SIPA established SIPC to provide certain financial protections to the customers of insolvent securities firms. As required under law, SIPC either liquidates a failed firm itself (in cases where the liabilities are limited and there are less than 500 customers) or a trustee selected by SIPC and appointed by the court liquidates the firm. In either situation, SIPC is authorized to make advances from its customer protection fund to promptly satisfy customer claims for missing cash and securities up to amounts specified in SIPA. Between 1971 and 2002, SIPC initiated a total of 304 liquidation proceedings and paid about $406 million to satisfy such customer claims. SIPC was established in response to a specific problem facing the securities industry in the late 1960s: how to ensure that customers recover their cash and securities from securities firms that fail or cease operations and cannot meet their custodial obligations to customers. The problem peaked in the late 1960s, when outdated methods of processing securities trades, coupled with the lack of a centralized clearing system able to handle a large surge in trading volume, led to widespread accounting and reporting mistakes and abuses at securities firms. Before many firms could modernize their trade processing operations, stock prices declined sharply, which resulted in hundreds of securities firms merging, failing, or going out of business. During that period, some firms used customer property for proprietary activities, and procedures broke down for proper customer account management, making it difficult to locate and deliver securities belonging to customers. The breakdown resulted in customer losses exceeding $100 million because failed firms could not account for their customers’ property. Congress became concerned that a repetition of these events could undermine public confidence in the securities markets. SIPC’s statutory mission is to promote confidence in securities markets by allowing for the prompt return of missing customer cash and/or securities held at a failed firm. SIPC fulfills its mission by initiating liquidation proceedings when appropriate and transferring customer accounts to another securities firm or returning the cash or securities to the customer by restoring to customer accounts the customer’s “net equity.” SIPC defines net equity as the value of cash or securities in a customer’s account as of the filing date, less any money owed to the firm by the customer, plus any indebtedness the customer has paid back with the trustee’s approval within 60 days after notice of the liquidation proceeding was published. The filing date typically is the date that SIPC applies to a federal district court for an order initiating proceedings. SIPA sets coverage at a maximum of $500,000 per customer, of which no more than $100,000 may be a claim for cash. SIPC is not intended to keep firms from failing or to shield investors from losses caused by changes in the market value of securities. SIPC is a nonprofit corporation governed by a seven-member Board of Directors that includes two U.S. government, three industry, and two public representatives. SIPC has 31 staff located in Washington, D.C. Most securities firms that are registered as broker-dealers under Section 15(b) of the Securities Exchange Act of 1934 automatically become SIPC members, regardless of whether they hold customer property. As of December 31, 2002, SIPC had 6,679 members. SIPA excludes from membership securities firms whose principal business—as determined by SIPC subject to SEC review—is conducted outside of the United States, its territories, and possessions. Also, a securities firm is not required to be a SIPC member if its business consists solely of (1) distributing shares of mutual funds or unit investment trusts, (2) selling variable annuities, (3) providing insurance, or (4) rendering investment advisory services to one or more registered investment companies or insurance company separate accounts. SIPA, as recently amended, also exempts a certain class of firms that are registered with SEC solely because they may affect transactions in single stock futures. SIPA covers most types of securities such as notes, stocks, bonds, and certificates of deposit. However, some investments are not covered. SIPA does not cover any interest in gold, silver, or other commodity; commodity contract; or commodity option. Also, SIPA does not cover investment contracts that are not registered as securities with SEC under the Securities Act of 1933. Shares of mutual funds are protected securities; but securities firms that deal only in mutual funds are not SIPC members, and thus their customers are not protected by SIPC. In addition, SIPA does not cover situations where an individual has a debtor-creditor relationship, such as a lending arrangement, with a SIPC member firm. Investors who attain SIPC customer status are a preferred class of creditors compared with other individuals or companies that have claims against the failed firm and are much more likely to get a part or all of their claims satisfied. This is because SIPC customers share in any customer property that the bankrupt firm possesses before any other creditors may do so. Although bankers and brokers are customers under SIPA, they are not eligible for SIPC fund advances. SIPA states that most customers are eligible for SIPC assistance, but SIPC funds may not be used to pay claims of any failed brokerage firm customer who is a general partner, officer, or director of the firm; the beneficial owner of 5 percent or more of any class of equity security of the firm (other than certain nonconvertible preferred stocks); a limited partner with a participation of 5 percent or more in the net assets or net profits of the firm; someone with the power to exercise a controlling influence over the management or policies of the firm; and a broker or dealer or bank acting for itself rather than for its own customer or customers. The SIPC fund was valued at $1.26 billion as of December 31, 2002, which it uses to make advances to trustees for customer claims and to cover the administrative expenses of a liquidation proceeding. Administrative expenses in a SIPA liquidation include the expenses incurred by a trustee and the trustee’s staff, legal counsel, and other advisors. The SIPC fund is financed by annual assessments on all member firms—periodically set by SIPC—and interest generated from its investments in U.S. Treasury notes. SIPC, after consultation with the SROs, sets the amount of member assessments based on the amount necessary to maintain the fund and repay any borrowings by SIPC. At different times during the 1970s, 1980s, and 1990s members were assessed at a higher rate. Rates fluctuated depending on the level of expenses. SIPC’s board of directors attempted to match assessment rate increases with declines in the fund balance, so that years of high SIPC expenses were followed by periods of higher assessments. Since 1996, SIPC has charged each broker-dealer member an annual assessment of $150. If the SIPC fund becomes or appears to be insufficient to carry out the purposes of SIPA, SIPC may borrow up to $1 billion from the U.S. Treasury through SEC (i.e., SEC would borrow the funds from the U.S. Treasury and then relend the funds to SIPC). In addition, SIPC has a $1 billion line of credit with a consortium of banks. SIPA gives SEC oversight responsibility over SIPC. SEC’s primary mission is to protect investors and the integrity of the securities markets. SEC seeks to fulfill its mission by requiring public companies to disclose financial and other information to the public. SEC is also responsible for conducting investigations of potential securities law violations and overseeing SROs such as securities exchanges, as well as broker-dealers (securities firms), mutual funds, investment advisors, and public utility holding companies. SEC may sue SIPC to compel it to act to protect investors. SIPC must submit all proposed changes to rules or bylaws to SEC for approval; and SEC may require SIPC to adopt, amend, or repeal any bylaw or rule. In addition, SIPA authorizes SEC to conduct inspections and examinations of SIPC and requires SIPC to furnish SEC with reports and records that it believes are necessary or appropriate in the public interest or to fulfill the purposes of SIPA. The law that created SIPC also required SEC to strengthen customer protection and increase investor confidence in the securities markets by increasing the financial responsibility of broker-dealers. Pursuant to this mandate, SEC developed a framework for customer protection based on two key rules: (1) the customer protection rule and (2) the net capital rule. These rules respectively require broker-dealers that carry customer accounts to (1) keep customer cash and securities separate from those of the company itself and (2) maintain sufficient liquid assets to protect customer interests if the firm ceases doing business. SEC and SROs, such as NYSE, are responsible for enforcing the net capital and customer protection rules. Under a typical SIPC property distribution process, SIPC customers are to receive any securities that the firms holds that are registered in their name or that are being registered in their name, subject to the payment of any debt to the firm. If some of the customer assets are missing and cannot be found by the trustee, the customer will receive a pro rata share of the firm’s remaining customer property. In addition, SIPC is required to replace missing securities and cash in an investor’s account up to the statutory limits. For firms with excess SIPC policies, this coverage would be available as well. For example, if a firm is liquidated by a SIPC trustee that should have $10 billion in customer assets, but the trustee can account for only $9.8 billion or 98 percent of the $10 billion in assets, each customer would receive 98 percent of their net equity (pro rata share).