing to include small firm 

representation on the Task Force. 

A Better Approach 

FSI believes that true SIPe modernization requires a system that provides recovery to 

defrauded securities investors in a smooth and orderly process. In order to be equitable, 

such a system should impose the greatest cost for maintaining the system on those that 

present the greatest risk. This system must also provide broker-dealers with greater 

predictability so that they can budget appropriately for the costs. Finally, the system must 

avoid imposing a disproportionate impact on IBD or other firms. 

We thank the Subcommittee for holding this hearing and for the work it is doing to address 

these issues. Please contact David T. Bellaire, Esq., FSI's General Counsel & Director of 

Government Affairs at 770 980-8488 or david.bellaire@financialservices.org if you would 

like more information on the Financial Services Institute and our position on this important 

issue. 

Background on FSI and the Independent Broker-Dealer Community 

The IBD community has been an important and active part of the lives of American 

investors for more than 30 years. The IBD business model focuses on comprehensive 

financial planning services and unbiased investment advice. IBD firms also share a number 

of other similar business characteristics. They generally clear their securities business on a 

fully disclosed basis; primarily engage in the sale of packaged products, such as mutual 

funds and variable insurance products; take a comprehensive approach to their clients' 

financial goals and objectives; and provide investment advisory services through either 

affiliated registered investment adviser firms or such firms owned by their registered 

representatives. Due to their unique business model, IBDs and their affiliated financial 
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advisors are especially well positioned to provide middle-class Americans with the financial 

advice, products, and services necessary to achieve their financial goals and objectives. 

In the U.S., approximately 201,000 financial advisors - or 64% percent of all practicing 

registered representatives - operate as self-employed independent contractors, rather than 

employees of their affiliated broker-dealer firm.' These financial advisors provide 

comprehensive and affordable financial services that help millions of individuals, families, 

small businesses, associations, organizations, and retirement plans with financial education, 

planning, implementation, and investment monitoring. Clients of independent financial 

advisors are typically "main street America" - it is, in fact, almost part of the "charter" of 

the independent channel. The core market for advisors affiliated with IBDs is clients who 

have tens and hundreds of thousands, as opposed to millions, of dollars to invest. 

Independent financial advisors are entrepreneurial business owners who typically have 

strong ties, visibility, and individual name recognition within their communities and client 

base. Most of their new clients come through referrals from existing clients or other centers 

of influence. 2 Independent financial advisors get to know their clients personally and provide 

them investment advice in face-to-face meetings. Due to their close ties to the communities 

in which they operate their small businesses, we believe these financial advisors have a 

strong incentive to make the achievement of their clients' investment objectives their 

primary goal. 

FSI is the advocacy organization for IBDs and independent financial advisors. Member firms 

formed FSI to improve their compliance efforts and promote the IBD business model. FSI is 

committed to preserving the valuable role that IBDs and independent advisors play in 

helping Americans plan for and achieve their financial goals. Our mission is to insure our 

members operate in a regulatory environment that is fair and balanced. FSI's advocacy 

efforts on behalf of our members include industry surveys, research, and outreach to 

legislators, regulators, and policymakers. We also provide our members with an appropriate 

forum to share best practices in an effort to improve their compliance, operations, and 

marketing efforts. 

1 Cerulli Associates atlm.J2..JLW'NW.ccruUi.com/, 

1 These "centers of influence" may include lawyers, accountants, human resources managers, or other trusted advisors. 
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AGILE FUNDS INVESTOR COMMITTE 

March 2, 2012 

Members of the Capital Markets, Insurance and 

Government Sponsored Entities Subcommittee: 

Chairman Garrett, Ranking Member Maxine Waters, and members of the Capital 

Markets and Government Sponsored Entities Subcommittee of the Committee on 

Financial Services (the "Committee"). 

This letter is submitted for the official record of the Committee's March 7, 2012 hearing 

"The Sccurities Investor Protection Corporation: Past, Present, and Future" 

My name is Peter J. Leveton. I live in Lakewood, Colorado, a Denver suburb in Congressman Ed 

Perlmutter's 7th District. I am an indirect investor victim of the Bernard L. MadoffInvestment 

Securities, LLC CMadoff"or "BLMIS") Ponzi scheme, and a Co-Chairman of the Agile Funds 

Investor Committee ofthc Agile Group, LLC, Boulder, Colorado CAgile" or "Agile Group"). 

In December 2008, Agile had 205 investors and managed three primary hedge funds. The Group 

and its funds are currently in liquidation. 

A large portion of Agile's funds under management were invested by Agile in the Rye Select 

Broad Market Prime Fund (the "Prime Fund") managed by Tremont Group Holdings, Inc. 

("Tremont" or "Tremont Group"), and invested by Tremont with Madoff/BLMIS. Tremont is a 

subsidiary of Oppcnheimer Funds, itself a subsidiary of Massachusetts Mutual Life Insurance 

Company. 

This letter is written on behalf of Agile's 205 Indirect investors, several hundred Ponzi Victims 

Coalition Indirect invcstors from morc than 20 states; and, by extension, all Madoff Indirect 

investors who filed approximately 11,000 Securities Investor Protection Corporation ("SIPC") 

claims on or before the bar date of July 2, 2009. 

When I testified before this Committee on December 9, 2009, I believed Congress would resolve 

the Madoffmatter before the end of2010. Unfortunately, we are not much further along now 

than we were then. 

For many people, Bernie Madoff and BLMIS are yesterday's news. I believe that unless this 

Committee takes action quickly, the 11,000 Indirect investors will end up holding the same 

empty bag we have held since Madoffs arrest in December 2008, almost three and one-half 

years ago. Because the scandal broke so long ago, we are worried that except for a few Members 

of this Committee, the only people who still have a passionate concern for the Indirect investors 

are the investors themselves. 

We need your help now more than ever and we implore you to take action soon! 
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"Indirect" Madoff/BLMIS investors are those individuals and entities who did not invest directly 

with Madoff and did not have their own BLMIS account. The individual Indirect investors 

placed their money in hedge funds, family partnerships, pension funds, retirement funds and 

other intermediaries that then invested with Madoff/BLMIS, or a feeder fund which in tum 

invested with Madoff and had their own BLMIS account .. Many Indirect investor victims did 

not know their money was being invested with Madoff/BLMIS and many, if not most, of us had 

never even heard of Madoff until the day we learned he had stolen our life savings. 

"Direct" MadofflBLMIS investors are those individuals and entities who invested directly with 

Bernard 1. Madoff, had their own BLMlS account and knew exactly who Madoffwas. 

We Indirect investors are Americans from all walks oflife and include farmers, teachers, 

engineers, doctors, lawyers, entrepreneurs, business owners, corporate executives, and others 

who have worked hard, saved wisely, paid our taxes, educated our children, contributed to 

charities, benefited society in many ways and essentially tried to do "everything right" our entire 

lives. 

• Many of us are your constituents. 

• Many of us placed a lifetime of savings in what we believed were safe investments but 

which were ultimately invested with BLMIS, often without our knowledge. 

• Many of us are now devastated, financially and psychologically. 

• Many of us have sold or are trying to sell our homes just to obtain money to live on 

without becoming wards of the state. 

• Many of us in our 60s, 70s and 80s have been retired but have had to, or are attempting 

to, .go back to work, often accepting menial jobs to obtain money for food and shelter. 

• Some of us have had to beg for support from our siblings, children and friends 

Because nothing for Indirect investors has changed, the above description is substantially the 

same as I submitted for the 2009 Committee hearing. 

The Madoff/BLMIS matter has been covered extensively by the media, has been 

investigated extensively by the Securities and Exchange Commission and has been 

discussed many times by this Committee. I believe the Committee members are fully 

aware of the background, and don't plan to reiterate it in this letter. 

The letter focuses on the current status ofBLMIS Indirect investor victims, H. R. 1987, 

H.R. 757, and the February 2012 SIPC Modernization Task Force Report (the "Task 

Force Report"). 

My objectives are: 

1. To gain financial relief for all Indirect investors via Madoff-related legislation 

which we hope will be ultimately approved by this Committee and sent to the 

House Committee on Financial Services during the 112th Congress. Without the 

passage of such legislation, Indirect investors will remain on the "outside looking 

in" and will have received only platitudes and conversation, but no financial 

relief; 

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2. To encourage the principal sponsors of H.R. 757 and H.R. 1987 to consolidate 

the two Bills into one straightforward and powerful Bill that will assist all Madoff 

investors and be passed by this Committee, the House Committee on Financial 

Services, the House of Representatives and the Senate; 

3. To clarify the incorrect assumption that all Tremont Group Indirect investors will 

receive their pro rata share of monies that Irving H. Picard, the BLMIS 

Bankruptcy Trustee ("Picard" or the "Trustee") recovers from third parties and 

distributes to the Tremont Funds pursuant to the Trustee/Tremont Settlement 

Agreement. This assumption is incorrect because evcn though Agile and other 

Prime Fund investors were "net losers", the Fund itself was determined by the 

Trustee to be a "net winner" and therefore not eligible to receive the Trustee's 

distributions. We hope this matter will be worked out within Tremont, but at the 

moment there is no assurance that the Prime Fund investors will receive anything 

at all from the Trustee/Tremont Settlement of more than $2 billion. This situation 

is grossly unfair, and once again we need your help to protect the Indirect 

investors 

4. To correct the discrimination of non-ERISA plan Indirect investors as proposed in 

the Task Force Report .. 

Comments Related to the Task Foree Report 

My Task Force Report comments are limited to those few sections on pages 12 and 13 

that are spccifically applicable to Indirect investors. 

In summary, despite all the fanfare, I and many other Indirect investors are extremely 

displeased and disappointed in the Report because the Task Force elected to continue 

"business as usual" for non-ERISA plan Indirect investors. Instead of helping such 

Indirect investors, the Task Force recommendations have actually made things worse for 

us. 

We believe this is not at all what Chairman Kanjorski and thc Illth Congress Capital 

Markets Subcommittee had in mind in the spring of 20 10 whcn the Committee directed 

SIPC to create a Task Force. In providing this direction the Chairman stated: "The recent 

colossal failure of Bernard Madoffs firm and its effect on investors has highlighted the 

need for Congress to enact modification to SIPA and for SIPC to pursue regulatory, 

policy, and organizational changes." 

We further believe that SIPe's hand-picked Task Force, which to my knowledge 

excluded any Indirect investor representation, did not address the discrimination against 

hedge fund, fund of funds and mutual fund Indirect investor because of its desire to 

protect SIPe's Board and Management, limit the financial responsibility of SIPC' s 

broker-dealer members, and limit the amount of work required of the SIPC staff. 

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The Report, on page 13, recommends "no change to thcir treatment", i.e., no passthrough participation, for "Investors who own shares of a hedge fund, fund of funds, or 

mutual fund, where the fund is the account holder". 

However, two paragraphs later the Report notes that the following Indirect investor 

categories "are currently not eligible for pass-through protection and the Task Force is 

recommending that treatment of these individuals be changed: 

I. Individual participants of a defined benefit pension plan, where the plan is the 

account holder; 

2. Individual participants in a defined contribution plan, where the plan is the 

account holder; and 

3. Individual participants in a deferred profit sharing plan, where the plan is the 

account holder" should receive pass-through protection. 

Although the money from both ERISA and non-ERISA investors was placed indirectly in 

the Madofffraud, these recommendations separate Indirect investors into two classes 

(those in ERISA plans and those not in ERISA plans), and worsen the inequities of the 

original SIP A. 

It is impossible to fathom why the Task Force would differentiate between the ERISA 

plan Indirect investors and all other Indirect investors, unless the differentiation resulted 

from extensive third party lobbying. While the demographic and financial profiles of the 

two classes are most likely quite similar, the differentiation elevates the ERISA plan 

Indirect investors to a substantially preferred position over all non-ERISA plan Indirect 

investors. 

The Task Force's feeble rationale that pass-through participation for non-ERISA Indirect 

investors is not feasible because "much of the information concerning the underlying 

investors and the size of their investment is proprietary and generally unavailable to the 

broker" is bogus. 

It is hard to imagine that any Indirect investor would refuse to provide information if it 

meant the difference between SIPe relief to recover a portion of their investment and no 

SIPe relief. 

The Report, referring to non-ERISA Indirect investors, goes on to state that "Without 

access to the books and records of the underlying funds, it is impossible to ascertain the 

amount of additional exposure to the SIPe fund if protection is extended to this group." 

Again, this is a bogus rationale because such information is relatively easy to obtain 

through the discovery process and review ofthc books and records of the underlying 

funds and feeder funds. 

I submit that the needed information is just as easy to obtain for non-ERISA Indirect 

investors as it is for ERISA Indirect investors. Additionally, the Trustee and SIPe have a 

large portion of the information already in their records. 

4 
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Trustee Picard knows exactly who we are, our street and email addresses, and the hedge 

funds, funds of funds, and mutual funds in which we invested. In fact, all Indirect 

investors who filed SIPC claims before the July 2, 2009 bar date routinely receive the 

Trustee's Bankruptcy Court filings that request approval oflegal fees and expenses, 

which now total more than $273 million. 

We believe the above matter deserves serious investigation. We strongly recommend 

that the Committee interview Task Force members, require them to explain the rationale 

and logic for their recommendations, and require that they fully disclose all information 

with respect to third party influence. 

We would also like you to know that our efforts to mobilize the Indirect investors were 

consistently blocked by SIPC and the Trustee. Our many written and verbal requests of 

SIPC and the Trustee to provide us with the Indirect investors' states ofresidencc (which 

would have helped us contact Indirect investors and their elected officials) were all 

refused based on assertions of "privacy". A blatant contrast with the Direct investors' 

names which were published in the national press and picked up by numerous other 

media early in the Madoff process. 

To eliminate this discrimination between classes of Indirect investors, we request that the 

Committee disregard the Task Force "pass-through participation" recommendations for 

ERISA-only accounts, and approve legislation that will instead provide true and equitable 

"pass-through participation" for all Indirect investors. 

General Comments Related to Indirect Investor Victims, H.R.7S7 and H.R. 1987 

According to the Trustee's most recent report, as of February 15,2012, Trustee Picard 

recovered for the sole benefit of Direct investors approximately $9.1 billion (52%) of the 

approximately $17.3 billion in initial BLMIS principal investments. The same report 

states that SIPC has advanced the Trustee approximately $800 million to distribute to 

2,426 Direct investor "allowed claims" -- an average of about $330,000 per claim. 

Over the same period, because SIPC, the Trustee, and certain Federal judges have 

determined that Indirect investors are not "Customers" under SIP A, neither SIPC nor the 

Trustee has done anything to assist the approximately 11,000 Indirect investors. 

H.R. 1987, introduced by Congressmen Gary Ackerman, provides for SIPC 

reimbursement up to $100,000 per Indirect invcstor. We are working closely with 

Congressman Ed Perlmutter and his staff, and Congressman Ackerman's staff to increase 

this amount to something closer to the $500,000 per account SIPC relief provided Direct 

investors, and to modify other important aspects of H.R. 1987. In fact, because Direct 

and Indirect investor monies were stolen in the same fraud, we believe that all investors 

should be treated the same way. 

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HR 757, introduced by Chainnan Scott Garrett, has received broad-based support from 

Direct investors because it proposes to eliminate investor "clawbacks" and calculate 

SIPe's reimbursement of up to $500,000 per account based on the "final statement 

balances'" instead of the "cash in leash out" method used by the Trustee. At this point 

neither provision ofB.R.757 helps Indirect investors because, as noted above, we are not 

considered "Customers" and therefore, we are not currently eligible for SIPC relief. 

Accordingly, our only realistic hope to gain SIPC relief is through new legislation 

initiated by this Committee. 

For the benefit of all Madoff victims, I strongly urge Chairman Garrett, Congressman 

Ackennan, and this Committee to combine the most equitable measures ofB.R. 757 and 

B.R. 1987, pass the combined Bill, and work with the Leadership and Members of the 

Committee on Financial Services to pass and send the Bill to the House of 

Representatives and subsequently to the Senate. 

I am very familiar with many of the issues surrounding H.R. 757 and H.R. 1987 and to 

provide a much-needed Indirect investor-perspective request that I be invited to 

participate in the mark-up sessions for a final Bill. 

Closing 

We look to you and your congressional colleagues as our last and only hope to carry out 

what we believe was Congress' original intent of protecting all investors when it enacted 

SIPA. 

I will be in town the remainder of this week and would welcome the opportunity to 

discuss these matters in person with you or your staffs. 

Peter J. Leveton 

Co-Chainnan, Agile Funds Investor Committee 

Ce\l-303-981-8783s 

Fax-303-730-9142 

Pete3489@aol.com 

6 

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