[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
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
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HOUSE COMMITTEE ON FINANCIAL SERVICES
SPENCER BACHUS, Alabama, Chairman
JEB HENSARLING, Texas, Vice BARNEY FRANK, Massachusetts,
Chairman Ranking Member
PETER T. KING, New York MAXINE WATERS, California
EDWARD R. ROYCE, California CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois BRAD SHERMAN, California
GARY G. MILLER, California GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California JOE BACA, California
MICHELE BACHMANN, Minnesota STEPHEN F. LYNCH, Massachusetts
THADDEUS G. McCOTTER, Michigan BRAD MILLER, North Carolina
KEVIN McCARTHY, California DAVID SCOTT, Georgia
STEVAN PEARCE, New Mexico AL GREEN, Texas
BILL POSEY, Florida EMANUEL CLEAVER, Missouri
MICHAEL G. FITZPATRICK, GWEN MOORE, Wisconsin
Pennsylvania KEITH ELLISON, Minnesota
LYNN A. WESTMORELAND, Georgia ED PERLMUTTER, Colorado
BLAINE LUETKEMEYER, Missouri JOE DONNELLY, Indiana
BILL HUIZENGA, Michigan ANDRE CARSON, Indiana
SEAN P. DUFFY, Wisconsin JAMES A. HIMES, Connecticut
NAN A. S. HAYWORTH, New York GARY C. PETERS, Michigan
JAMES B. RENACCI, Ohio JOHN C. CARNEY, Jr., Delaware
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
James H. Clinger, Staff Director and Chief Counsel
Subcommittee on Capital Markets and Government Sponsored Enterprises
SCOTT GARRETT, New Jersey, Chairman
DAVID SCHWEIKERT, Arizona, Vice MAXINE WATERS, California, Ranking
Chairman Member
PETER T. KING, New York GARY L. ACKERMAN, New York
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma RUBEN HINOJOSA, Texas
DONALD A. MANZULLO, Illinois STEPHEN F. LYNCH, Massachusetts
JUDY BIGGERT, Illinois BRAD MILLER, North Carolina
JEB HENSARLING, Texas CAROLYN B. MALONEY, New York
RANDY NEUGEBAUER, Texas GWEN MOORE, Wisconsin
JOHN CAMPBELL, California ED PERLMUTTER, Colorado
THADDEUS G. McCOTTER, Michigan JOE DONNELLY, Indiana
KEVIN McCARTHY, California ANDRE CARSON, Indiana
STEVAN PEARCE, New Mexico JAMES A. HIMES, Connecticut
BILL POSEY, Florida GARY C. PETERS, Michigan
MICHAEL G. FITZPATRICK, AL GREEN, Texas
Pennsylvania KEITH ELLISON, Minnesota
NAN A. S. HAYWORTH, New York
ROBERT HURT, Virginia
MICHAEL G. GRIMM, New York
STEVE STIVERS, Ohio
ROBERT J. DOLD, Illinois
C O N T E N T S
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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
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. 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.
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 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 statutory-mandated 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 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 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.
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.
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, presently, asking for more prolonged
discovery rather than getting to the heart of the issue in the
legal proceeding.
You put all of that together, 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.
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.
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 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 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 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 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. 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 SIPC-member brokerage firm and did not receive
those assets. There is no such investor.
The investors who lost money knowingly and willingly sent
their money to an offshore bank. And saying that there is some
vague connection between--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.
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?
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 $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 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 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.
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.
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 broker-dealer.
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 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?
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.
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 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.
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 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 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
pass-through, there is already a level of fiduciary obligation
under ERISA, so we felt that level of protection, if you will,
gave us some comfort.
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?
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.
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.
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.
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
broker-dealer 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.
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 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 pass-through 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 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 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 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
non-insurance 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.
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.
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 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.
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.
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.
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 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 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 broker-dealer 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 protection 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.
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.
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 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.
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-and-paste 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 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.
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.]
A P P E N D I X
March 7, 2012
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