WSJ: Burned Investors Won't Find Strong Safety Net

By JANE J. KIM

Investors who lost money with Bernard Madoff shouldn't count on the Securities Investor Protection Corp. riding to their rescue.

The federally mandated SIPC has a narrow requirement as to what it covers -- generally theft in brokerage accounts.

Furthermore, securities attorneys say the nonprofit organization, which is supported by brokerages' membership fees, has a miserly track record of paying out claims and its current reserves may not be nearly big enough to handle potential losses from the Madoff case.

On Monday, SIPC started the process of liquidating Bernard L. Madoff Investment Securities LLC. The case is by far, the biggest one that SIPC has ever handled. Madoff reported that it held more than $17 billion at the start of this year.

Indeed, since its creation by Congress in 1970, SIPC has had to spend only $508 million to reimburse investors after recovering assets. The Madoff case alone is likely to dwarf that.
Ceiling on Coverage

SIPC covers losses up to $500,000 per customer, which includes $100,000 on claims for cash.

Virtually all broker dealers registered with the Securities and Exchange Commission are required to have SIPC coverage, and most brokerage firms carry excess coverage for losses above this amount.

When a brokerage firm files for bankruptcy, SIPC will typically step in to help transfer investors' holdings to another firm. With Madoff's firm, however, it's not likely that SIPC and the trustee will be able to transfer the customers accounts to a solvent brokerage firm. That means that it could be months, even years, before SIPC starts paying out claims, experts say.

"We don't have any faith or reliability in the firm's statements," says SIPC's president and chief executive Steve Harbeck.

"The individual victims will have to file claims asserting and proving what they gave to Madoff securities, and we'll have to compare that to records that we have on hand," Mr. Harbeck says. "We don't know how much people gave to this organization, and we don't know how much realistically they think they're owed."

Losses from theft and proven unauthorized trading are generally covered. Losses from fraud, churning or manipulation of stock prices are usually not. SIPC also doesn't cover investment losses or some holdings, such as currencies, hedge funds and limited partnerships not registered with the SEC.

"Our job is really elegantly simple: It's to return the contents of your account," says Mr. Harbeck.

Securities attorneys say SIPC often takes a narrow definition of what is covered by its statute, the Securities Investor Protection Act. "Literally, you have to prove that someone reached into your brokerage account and wrote a check to themselves," said Robert Uhl, a securities attorney in Beverly Hills, Calif.

Mark Maddox, an Indianapolis attorney, has represented about 300 investors from 1997 to 2001 who struggled to get SIPC to pay their claims after they lost money when the Stratton Oakmont brokerage firm filed for bankruptcy in 1997. Of those clients, he says that SIPC initially denied about 90% of his claims, forcing him to file appeals. In most cases, SIPC took the position that it would be responsible only for losses up to its $100,000 cash limit.

"SIPC doesn't like to pay claims and when they do pay a claim, they try to pay as little as possible," he says.

SIPC says only 349 customers through 2007 have failed to get their entire portfolios back.

Some industry watchers question whether SIPC has enough in reserves to cover potential claims in the Madoff liquidation. Currently, the SIPC Fund has about $1.6 billion to cover potential claims and SIPC can borrow up to $1 billion from an international consortium of banks and another $1 billion from the Securities and Exchange Commission.

"There are so many different things that we don't know that it's impossible to determine what the SIPC exposure is," says Mr. Harbeck.
Annual Fee: $150

SIPC's reserve is funded by its member brokerage firms, which all pay a flat fee of $150 a year. SIPC used to charge an assessment fee based on the firm's net operating revenues but moved to a flat annual fee of $150 in 1996 after its fund hit $1 billion.

SIPC's reserves are tiny compared to what's held by the Federal Deposit Insurance Corp., which covers bank deposits up to $250,000. The FDIC's reserves totaled $34.6 billion as of the third quarter. But SIPC says its coffers don't need to be big because brokerage firms are supposed to keep investors' stocks and bonds segregated from the firms' assets.

Banks, by contrast, lend out customers' money to other customers, who might default on those loans.

Now that SIPC has started the liquidation process, the court-appointed trustee will compile a mailing list of the company's customers. After the court has approved the claim forms and authorized the publication of notice, the trustee will mail out the claim forms to customers.

Investors will typically have six months to file their claims, which must be sent by certified mail, from the time the notice is published. Eventually, the trustee will set up a Web site with more information.

For now, any investors with brokerage accounts at Mr. Madoff's firm should save any documentation, such as monthly statements and investor reports going back as far as possible, says Steven Caruso, a securities attorney in New York.

"Those statements show what was supposed to be in your account or what the value was," says Mr. Caruso, who worked with about 500 investors to file claims with SIPC in the Stratton Oakmont case.

In many of those cases, his clients had to provide detailed paper trails -- such as documentation proving that they complained to the firm about unauthorized trades at the time of the trade -- in order to show that their trades were unauthorized.

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