[Senate Hearing 114-163]
[From the U.S. Government Publishing Office]
S. Hrg. 114-163
OVERSIGHT OF THE SECURITIES INVESTOR PROTECTION CORPORATION
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
SECURITIES, INSURANCE, AND INVESTMENT
OF THE
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING THE SECURITIES INVESTOR PROTECTION CORPORATION'S (SIPC)
CONTINUING OVERSIGHT AND PROTECTION OF INVESTORS, THE AGENCY'S RESPONSE
TO RECENT CLAIMS AND CUSTOMER PROTECTION, AND CONSIDERING THE NEED FOR
ANY SPECIFIC SIPC REFORMS TO BE MADE
__________
SEPTEMBER 30, 2015
__________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
MIKE CRAPO, Idaho SHERROD BROWN, Ohio
BOB CORKER, Tennessee JACK REED, Rhode Island
DAVID VITTER, Louisiana CHARLES E. SCHUMER, New York
PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey
MARK KIRK, Illinois JON TESTER, Montana
DEAN HELLER, Nevada MARK R. WARNER, Virginia
TIM SCOTT, South Carolina JEFF MERKLEY, Oregon
BEN SASSE, Nebraska ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota JOE DONNELLY, Indiana
JERRY MORAN, Kansas
William D. Duhnke III, Staff Director and Counsel
Mark Powden, Democratic Staff Director
Dawn Ratliff, Chief Clerk
Troy Cornell, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
______
Subcommittee on Securities, Insurance, and Investment
MIKE CRAPO, Idaho, Chairman
MARK R. WARNER, Virginia, Ranking Democratic Member
BOB CORKER, Tennessee JACK REED, Rhode Island
DAVID VITTER, Louisiana CHARLES E. SCHUMER, New York
PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey
MARK KIRK, Illinois JON TESTER, Montana
TIM SCOTT, South Carolina ELIZABETH WARREN, Massachusetts
BEN SASSE, Nebraska JOE DONNELLY, Indiana
JERRY MORAN, Kansas
Gregg Richard, Subcommittee Staff Director
Milan Dalal, Democratic Subcommittee Staff Director
C O N T E N T S
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WEDNESDAY, SEPTEMBER 30, 2015
Page
Opening statement of Chairman Crapo.............................. 1
Opening statements, comments, or prepared statements of:
Senator Warner............................................... 1
Senator Vitter............................................... 2
WITNESSES
Stephen P. Harbeck, President and CEO, Securities Investor
Protection Corporation......................................... 3
Prepared statement........................................... 21
Sigmund S. Wissner-Gross, Esq., Senior Partner, Brown Rudnick LLP 5
Prepared statement........................................... 40
J.W. Verret, Assistant Professor of Law, George Mason University
School of Law, and Senior Scholar, Mercatus Center at George
Mason University............................................... 7
Prepared statement........................................... 69
James W. Giddens, Partner, Hughes Hubbard & Reed LLP, and
Trustee, SIPA Liquidations of Lehman Brothers Inc. and MF
Global Inc..................................................... 9
Prepared statement........................................... 70
Additional Material Supplied for the Record
Prepared statement of Richard R. Cheatham........................ 73
Prepared statement of Laurence Kotlikoff......................... 77
(iii)
OVERSIGHT OF THE SECURITIES INVESTOR PROTECTION CORPORATION
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WEDNESDAY, SEPTEMBER 30, 2015
U.S. Senate,
Subcommittee on Securities, Insurance,
and Investment,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Subcommittee convened at 10:16 a.m., in room 538,
Dirksen Senate Office Building, Hon. Mike Crapo, Chairman of
the Subcommittee, presiding.
OPENING STATEMENT OF SENATOR MIKE CRAPO
Senator Crapo. This hearing will come to order.
I, first of all, want to thank my colleague and Ranking
Member Senator Warner for his help in working together with us
on this hearing, and also, I would like to thank Senator Vitter
for encouraging our Subcommittee to hold an oversight hearing
on the Securities Investor Protection Corporation, known as
SIPC, and also thank you, Senator Vitter, for your efforts to
help the investors.
SIPC was created by Congress in 1970 to oversee the
liquidation of member broker-dealers that close when the
broker-dealer is bankrupt or in financial trouble and customer
assets are missing. In recent years, SIPC has been the center
of attention because of the financial trouble and failure of
Lehman Brothers, Bernie Madoff Investment Securities, MF
Global, and Stanford Investment Group. Each event has had a
lasting effect on investors, the broader sanction, and has
highlighted the function of the SIPC.
Today, we continue that discussion with our expert
witnesses. Specifically, how is SIPC protecting investors?
Specifically, how has SIPC responded to recent claims and
customer protection? And are there any specific SIPC reforms
that we should consider or that SIPC should consider and why?
I look forward to the testimony of our witnesses today. I
think that we have got a very strong panel of strong witnesses
who understand this issue well and will give us strong advice.
And with that, let me turn it to you, Senator Warner, if
you have any opening statement.
STATEMENT OF SENATOR MARK R. WARNER
Senator Warner. Well, thank you, Mr. Chairman. I want to
also thank you for holding this hearing and echo what you said
about Senator Vitter.
This is an area--we have heard of SIPC. Frankly,
unfortunately, I think we all kind of heard more about it than
we perhaps wanted to hear about it and post-Madoff, Stanford,
some of the other schemes that have taken place, I am curious
to learn more about the fact that different types of
securities, cash, CDs, others, seem to have different levels of
protection. So, I am anxious to see where we might see reforms.
I do think it is interesting to note that 7 years after the
Madoff fraud, only 10 percent of investment advisors are
examined annually. That, to me, raises some questions about if
we are going to be prophylactic going forward. Rather than
simply trying to make sure we rectify things after the fact, we
do need some ability to be more proactive on the front end.
So, Mr. Chairman, I have got other comments. I will keep
those in reserve so that we can move to the witnesses and get
to the questions. Thank you.
Senator Crapo. Thank you, Senator Warner, and I do
understand, Senator Vitter, that you would like to make an
opening statement, as well.
Senator Vitter. If I could, Mr. Chairman.
Senator Crapo. Certainly.
STATEMENT OF SENATOR DAVID VITTER
Senator Vitter. Thank you very much.
First, I would like to make a few items part of the record
by unanimous consent. The first is a statement from Richard
Sheedam, an investor who has filed a lawsuit disputing SIPC's
statement of facts with the SEC on the Stanford issue.
And the second is a statement of Dr. Laurence Kotlikoff,
who was scheduled to testify at a similar hearing on SIPC
oversight before this Committee earlier this year, but that was
rescheduled, and his statement as prepared for delivery.
Senator Crapo. Without objection.
Senator Vitter. Thank you.
Chairman Crapo and Ranking Member Warner, I want to thank
both of you for holding this important hearing on SIPC
oversight today. I can tell you, not enough attention is paid
in Congress to SIPC and Wall Street has noticed. Wall Street
basically runs SIPC their way, and I believe investors really
need to beware.
I want to take just a minute before we start to underscore
an important point that Dr. Kotlikoff makes in his testimony
when he says, quote, ``Today, no investor can be confident
their assets are protected by SIPC as Congress intended when
SIPA was enacted,'' and I think that is the bottom line and
that should concern all of us. I want to associate myself with
those remarks.
I think it is important for investors to notice, because
broker-dealers across the country plaster the SIPC logo across
their doors and their Web sites and all of their literature.
Investors are led to believe that if the broker-dealer fails,
SIPC will be there to help them. I can tell you from bitter
experience watching the Stanford case, trying to help those
victims however I can that this is just patently false.
Congress owes it to investors to act and to change this. We
need to decide if we are going to restore SIPC to what Congress
intended in the 1970s. Otherwise, we just as soon abolish it.
The status quo is a really perverse and rigged system that
allows Wall Street to suck in innocent investors with these
promises that someone is looking out for them to ensure that
the system is set up fairly. But then when push comes to shove,
SIPC can easily deny those claims for customer protection. Only
the lucky few who can find their way into a court with the
right kind of experience in these complex transactions has any
hope of relief. Most of the victims are forced to return to
work with their life savings evaporated.
Now, Mr. Harbeck in his statement suggests that the Senate
really needs to act on current SIPC nominees. The first
nominee, Leslie Bains, is a Managing Director at CITI and used
to work at Chase Manhattan Bank and HSBC. The second nominee,
John Mendez, is an equity partner at Latham and Watkins LLP.
While they may be perfectly nice people, I do not think they
bring the necessary track record of reform and investor
protection to SIPC that is desperately needed. If they are
confirmed without reforming SIPC, Ms. Bains would continue her
day job, for instance, at CITI. Mr. Mendez would continue to be
an equity partner at a firm that has grown into a very
significant securities litigation practice, including
securities class action, shareholder litigation defense, and
white collar criminal matters.
I can assure you, those two nominations will not be
confirmed until there is real reform at SIPC. We all saw the
trouble that Sharon Bowen had getting confirmed at the CFTC.
These nominees, in my opinion, are more of the same. The
President needs to nominate two individuals with a track record
of reform and investor protection, and we need to act on SIPC
reform.
Thank you, Chairman Crapo, for holding this hearing, and to
our witnesses on the panel for being here. I look forward to
our discussion.
Senator Crapo. Thank you very much, Senator Vitter.
Senator Reed, do you care to make an opening statement?
Senator Reed. No.
Senator Crapo. All right. Thank you very much.
With that, then, we will turn to our witnesses. We have
with us today, as I indicated, four very solid witnesses: Mr.
Stephen Harbeck, President and CEO of SIPC; Mr. Sigmund
Wissner-Gross, Counselor-at-Law at Brown Rudnick; Professor
J.W. Verret, Assistant Professor of Law at George Mason
University Law School; and Mr. James Giddens, Partner at Hughes
Hubbard and Reed.
Gentlemen, we will go in the order I have introduced you.
You have probably already been informed of this. We have a
little clock that tries to keep you to 5 minutes for your
introductory remarks. We ask that you try to keep your
introductory remarks to 5 minutes and allow us time for
questioning.
With that, let us begin. Mr. Harbeck.
STATEMENT OF STEPHEN P. HARBECK, PRESIDENT AND CEO, SECURITIES
INVESTOR PROTECTION CORPORATION
Mr. Harbeck. Thank you, Mr. Chairman. Chairman Crapo,
Ranking Member Warner, and Members of the Subcommittee, I
appreciate the opportunity to testify on the progress of the
Securities Investor Protection Corporation since the beginning
of the 2008 financial crisis. The Subcommittee has asked SIPC,
how is SIPC protecting investors, how SIPC is responding to
recent claims and customer protection, and if there are any
reforms Congress should consider.
The best way to describe how SIPC protects investors,
responds to claims, and operates the customer protection regime
mandated by statute is to provide you with an overview of
SIPC's cases in the recent history. The narrative which
follows, I think, demonstrates that SIPC has protected
investors as contemplated by the Securities Investor Protection
Act, known as SIPA, and I believe the results achieved to date
are impressive given the challenges that the SIPC has faced.
Let me turn to Lehman Brothers first. Lehman Brothers is
the largest bankruptcy of any kind in history. With securities
customer accounts essentially frozen and substantial customer
assets at risk, SIPC initiated a customer protection proceeding
on September 19, 2008. In response to the question, how does
SIPC protect investors, I would note the following.
That same day, in what was called the most important
bankruptcy hearing in history, Bankruptcy Judge Peck approved
the transfer of 110,000 customer accounts containing $92
billion in assets to solvent brokerage firms. Judge Peck noted
that he had heard credible evidence that without the ability to
transfer those accounts under SIPA, securities markets
worldwide could cease to function. SIPC is proud to have been a
major actor in restoring investor confidence in the securities
markets at that crucial time. The actual transfer of the
accounts took place in the ensuing 10 days.
Today, all Lehman Brothers customers have received 100
percent of the contents of their securities accounts and
general creditors have received a distribution of 35 percent.
In short, the bankruptcy processes embedded in the Securities
Investor Protection Act have worked well in a severe stress
case.
I would now turn to Bernard Madoff. That Ponzi scheme
collapsed in December 2008, shortly after the failure of Lehman
Brothers. SIPC's intervention resulted in advances to customers
in the payment of administrative expenses which had results
which were literally unimaginable at that time in 2008. Every
customer who has left $975,000 or less with Madoff has received
all of his or her money back from the trustee. Customers with
larger claims have received 48 percent of their initial
investments, and that means that a claimant with a $10 million
claim against Bernard Madoff's firm has already received $5.3
million when you take into account the addition of a
distribution of customer property and advances from SIPC.
SIPC made the determination that every piece of furniture
in Madoff was purchased with stolen money, so the liquidation
of all assets would go into customer property and not for the
payment of administrative expenses. SIPC picks up all of those
administrative expenses.
In addition, substantial painstaking research by the
trustee enabled the U.S. Attorney for the Southern District of
New York to create a $4 billion forfeiture fund, which has not
yet been distributed by the United States Attorney.
Finally, in terms of the large cases SIPC has had, MF
Global has had absolutely stunning results. I got a call at
5:20 in the morning that customers of MF Global were in need of
protection. That was the first time SIPC had ever heard of that
need. After receiving authority from SIPC's Chairman within the
hour, SIPC mobilized and initiated a liquidation proceeding
that day. That was the eighth largest bankruptcy of any kind in
history, larger in terms of assets than that of Chrysler. The
results are, as I said, stunning. Each customer for both
securities and commodities have received all of their assets,
and general creditors have received 95 percent of their assets.
In short, the process worked and it worked very well.
In terms of SIPC's financial condition, SIPC now has $2.4
billion, which is more money than SIPC has had to expend on all
liquidations in its 45-year history. We believe we have
sufficient assets, but we will continue to monitor the issue as
to whether our assets are sufficient.
Since December of 2012, SIPC has only had to initiate four
new cases. Those new cases have cost SIPC $7 million. I would
view that as a return to normal, because the large cases that
we saw were out of the ordinary.
I do urge the Committee to move on SIPC's nominees, and we
can discuss that at a later time.
There are some reforms that have been suggested by the task
force. Our Board did consider them. Two of them, we are looking
for an appropriate legislative vehicle to put in place. They
are in the nature of technical amendments. Some of the larger
suggestions of the task force report were studied and the Board
decided not to take action with them for larger macroeconomic
reasons relating to protection by the FDIC, for example.
With respect to S. 67, my comments in my written statement
stand for themselves, but I would be pleased to discuss them
with you if you wish, and I would appreciate the opportunity to
answer any of your questions.
Senator Crapo. Thank you, Mr. Harbeck.
Mr. Wissner-Gross.
STATEMENT OF SIGMUND S. WISSNER-GROSS, ESQ., SENIOR PARTNER,
BROWN RUDNICK LLP
Mr. Wissner-Gross. Thank you, Mr. Chairman, and thank you
for the opportunity to speak before this panel. My name is
Sigmund Wissner-Gross. I am a senior partner at the law firm of
Brown Rudnick LLP. I am here not on behalf of the firm, but in
my individual capacity.
I had the pleasure, at times the interesting experience, of
litigating the New Times SIPA proceeding during the period from
2000 through 2006. Mr. Giddens, who is here, was the trustee in
that case. What I would like to do is focus my verbal remarks
on some reforms that I think are needed. I will refer from my
witness statement for the details of my experience in the New
Times case, which, I think, illustrates many of the problems
with SIPC.
At the outset, let me say that I wholeheartedly endorse the
way Senator Vitter has framed this situation. There is a real
problem. The average investor has no idea that SIPC is not
really the guarantor of its investments. The average investor
thinks that the SIPC logo on their brokerage statement is akin
to an FDIC-insured institution. It is not.
SIPA is a carefully crafted statute that was created and
passed in 1970 to address circumstances at the time. There have
been a host of Ponzi schemes--terrible frauds--Stanford and
others beyond Madoff, that really require a fresh look and a
need for reform and amendment of the statute to more
appropriately address the varied circumstances that defrauded
investors experience.
My case, New Times, was one, where we can get into it if
the panel thinks it is appropriate, where all the victims had
their funds misappropriated. They thought they had purchased
either mutual fund shares or money market shares, all of which
were never purchased, and I had to litigate for several years,
ultimately succeeding, before the bankruptcy, the district
court, the Second Circuit, to establish that victims who
thought they had invested in fictitious or non-existent money
market shares should have their claims treated as claims for
securities, which at the time would have entitled them to
$500,000 of coverage. At the time, a claim for cash was only
allowed $100,000 of coverage, which, for those victims who had
invested their life's savings, meant all the difference between
getting some recovery or a significant recovery.
Let me turn to what I think are some specific reforms that
are needed. I concur with Mr. Giddens, and I do not want to
steal his thunder on this, but I concur that SIPC's maximum
coverage should be increased from $500,000 to $1.3 million.
That is a sound recommendation. That reflects the fact that the
times are different and there should be increased coverage.
I also concur that there needs to be no distinction between
claims for cash and claims for securities. That may have been a
sensible distinction at the time of the passage of SIPA in
1970. I, unfortunately, had to litigate and win on that issue
before the Second Circuit. I concur with Mr. Giddens that that
distinction is a distinction without a difference. Customers
who have other claims for cash or securities should be entitled
to coverage in the maximum amount available.
But, I think more is needed, and I think the S. 67 does
identify a number of very tangible specific reforms that are
warranted.
First, I think it is clear that the SEC, which has
oversight, should have more than that. The SEC, clearly, in my
view, should have the right, as well as SIPC, to apply for a
protective decree with respect to a SIPA member. That
prerogative should not be restricted to SIPC. While I think
SIPC has done many great things, and Mr. Harbeck has identified
some of the more notable achievements, the fact of the matter
is that, in my experience, SIPC at times has taken a very
narrow and unduly restrictive approach toward investor
protection. SIPC does have a reputation in the legal
marketplace as being very litigious, sometimes on an
unwarranted basis, sometimes to try to establish a point of law
when it should have exhibited pragmatism and effort to focus
more on investor protection. I think it would be prudent to
allow the SEC, which has oversight responsibility, to have the
ability to appoint or seek to intervene in terms of a SIPA
proceeding. The Stanford matter, that actually would have
solved that situation.
In addition, while I do not concur that trustees should be
limited to one case, as proposed in S. 67, I think there is a
significant issue about SIPC using the same trustees time and
time again. While I respect Hughes Hubbard a great deal as a
firm, my experience was that, in my litigation with them, they
invariably looked to SIPC to guide them on particularly
significant determinations and approaches and policies in the
case, and my sense was that they always acted in tandem, but it
was always the trustee acting essentially at the direction of
SIPC. I think there needs to be some reform so that the trustee
will, in fact, be independent and do the right thing.
Finally, with respect to the investor, I appreciate that
there is a lively debate about whether the rules proposed in S.
67 in terms of net equity statements, of whether that should be
a binding approach or another approach should apply. I think
that there does need to be reform so that customer protection,
it is advanced so that you do have with these Ponzi schemes a
whole variety of ways in which customers are defrauded. In my
experience, it is often the case that the statute does not
apply on all foras. So, there needs to be a reform to make sure
that people who have lost money, were innocent victims who,
frankly, do not fit within the specific definitions or labels
of the SIPA statute, are protected. I think S. 67 is an
excellent start in that regard.
Senator Crapo. Thank you, Mr. Wissner-Gross.
Professor Verret.
STATEMENT OF J.W. VERRET, ASSISTANT PROFESSOR OF LAW, GEORGE
MASON UNIVERSITY SCHOOL OF LAW, AND SENIOR SCHOLAR, MERCATUS
CENTER AT GEORGE MASON UNIVERSITY
Mr. Verret. Chairman Crapo and Ranking Member Warner, I
appreciate the opportunity to join you today to talk about this
important issue. My name is J.W. Verret. As you mentioned, I
teach at George Mason Law School, corporate and securities and
banking law. I also serve as a Senior Scholar at the Mercatus
Center, and until recently, I was Chief Economist and Senior
Counsel for Chairman Hensarling at House Financial Services,
where I first started to spend a significant amount of time on
this issue.
The explosive growth in federally backed loan and guarantee
programs has been an appropriate focus of congressional
oversight in recent years. OMB estimates the Federal Government
supports over $3 trillion in loans and guarantees. These loans
and guarantees are often shrouded by indirect Government
support and unreasonable assumptions in Government accounting
practices.
I submit that SIPC's provision of securities custody
insurance should be an appropriate part of that conversation.
Government officials appoint SIPC Directors and SIPC enjoys
access to a $2.5 billion line of credit with the Treasury
Department. Some may argue that statutory language that SIPC,
quote, ``SIPC shall not be an agency or establishment of the
United States Government'' suggests otherwise, and we certainly
all recall how similar statutory language in the GSEs proved
entirely meaningless and nonbinding when those entities were
placed under Federal conservatorship.
Today, I will argue that privatization of SIPC's custodial
insurance function is the best solution to protect American
taxpayers and also is the best solution to insert a level of
market discipline into SIPC's risk pricing for coverage. It
will add an element of risk pricing, I think, under a private
scheme. I will identify some unexplored solutions for victims
of Ponzi schemes. And though I argue that privatization is
certainly the first best solution, I am glad to constructively
engage in this Committee's examination of additional reforms to
SIPC.
Most broker-dealers and members of national exchanges are
required by statute to be members of SIPC, and SIPC is funded
by assessments on its membership. SIPC thereby enjoys a
statutory monopoly in the provision of securities custody
insurance underneath the ceiling of its coverage.
Now, some of my fellow panelists may argue that SIPC serves
an important role as a specialized liquidator or receiver of
broker-dealers and in overseeing that process. Now, assuming
that argument is true for the sake of argument, it remains a
tall leap of logic to further contend that a Government
monopoly in the provision of securities custody insurance is
thereby warranted.
SIPC's Board is currently composed of both private sector
and Government members. I submit--I will reiterate that
privatization of SIPC's insurance function is the first best
solution to the problems posed by the current structure of
SIPC, and we might begin by lowering the ceiling of that
coverage, where I would disagree with a couple of my fellow
panelists. I find it hard to accept that a market failure
necessitates a Government monopoly in this space, particularly
in the current information era, an era very different from the
1970s. In fact, there are underwriters at Lloyd's that will
sell excess of SIPC coverage for the portion of that market not
crowded out by SIPC.
In the absence of full privatization, the public-private
composition of SIPC's Board should not be viewed as a second-
best option. It would be better as a second-best option to
officially recognize SIPC for the Government entity that it is,
remove the private sector Board members, establish a similar
level of congressional accountability to that required of other
Government agencies, impose a term limit on its Chief Executive
Officer, as is the case among SEC Commissioners, and also
increase the level of the SEC's oversight of this entity.
The controversy and subsequent litigation between the SEC
and SIPC regarding the Stanford Ponzi scheme and issues with
respect to the Madoff victim claims also suggest a warning
label should be provided describing SIPC coverage that, quote,
``SIPC coverage only applies under limited circumstances and
SIPC reserves the right to deny claims despite reasonable
expectations of coverage.''
SIPC won the Stanford litigation because of a regrettable
stipulation of fact by the SEC. In the Madoff litigation, SIPC
utilized an aggressive valuation methodology from among a range
of methods it had used in prior cases. My impression of both of
those cases, in my professional opinion as a professor of
securities law, is that they were close calls that might have
come out either way. But it is also, nevertheless, very crystal
clear to me that SIPC's aggressive litigation position was
designed to minimize claims to a fund unprepared for them,
which suggests a clear conflict of interest for the receivers,
liquidators hired by SIPC and SIPC itself in the administration
of this fund.
I am not here today to relitigate those cases or to endorse
particular legislation. I sympathize with the victims. I
recognize they have been subjected to aggressive posturing by
SIPC. But, I worry about action that might further entrench
SIPC's monopoly. I would suggest instead looking at
undistributed funds in the SEC's Fair Funds, undistributed
funds that often sits in the CFPB's settlement awards, or
banking settlement agreements with DOJ and HUD. There is a
significant stash of money this Committee might consider to
make those victims whole.
I thank you for the opportunity to testify and I would just
reiterate that the design of SIPA in the 1970s may have made
sense in the 1970s. There were lots of ideas from the 1970s
that made sense at the time that will not necessarily stand the
test of time, like bell bottoms and the lava lamp. I think the
design of SIPC from that era does not stand the test of time
and needs to be reconsidered 40 years later. So, I thank you
for the chance to testify.
Senator Crapo. Thank you, Professor Verret.
Mr. Giddens.
STATEMENT OF JAMES W. GIDDENS, PARTNER, HUGHES
HUBBARD & REED LLP, AND TRUSTEE, SIPA LIQUIDATIONS OF LEHMAN
BROTHERS INC. AND MF GLOBAL INC.
Mr. Giddens. Chairman Crapo, Ranking Member Warner, and
Members of the Subcommittee, thank you for inviting me to
testify.
My testimony today is based on my experience with SIPA over
the past 45 years, most recently as trustee for the Lehman and
MF Global liquidations. In my experience, SIPA has succeeded in
protecting customers in these cases, the two largest broker-
dealer failures in history and the greatest challenges to the
statute.
In Lehman and MF Global, the 110,000 and 36,000 customers,
respectively, received 100 percent of their property. The
customers of these failed entities included mom-and-pop
investors, farmers and ranchers from all walks of life, from
every jurisdiction in the country.
With both Lehman and MF Global, we closely and
systematically consulted not only with the SEC, but the CFTC,
the Federal Reserve, and multiple congressional committees. We
have appreciated their guidance. In Lehman, I was also grateful
to have the support of Mr. Wissner-Gross, who publicly
supported my and SIPC's position before the United States
Supreme Court, seeking a review of a decision of the Second
Circuit.
However, I will say that, as with any statute, especially
one implemented decades ago, I believe there is room for
modernization and improvement. Consistent with my SIPA duty to
advance customer protection, I would like to provide three
considerations that may merit further study and, of course,
input from regulators,
industry experts, and the public. A more complete discussion of
these and 26 other recommendations is included in my written
testimony, which incorporates the detailed public submissions
of the SIPC Modernization Task Force as well as my own Lehman
and MF Global reports and prior testimony before the Senate
Banking and other congressional committees.
First, as proposed by the task force, I strongly support
increasing SIPC's maximum coverage from $500,000 to $1.3
million. That simply corresponds to an increase through
inflation from what was originally proposed in the 1970s.
Future coverage limits should also be tied to inflation. This
would immediately and significantly increase the protection for
customers, especially those who are not large or professional
investors.
Second, also in the task force report, I propose
eliminating the distinction between claims for cash and claims
for securities. This reform would resolve the potential
disparate treatment of customers and increase the amount of
customer protection available.
Finally, I believe consideration should also be given to
expanding the borrowing and guarantee authority available to
SIPC trustees and other liquidators. The SIPC fund has met the
demands of all previous SIPA liquidations. However, the Lehman
liquidation, in particular, demonstrated that just one failure
of a SIPC member broker-dealer could require at least a
temporary availability of much more substantial sums. The
ability to quickly and efficiently return customer property in
the early days of a liquidation would be enhanced if the
borrowing limit were increased.
In concluding, I believe that the SIPA statute has
succeeded in protecting customers of SIPC member brokerage
firms. I also believe the shared goal of continuing and
strengthening protection of investors, particularly
nonprofessional investors, can be achieved with improvements to
the statute and related laws.
Thank you, Chairman Crapo, Ranking Member Warner, and
Members of the Subcommittee, for the opportunity to testify
before you.
Senator Crapo. Thank you, Mr. Giddens.
I will start out with you, Mr. Harbeck, with some
questions, and my first question relates to basically the
appropriate amount for the SIPC fund. I think you indicated in
your testimony it is currently at $2.4 billion, and I
understand that the SIPC Board has set a target balance of $2.5
billion, which matches the line of credit that SIPC has with
the U.S. Treasury. How did you determine that $2.5 billion was
the appropriate amount, and given some of the other testimony
that we have heard today, is $2.5 billion the appropriate
amount?
Mr. Harbeck. Mr. Chairman, I can assure you that a subtext
in every single SIPC Board meeting is whether SIPC has
sufficient resources. In 2008, when we had $1.6 billion, we
realized when the Madoff case fell in December of 2008 that we
should turn on the assessment spigot. We did so. We have
completed all of the functions required in Lehman Brothers and
MF Global and Madoff with an expenditure of approximately $1.8
billion to date. But, we have at the same time increased our
resources from the 1.6 that we had in 2008 to 2.4.
I know, based on past experience, that whenever we reach a
plateau or a target, the Board of Directors takes a long hard
look, and since that was 7 years ago when they set that target,
that they will do so again.
We currently have assessments on all SIPC members of one-
quarter of 1 percent of net operating revenues. That generates
approximately $400 million a year. SIPC's resources currently,
the existing $2.4 billion that we have, is sufficient to have
satisfied all obligations in all cases in our history. With
that, we are always open to other ways to finance in an
emergency or to increase the fund if it becomes necessary.
Senator Crapo. Well, thank you, Mr. Harbeck.
For Mr. Wissner-Gross and Mr. Giddens, I appreciate your
perspectives on how SIPC responded to the claims because of the
financial trouble and failure of Lehman Brothers, Madoff, MF
Global, Stanford, and New Times. What are the main take-aways
about how SIPC responds to claims when a member firm fails
because of fraud as opposed to other financial reasons?
Mr. Wissner-Gross. If I could address that first, I do
think, again, I think SIPC has done a fine job in many
proceedings, but the ones that Mr. Harbeck has identified are
three of the 328 SIPA proceedings that it has handled since
1970, and my experience is primarily focused on New Times, so
let me address that.
I found that I actually had to fight at every step of the
way to secure coverage in that case. It was not an atypical
fraud claim. The Ponzi operator, a guy named Mr. Goren, had put
several hundred elderly investors into a program where he
basically embezzled their funds, gave them brokerage statements
that confirmed that they had purchased mutual funds and money
market shares, but had not, in fact, done that.
My recollection is initially that SIPC refused to
acknowledge customer status for any of them. So, my first job
was I had to fight both to try to get the SEC as well as the
bankruptcy judge involved to be supportive of the fact that
there should be customer claim or customer status acknowledged.
We ultimately, between the judge and SEC, I think, twisted
SIPC's arm to--through Mr. Giddens, the trustee--to acknowledge
that status.
Having accomplished that, then every individual customer
had to fight, in my view, with the SIPC trustee to acknowledge
and determine the fact of whether they had invested funds, the
amount of funds invested, and it was a very arduous process. We
represented quite a number of those defrauded investors who
were innocent beyond belief, and they included Holocaust
survivors, retirees, and so forth, not atypical of defrauded
investors in these schemes. Looking back on it, I would have
preferred that there be more of a presumption of a desire to
protect them in the first instance rather than to have those
investors be put through the grill in terms of establishing
coverage.
I highlighted one particular investor in my remarks, where
a woman named Mary Lee Stafford, who lost--who invested $75,000
and had it embezzled as a result of a purchase of money market
shares that were never purchased. Single mother, cancer victim.
This was all the money she had, and SIPC and the trustee denied
coverage. I fought it. The bankruptcy judge agreed with them. I
appealed it to the district court. I got it reversed. And they
should have, frankly, said, fine, let her get her money. It was
$69,000 out of pocket. That was all of her life's savings.
Instead, they appealed it to the Second Circuit, which was
their prerogative, and they were successful, and in the end,
she did not get anything in terms of coverage.
To me, frankly, that was a shame, because I think this was
in the gray area of coverage. She clearly could have been
acknowledged as a claimant. I would like to see those kinds of
things not happen in the future.
Senator Crapo. Thank you.
And, Mr. Giddens, my time has run out, but if you could
briefly respond, I would appreciate that.
Mr. Giddens. Yes. I have a different take on New Times. In
New Times, there were about 1,000 securities customers. Ninety-
nine-point-nine percent of all those customers received all
that they claimed on their claim forms and they were paid. SIPC
advanced millions of dollars. There were only, I think, two
claimants in the entire case who exceeded the limits of SIPC
participation. And I am sympathetic to anyone who loses money
in a Ponzi scheme and the like, but one of the difficulties
here was--and it was a complicated case--that there was also a
parallel SEC receivership going on with respect--at the same
time as the SIPC proceedings.
And from the 1970s on, one of the principles established in
the SIPA statute was, from the beginning, that if you loaned
money to the broker-dealer, that if you were a subordinated
lender or otherwise a lender or had promissory notes, you were
treated as a lender as opposed to a securities customer who
deposited cash in securities.
In the New Times case, the malefactor in that case
persuaded many of the individuals--fraudulently--to purchase
promissory notes from him individually, and these were not
customer transactions. In that case, we also, to assist
investors, did a substantive consolidation of certain entities
because under bankruptcy principles, there was so much
interrelationship of transactions and the like.
So, overall, my view is, yes, there always--in any SIPC
case, you have to apply the statute, and yes, based on
precedence and the like, I think we applied the law correctly
and I think the overall result was that virtually 99 percent of
all those claimants received all that they claimed in New
Times.
Senator Crapo. Thank you very much.
Senator Reed.
Senator Reed. Well, thank you very much, Mr. Chairman, and
gentlemen, thank you all for your testimony.
Mr. Harbeck, it strikes me that they call you at 5:20 in
the
morning after the other folks have failed, i.e., after
regulators, and others who were supposed to be governing the
conduct of these broker-dealers, failed. So, your role cannot
be isolated from the operations of the SEC and other agencies.
So, to what extent do you have any sort of insight into the
broker-dealer activities that might--or any influence over
their behaviors that might give you the tools to prevent rather
than just respond to these crises?
Mr. Harbeck. By design, SIPC is not a regulator. The
regulatory regime in the United States has a Federal regulator,
state regulators, self regulators, and Congress when it
established SIPC made sure that we were not another regulator.
That said, we work very, very closely with the SEC. The MF
Global case did, in fact, come up suddenly, but we work hand-
in-glove with the SEC. Even throughout the recent past when the
Securities and Exchange Commission was litigating with SIPC,
the relationship on the staff was professional and I can tell
you that right now, the relationship between the SEC and SIPC
is at a high point. Chairman Mary Jo White has met with our
Board of Directors. She is the first SEC Chairperson to do so.
We hope to have other members of the Commission meet with us
and meet with our Board of Directors to share common concerns.
We work hand-in-glove with the SEC. That is the answer to it.
Senator Reed. Do you think the SEC has the resources or the
capacity to thoroughly inspect broker-dealers? As Senator
Warner mentioned in his opening remarks, we are still at a very
low rate of inspections on a regular basis of broker-dealers.
Mr. Harbeck. Well, I believe Senator Warner mentioned
investment advisors, which are not covered by SIPC.
Senator Reed. Right.
Mr. Harbeck. But, frequently, the investment advisors
custody their securities at SIPC members. In fact, that is what
they are supposed to do. I think it would be an excellent idea
to increase the resources available for inspecting those
because that is a possible way to stop fraud ab initio.
Senator Reed. Mr. Giddens, you have been a trustee in
several cases, and in your testimony, you suggest that more
pre-liquidation disaster planning could be helpful. Could you
elaborate on that?
Mr. Giddens. Yes. The Lehman case was done on a very ad hoc
basis and under extraordinary circumstances, and there was not
sufficient time to involve SIPC or perhaps the SEC and the like
in the process. A great deal of the activity was dictated by
the Treasury Department and the Federal Reserve, all attempting
to avert a worldwide financial crisis. There was not sufficient
time or planning to fully understand the implications of the
transfers and the like.
Contrary to the public assumption, Barclays did not acquire
all the securities accounts of Lehman. They left behind
accounts--they could pick and choose assets. They did not
assume all the liabilities. That is not to criticize those who
structured that deal. It was--Barclays at the time was the only
prospective bidder. But, essentially, it took years to unravel
the intricacies and complications of Lehman through 76
proceedings around the world.
There is an attempt by requiring large firms to prepare so-
called living wills to more systematically sort of determine
where assets are, how assets will be obtained, and the like. As
I say, in Lehman, just by way of example, the British Prime
Minister claimed that $8 billion was improperly taken from the
U.K. and transferred back to the United States. So, that turned
out not to be correct and they later dropped that sort of
thing, but there was such confusion and misunderstanding about
how the system operated, so that preplanning involving those
who would be involved in a liquidation is very, very important.
It is also very important to identify the categories of all
the claimants, not just securities claimants, but unsecured
creditors and the like. That would help enormously in any
liquidation if you really had a clearer picture of what you are
trying to achieve.
Senator Reed. Thank you very much.
Thank you, Mr. Chairman.
Senator Crapo. Thank you, Senator Reed.
I am going to just ask one more quick question before I
turn both the gavel and the time over to Senator Vitter, and
that is for Professor Verret, I am interested in your argument
about privatization. Could you just briefly tell me how you
envision that would work?
Mr. Verret. Sure. I think that, you know, first, I think
there would be a substantial transition period, recognizing the
fact that members have been assessed for the fund that is
currently there with the expectation of coverage. So, you would
have to work through some transition issues. I think you would
begin by lowering the ceiling of coverage. But, I think part of
the benefit you would get there is for whatever is not crowded
out by SIPC coverage, I think you would see private sector
operators doing risk-based premiums, risk-based pricing. That
would go along with some of the issues we have talked about
today.
I mean, I would expect that a private-based provider would
set your risk-based premium based on the adequacy of your
resolution planning, your living will. I think that one of the
problems with the current structure is that not only is there a
Government subsidy through the Treasury's lending to all firms
provided with coverage, but there is internal subsidization.
The best actors subsidize the worst actors with an assessment
that is homogenous, you know, homogenous assessment. So, I
think that, for instance, publicly traded broker-dealers that
have Section 404 internal controls are a very different
situation from nonpublic broker-dealers, and so you would
expect the premium to be very different there.
So, in short, to answer your question, I think there would
be a transition, but I think--and I think you would probably
begin by lowering the ceiling of coverage. But I think that you
would see some risk-based pricing, some market discipline
inserted into that process. That would be very helpful with a
lot of the issues we have been describing.
Senator Crapo. Well, thank you very much, and as you can
see, it is a busy morning and I, too, am going to be called
away to another obligation. But, I know this is a critical
issue to Senator Vitter, and at this point, I am going to turn
both the gavel and the time over to you, Senator Vitter. Thank
you.
Senator Vitter. [Presiding.] Thank you, Senator Crapo.
Thanks for calling and sharing this hearing. Thanks to all of
you for being here.
Mr. Wissner-Gross, I want to step back and sort of start
with the big picture in terms of some of the comments you
suggested. Under the current system, we have SIPC, we have this
SIPC ``Good Housekeeping Seal'' logo, correct?
Mr. Wissner-Gross. Yes.
Senator Vitter. And that is very widely used by SIPC
members. I mean, they put it on all of their Web sites----
Mr. Wissner-Gross. On every statement.
Senator Vitter. Yes, every statement, every Web site, every
piece of literature, every entry door, basically, because it is
that sort of ``Good Housekeeping Seal'' logo similar to FDIC,
would you agree with that?
Mr. Wissner-Gross. Yes, Senator.
Senator Vitter. And yet the reality is, say, compared to
FDIC, it is fundamentally different and it is fundamentally
less protection, would you also agree with that?
Mr. Wissner-Gross. Yes, Senator.
Senator Vitter. So, it seems to me the big picture is that
the average customer is sort of actively being misled, as given
this ``Good Housekeeping Seal,'' member firms are actively
using that for their benefit in the market, and it is not there
when customers need it in many cases. In fact, it is most
uncertain, it seems to me--correct me if you think this is
wrong--but it is most uncertain in many outright cases of fraud
versus simply failure, and it seems to me that is particularly
ironic, would you agree with that?
Mr. Wissner-Gross. Well, I am not sure I am going to go all
the way with you on that comment. I do think that fraudsters
will typically use the SIPC logo as a means of trying to lull
their investors into thinking that it has SIPC protection. I do
not know whether I am prepared to go with you all the way to
say it is being used by the well-established brokerage firms to
somehow facilitate a fraud. But I do concur----
Senator Vitter. No, no, I did not say that or did not mean
to suggest that. What I am saying is, when push comes to shove,
often, the victims who have most difficulty being made whole
are victims of outright fraud versus other cases----
Mr. Wissner-Gross. That is----
Senator Vitter.----of market failure.
Mr. Wissner-Gross. That is correct.
Senator Vitter. And it seems to me that is particularly
ironic that it is least certain in many cases of outright fraud
versus market failure.
Mr. Wissner-Gross. I will agree with you.
Senator Vitter. That is all I was trying to say.
Now, it seems to me we should recognize this fundamental
disconnect and correct it in some way, either make that ``Good
Housekeeping Seal'' what it purports to be, or take it off
everybody's doors and stop the complete misrepresentation.
Mr. Wissner-Gross. Well, I will agree that if it is going
to be there, there should be an appropriate disclaimer----
Senator Vitter. Right.
Mr. Wissner-Gross.----so that people understand what is at
issue. But, I think, more to the point, as I said in my opening
remarks, I concur that you have properly framed the issue and I
think the proposed legislation identifies several ways in which
we can hopefully begin to rectify the problem.
Senator Vitter. Correct. Is not one of the big
differences--I keep using this analogy with FDIC because I
think that is how consumers read that ``Good Housekeeping
Seal''--is not one big difference that SIPC has industry
members who are clearly active, ongoing industry members who
have vested interests in SIPC members and private sector
industry partners?
Mr. Wissner-Gross. I will agree with you there, as well.
Senator Vitter. Do you think that poses a potential
conflict?
Mr. Wissner-Gross. Yes, Senator. I think--and there are
various ways in which that could be addressed, particularly if
you have a board that is truly independent.
Senator Vitter. Correct. Do you have any particular
thoughts about the best way to erase that potential conflict?
Mr. Wissner-Gross. Well, the same broker-dealers are
regulated by the SEC, and typically when there is fraud, it is
identified by the SEC. I do not have specific recommendations,
but I think that you have correctly framed the problem. I think
there has to be a better path to ensuring that SIPC, true to
its mandate, is truly independent, truly looking out for the
best interest of investors, and truly able to protect those
interests.
Senator Vitter. And would one partial or whole solution be
giving SEC more outright authority over SIPC----
Mr. Wissner-Gross. Yes. I----
Senator Vitter.----in certain cases, including fraud?
Mr. Wissner-Gross. I 100 percent agree with you, and in
fact, I endorse the proposal allowing the SEC to be able to
initiate SIPA proceedings. And, clearly, they have already a
statutory right of oversight. I think it would be in the best
interest of everybody to have the SEC, which can shut down
firms after identifying fraud, also being much more intimately
involved with the day-to-day operations and enforcement of
those situations.
Senator Vitter. Right. Mr. Harbeck, obviously, I am very
concerned about the Stanford case. I represent a lot of
Stanford investors. To date, how many of those Stanford
investors have gotten any recovery from SIPC?
Mr. Harbeck. None, sir, as a result of the case of SEC v.
SIPC----
Senator Vitter. OK.
Mr. Harbeck.----where the court stated that the Stanford
victims did not fall under the statutory program that we
administer.
Senator Vitter. OK. So, I just want to make clear, we are
talking about these other cases, 99 percent, great majority,
blah, blah, blah. Stanford, just factual basis--I want to be
clear--everybody has been shut out of recovery.
Mr. Harbeck. That is correct.
Senator Vitter. OK.
Mr. Harbeck. SIPC----
Senator Vitter. Now, let us walk through SIPC's arguments
for that, because as I have followed them, they are changing.
At the district court--let me just ask you if you can put in
layman's terms, not hyper-technical terms, but in layman's
terms, the grounds for SIPC not standing behind those
investors.
Mr. Harbeck. Senator, as you know, the Securities Investor
Protection Act is a complex statute. But if you would try to
reduce it to one sentence in terms of what is protected and
what is not protected, that sentence would be as follows: SIPC
protects the custody function that brokerage firms perform for
their customers and only the custody function. And in the
Stanford case, it was our consistent view for the 2 years prior
to that lawsuit that all of the customers that the SEC knew of
had their certificates of deposit, or they were in the custody
of another entity that had their certificates of deposit, or
they were book entry. SIPC----
Senator Vitter. You are basically talking about Antiguan
CDs?
Mr. Harbeck. That is correct.
Senator Vitter. OK.
Mr. Harbeck. All money went directly to the Stanford
International Bank of Antigua, or a bank account owned by the
Stanford International Bank of Antigua. The SIPC member
brokerage firm was not holding any assets, nor was it supposed
to be, for those customers.
Senator Vitter. Now, Mr. Harbeck, that is the argument that
you all made in district court. You changed the argument when
it got to appeal. I will get to that in a minute. But, let us
start with the district court. Is it not correct that those
customers were issued these Antiguan CDs and there was never
money in that Antiguan bank backing them up? That was a
complete fraud.
Mr. Harbeck. There was absolute fraud ab initio. However--
--
Senator Vitter. Was there money in the Antiguan bank
backing up those CDs?
Mr. Harbeck. There is some. There is an independent entity
or receiver in the Stanford--in Antigua that is in charge of
restoring those customers to the extent he can.
Senator Vitter. I do not know what that means. Was there
money in that Antiguan bank backing up those CDs or not?
Mr. Harbeck. Senator, we do not have investigatory
authority. Certainly, we do not have it overseas.
Senator Vitter. There has been forensic accounting that has
shown that there was no money in that Antiguan bank backing up
the CDs. Do you agree with that, because that is the record?
Mr. Harbeck. I do not believe it is the record in the case
that we litigated. I will assume it is true.
Senator Vitter. You will assume it is true?
Mr. Harbeck. For purposes of discussion, of course.
Senator Vitter. So, in the district court, the argument is,
well, this was an investment in a foreign bank that is not
covered under the SIPC law, under SIPA, but the money never
reached the foreign bank. The CDs were issued. There was no
cash backing them up. You do not think that is a problem with
your argument?
Mr. Harbeck. No, I do not, because I--I do not agree with
you in this regard. As far as I know and as far as the SEC
stated, all monies either went to the Stanford International
Bank or went to a bank account under its control.
Senator Vitter. Well, you are talking about an SEC
statement of facts submitted to the district court that was
incorrect, that is contrary to the forensic accounting. Are you
aware of that?
Mr. Harbeck. I am aware that someone has submitted an
affidavit saying the money did not go to Antigua. The SEC, when
we asked them about that, did say that the money went to an
American bank account owned by the Stanford International Bank
of Antigua.
Senator Vitter. An American bank account?
Mr. Harbeck. Correct.
Senator Vitter. OK. So, Mr. Harbeck, I think you are aware
of what I just laid out, because when the case went to circuit
court, you all changed your argument completely.
Mr. Harbeck. That is not correct, sir.
Senator Vitter. Well, in the circuit court, your primary
argument was that somehow this was a loan from the customers to
the broker-dealers and there is a specific exclusion to cover
that. Was that not a significant argument----
Mr. Harbeck. That was----
Senator Vitter.----that SIPC made in----
Mr. Harbeck. That was a secondary argument that we made in
both courts, sir.
Senator Vitter. And when these customers were buying CDs,
you think they were loaning the broker-dealers money or
investing in the broker-dealers?
Mr. Harbeck. That is not what the court said. The court
said that----
Senator Vitter. I am asking what you said in terms of that
particular argument. You made that argument. So, do you think
it was a fair characterization in making that argument that in
buying CDs, these customers were loaning the broker-dealers
money?
Mr. Harbeck. The SEC argued that if you substantively
consolidated these entities, then a SIPC member firm was
holding assets for the debtor. Substantive consolidation never
took place, number one. But what the court said is that if it
did, then people would be--instead of lending money to the
Stanford International Bank, which is what a CD is, it would be
lending money to the brokerage firm and that is not protected
by statute.
Senator Vitter. Right, except they had a CD and they never
agreed to lend money to the brokerage firm. The brokerage firm
stole the money, kept the money. That is cash. That is covered
under SIPA. Cash is covered under SIPA. CD is covered under
SIPA. And yet you all concocted this ridiculous theory that,
no, it was not a CD, even though the customer had a CD piece of
paper. It was not cash, even though that is what the broker-
dealer stole and diverted. It was somehow a loan to the broker-
dealer, which obviously the customer never agreed to. I mean,
do you not----
Mr. Harbeck. Senator, your statement does not comport with
the stipulated facts.
Senator Vitter. Well, the stipulated facts were wrong and
have been disproved by the forensic accountant.
Mr. Harbeck. I disagree.
Senator Vitter. OK. Well, I think the broader point here is
that I do not think an entity like FDIC would have spent tens
of millions of dollars to do back-somersaults to make those
sorts of arguments. I think only an entity dominated by
industry members would have done those back-somersaults and
spent tens of millions of dollars in legal fees to make those
sorts of arguments. I guess that is my broader point.
Let me go to Mr. Giddens, and I have another concern about
the trustee relationship. And, Mr. Giddens, I acknowledge you
are a very competent person in the roles you have played and I
do not question your competence or your integrity. I do
question the conflict of interest between people who are named
over and over and over as trustees, make a lot of money doing
it, and that person's role protecting the investors, and I
think that is a built-in and serious conflict, that practice.
So, with that in mind, let me ask you, how many times have
you and your firm--or your firm--acted as SIPC matter trustee?
Mr. Giddens. I believe in five or six cases out of the 300
cases over 45 years.
Senator Vitter. So, five or six cases?
Mr. Giddens. Yes.
Senator Vitter. And roughly how much money do you think you
and your firm have made doing that?
Mr. Giddens. I do not, off the top of my head, know. What I
would say is, one, I have never applied for compensation for
myself as trustee in a personal capacity. The law firm, of
which I am a partner, has to apply to the bankruptcy court for
compensation. That compensation is on notice to all creditors,
and after a hearing, the compensation has to be approved by a
bankruptcy court and a bankruptcy judge. The cumulative amount
of compensation, I do not know. In terms of the----
Senator Vitter. Can you give us a sense of proportion, a
ballpark figure?
Mr. Giddens. I really----
Senator Vitter. Was it over a million dollars in each case?
Mr. Giddens. No. It was less than a million in some cases
and over several million dollars in other cases. Again, the
compensation is governed by Bankruptcy Code requirements, where
the compensation should be based on results achieved. There is
also a public interest discount.
In terms of--if I may just comment on--I think you raise a
legitimate question. On the conflict of interest, I would point
out that, for example, in Lehman and MF Global, we have had
adversary proceedings against principal firms on Wall Street,
major, major issues involving billions of dollars in firms such
as JP Morgan, Goldman Sachs, Morgan Stanley, and the like. So,
it is not correct that there is a bias toward large Wall Street
institutions. They equally have disputes with SIPC and the SEC
about what is covered, for example, repo transactions and
things of that sort.
Senator Vitter. Well, just to clarify, I was not talking
about a bias there. I was talking about a bias of the trustee
toward SIPC----
Mr. Giddens. Well----
Senator Vitter.----because SIPC hires a trustee, in some
cases, over and over. That is a major book of business. That is
a major source of compensation for the firm. So, that is the
bias I was talking about.
Just to give you an example, you were not named trustee in
Stanford. If you were, and if you had decided matters in terms
of customer status and compensation contrary to the way SIPC
has fought--SIPC has fought the SEC, SIPC has gone to court,
SIPC has gone to circuit court, SIPC has spent tens of millions
of dollars on this--do you think you would be a prime candidate
to be hired as a trustee the next time?
Mr. Giddens. Umm--I am not sure I fully understand the
question. If the----
Senator Vitter. Let me restate it.
Mr. Giddens. If you are saying, hypothetically----
Senator Vitter. If you were the trustee in Stanford, and if
you had disagreed with SIPC on this fundamental question of
customer status and right to recovery----
Mr. Giddens. Well----
Senator Vitter.----which SIPC has fought tooth and nail to
an extraordinary extent--SEC told them to act otherwise. SIPC
fought the SEC. SIPC went to court. SIPC went to circuit court.
SIPC spent millions of dollars fighting this, which obviously
come out of the assets of the fraudster. Do you think, if you
had fundamentally disagreed with SIPC on that, do you think you
would be a prime candidate to be named a trustee in the next
big SIPC case?
Mr. Giddens. The answer is, I do not know. The answer is,
if I--the confusing part is to be appointed a trustee or being
suggested as a trustee by SIPC to the district court, which has
to appoint you, that would mean that SIPC had started a SIPC
liquidation of Stanford. And if I were the trustee, I would
look at the statute. That would be my job. Obviously, I would
discuss it with SIPC, the SEC, and others involved and try to
reach a fair decision. I am sympathetic to any group of people
who are defrauded, and I think whether it is a SIPC trustee or
an independent trustee, you ought to use all your resources to
try to find ways for recovery. There are other avenues, maybe
not successful, other than simply relying on the SIPC fund.
Senator Vitter. Right. Well, we can just disagree about
this. I will answer my own question. I think it is obvious that
you would not be on the short list by SIPC the next time, and
that is the conflict I am talking about, similar to the
conflict in terms of industry members of SIPC.
Let me end on that note. First of all, thank you all very
much for your testimony and your participation. I think this
has been an important and productive discussion.
I am determined that this discussion moves to action in
terms of appropriate reform, and I am equally determined that
there will be no confirmation of outstanding proposed SIPC
members unless and until that reform happens. So, I look
forward to all of that.
Thank you very much. The hearing is adjourned.
[Whereupon, at 11:20 a.m., the hearing was adjourned.]
[Prepared statements and additional material supplied for
the record follow:]
PREPARED STATEMENT OF STEPHEN P. HARBECK
President and CEO
Securities Investor Protection Corporation
September 30, 2015
Chairman Crapo, Ranking Member Warner, and Members of the
Subcommittee:
Thank you for the opportunity to brief you on the progress the
Securities Investor Protection Corporation (SIPC) has made since the
beginning of the 2008 financial crisis.
The Subcommittee has asked how SIPC is protecting investors, how
SIPC is responding to recent claims and customer protection, and if
there are any reforms Congress should consider. The best way to
describe how SIPC protects investors, responds to claims, and operates
the customer protection regime mandated by statute is to provide you
with an overview of SIPC's performance since the beginning of the 2008
financial crisis, which includes the most significant cases in SIPC's
history. Potential reforms will be addressed at the end of this
statement. The narrative which follows demonstrates that SIPC has
protected investors as contemplated by the Securities Investor
Protection Act (SIPA). I believe the results achieved to date are
impressive, given the scope of the challenges presented.
How is SIPC protecting investors and how has it responded to recent
claims and customer protection?
Lehman Brothers Inc.
Lehman Brothers is the largest bankruptcy proceeding of any kind in
history. With securities customers' accounts essentially frozen and
substantial customer assets at risk, SIPC initiated a customer
protection proceeding on September 19, 2008. That same day, in what has
been called the most important bankruptcy hearing in history,
Bankruptcy Judge James Peck approved the transfer of 110,000 customer
accounts containing $92 billion in assets to solvent brokerage firms.
Judge Peck noted that he had heard credible evidence that without the
ability to transfer those accounts under SIPA, securities markets
worldwide could cease to function. SIPC is proud to have been a major
actor in restoring investor confidence in the securities markets at
that time. The actual transfer of those accounts took place over the
next 10 days.
The SIPA trustee proceeded to close the complex, worldwide business
operations of Lehman. Among the highlights of that work was a victory
for investors in the Supreme Court of the United Kingdom that resulted
in additional assets being set aside for customers.
Today: All Lehman Brothers customers have received a 100 percent
distribution, and general unsecured creditors in that case have already
received 35 percent of their claims.
In short, the bankruptcy processes imbedded in SIPA have worked
well in a
severe stress case.
Bernard L. Madoff Investment Securities LLC
Bernard Madoff's Ponzi Scheme collapsed in December 2008. SIPC's
intervention resulted in advances to customers and the payment of
administrative expenses with results that were unimaginable at the
time.
Every customer who left $975,000 or less with Madoff has received
all of his, her, or its money back from the trustee. Customers with
larger claims have received 48.08 percent of their initial investment,
meaning that a claimant who left $10 million with Madoff has already
received $5.3 million from the trustee, including SIPC advances.
Further, SIPC took the position that every single asset of the Madoff
firm was purchased with stolen money, so all recoveries, of any nature,
should go into the ``fund of customer property.'' SIPC thus pays every
cent of the administrative expenses in that case.
In addition, based substantially upon painstaking research by the
trustee's staff and paid for by SIPC, the United States Attorney for
the Southern District of New York has amassed a sizable sum which
comprises a forfeiture fund. Distribution of that fund, which is in
excess of $4 billion, has not yet begun.
The SIPA trustee is engaged in extensive litigation which, if
successful, will benefit those who have not yet received all of their
net funds invested with Madoff.
In summary, the trustee has maximized the returns to victims given
the tools available to him. He has worked in cooperation with
regulatory and criminal authorities, and will continue to do so. There
will be additional distributions as more funds are added to the fund of
``customer property.''
MF Global Inc.
On October 31, 2011, the SEC notified me at 5:20 in the morning
that the customers of MF Global were in need of the protections of the
SIPA statute. After receiving authority from SIPC's Chairman within the
hour, the SIPC staff mobilized and initiated a liquidation proceeding
for that firm that afternoon. This is the eighth largest bankruptcy in
history.
The results in the MF Global case are stunning. All securities and
commodities customers have been paid in full. Last week, the trustee
commenced the final distribution to general creditors, who will receive
95 cents on the dollar. Bankruptcy Judge Martin Glenn recently stated
that ``At the outset of the case, nobody thought that customers would
recover everything they lost.''
The trustee and SIPC litigated a number of issues interpreting
SIPA, some of which were issues of first impression, and have been
uniformly successful.
In short, the process worked, and worked well.
SIPC's Financial Condition
In January 2009 some Members of the Committee expressed concern
about the financial condition of SIPC. I am pleased to report that SIPC
has performed all of its statutory duties during the financial crisis,
and that it continues to be in sound financial condition. In December
2008, the SIPC Fund stood at $1.7 billion. Immediately upon the
commencement of the Madoff case, the SIPC Board prudently increased the
assessments on SIPC member firms to .0025 percent of net operating
revenues. At the close of 2014 SIPC had $2.152 billion. Even including
all expenses of the financial crisis, this demonstrates that SIPC has
the ability to raise funds as needed to protect customers and meet its
statutory obligations. The SIPC Board has currently set a ``target''
balance for the SIPC Fund at $2.5 billion, which matches the increased
line of credit SIPC has with the United States Treasury.
New Cases
Since December 2012, SIPC has initiated four customer protection
proceedings, each of which is very modest in size. SIPC was able to
serve as trustee in three of the cases, and use the statutory ``direct
payment procedure'' in the fourth case. This has had the effect of
expediting claims determination and satisfaction, in order to return
customer assets as promptly as possible. Indeed two of those cases have
already been brought to a conclusion. To put these cases in perspective
with the cases discussed above, the combined cost to SIPC of protecting
customers and administrative expenses in these four proceedings is
approximately $7 million.
Are there specific SIPC reforms that SIPC and Congress should consider
and why?
Action on SIPC Nominees:
The Committee can assure that SIPC is in a position to be a rapid
response team by moving the nomination of SIPC's directors.
I noted above that SIPC was able to initiate a customer protection
proceeding for MF Global in a matter of hours. SIPC, by Bylaw, has
delegated the authority to initiate a customer protection proceeding to
the Chair. For more than a year, SIPC has been without a Chair, or a
Vice Chair to serve as Acting Chair. That means that today SIPC might
not be as nimble as it was on October 31, 2011, when I contacted SIPC's
then Chairman for authority to protect investors in the MF Global case.
With no Chair or Vice Chair, should that same urgent situation arise
today I would have to call a meeting of the entire Board, on literally
no notice.
Thus, I urge the Committee to move the nomination of SIPC's vacant
director positions forward.
The SIPC Task Force, Rulemaking, and Legislation
In February 2010, SIPC's Board created a SIPC Modernization Task
Force to formulate possible improvements to SIPA. In February 2012, the
Task Force made a number of recommendations, five of which would
require legislative change, and one of which required a rule change.
(Nine recommendations, which could be implemented as a matter of
policy, have been adopted.)
The SEC, working with SIPC, did institute a rule change requiring
the independent auditors of SIPC member brokerage firms to file copies
of their Audit Reports with SIPC. This program is part of an ``early
warning system'' that gives SIPC the opportunity for informed
discussion with regulators and self-regulators, who are responsible for
notifying SIPC concerning brokerage firms that may pose a risk to
investors.
After extended discussion the Board determined not to propose
legislation that would increase the maximum level of protection, and
eliminate the distinction in the levels of protection for cash and
securities. Among the reasons for the Board's decision was that such
legislation would create disparate levels of protection offered by the
FDIC and SIPC which could cause disruption and confusion, and also
create inappropriate incentives to move funds from banks to brokerage
firms. The Board also determined not to expand protection to
participants in pension funds on a pass through basis.
The Task Force also suggested legislation setting a minimum
assessment on SIPC members of the greater of $1,000 or 0.02 percent of
members' gross revenues from the securities business. Further, the Task
Force suggested legislation authorizing the use of the ``Direct Payment
Procedure'' where customer claims aggregate less than $5 million. The
Board discussed these proposals but deferred formally recommending a
separate bill on these more minor matters until an appropriate
opportunity arises.
Restoring Main Street Investor Protection and Confidence Act
While the letter inviting me to this hearing did not ask me to
address the Restoring Main Street Investor Protection and Confidence
Act, S. 67, that proposed legislation is relevant in the overall
context of this hearing. Accordingly, Attachments A and B provide an
analysis of that proposal.
I hope this summary has been helpful to the Subcommittee. I would
be pleased to answer any questions the Subcommittee may have.
______
Attachment A
Concerns Respecting The Proposed Restoring Main Street Investor
Protection and Confidence Act (S. 67)
The ``Restoring Main Street Investor Protection and Confidence
Act'' contains provisions that have a number of what appear to be
unintended consequences. Some of the concerns presented by the proposal
include:
The bill requires SIPC to accept as accurate financial
statements known to be intentionally fraudulent. Under the
bill, SIPC must accept whatever statement a thief issues to his
customers.
The bill legitimizes Ponzi Schemes by guaranteeing that the
Scheme's non-existent trades at backdated stock prices giving
rise to phony profits are backed by Federal taxpayer funds.
The bill makes Ponzi Schemes a better investment than
legitimate securities market trades by, among other things,
eliminating market risk.
The bill's limitations on the Bankruptcy Code's ``avoidance
powers'' in a SIPA case result in demonstrably inequitable
distributions of ``customer property.'' For example, had Mr.
Madoff's fraud been detected and closed a mere 2 days later,
the $175,000,000 in checks on his desk would have gone to
arbitrarily favored clients at the direct expense of other
clients to whom the funds actually belonged. This was more than
half of the liquid assets the firm had when it failed. Further,
as the United States Court of Appeals for the Second Circuit
correctly noted, ``any dollar paid to reimburse a fictitious
profit is a dollar no longer available to pay claims for money
actually invested.''
The bill provides a complex mechanism for honoring a
fraudulent final account statement in the interest of equity.
In reality, this is an invitation to extended litigation by
various claimants with disparate, conflicting and competing
interests in a finite corpus of customer property. This will
delay the timely return of customer property to injured
victims.
The bill gives unprecedented and unlimited power to the SEC
to compel the expenditure of both private and public funds.
That power includes the authority to require SIPC to initiate
the liquidation of any brokerage firm or other institution
regardless of whether statutory criteria are met.
The bill gives the SEC unlimited authority to change the
definition of the term ``customer.''
The bill renders the SEC's authority unreviewable by the
judiciary.
The bill operates retroactively. It would throw the Madoff
case, and the remarkable results achieved to date, into chaos
and uncertainty.
The bill forbids using a trustee on two SIPA cases
simultaneously. This eliminates efficiencies and denies
customers the benefits of expertise in the most significant
cases. SIPC has six ongoing proceedings. Only one individual
serves in more than one case. SIPC matches the size and
resources of the trustee and the trustee's counsel with the
nature and scope of the problem.
The bill makes it impossible to determine future costs and
risk.
The bill would reverse the judicial outcome in the Stanford-Antigua
Bank Fraud Case.
SIPC declined to initiate a customer protection proceeding for the
Stanford Financial Group in connection with the Stanford-Antigua Bank
Fraud. For the first time in SIPC's history, the SEC sued SIPC to
compel SIPC to begin a proceeding. The District Court and Court of
Appeals examined the circumstances and considered the legal issues in
the case and determined that the victims of the Stanford Antigua Bank
Fraud were not ``customers'' that SIPA was designed to protect.
The Restoring Main Street Investor Protection and Confidence Act,
S. 67, would require SIPC to underwrite, guarantee, and pay the debt
obligations, represented by Certificates of Deposit of the Stanford
International Bank, a foreign bank in an offshore tax haven. The
Antiguan Bank CD purchasers knowingly sent their money away from a SIPC
member to an Antiguan Bank where, in the words of the SEC, the
claimants received ``high rates of return on CDs that greatly exceeded
those offered by commercial banks in the United States.''
While SIPC has sympathy for the victims of the Stanford and any
other fraud, SIPC was not designed to refund the original purchase
price of a bad investment, even where the investment was induced by
fraud.
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
PREPARED STATEMENT OF J.W. VERRET
Assistant Professor of Law, George Mason School of Law
Senior Scholar, Mercatus Center at George Mason University *
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* The ideas presented in this document do not represent official
positions of the Mercatus Center or George Mason University.
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September 30, 2015
Chairman Crapo, Ranking Member Warner, and Members of the
Subcommittee, I appreciate the opportunity to testify today on your
Subcommittee's oversight of the Securities Investor Protection
Corporation.
My name is J.W. Verret. I am an assistant professor of law at
George Mason University Law School, where I teach corporate,
securities, and banking law. I serve as a senior scholar at the
Mercatus Center at George Mason University, and until recently I was
Chief Economist and Senior Counsel at the House Committee on Financial
Services.
The explosive growth in federally backed loan and guaranty programs
has been an appropriate focus of congressional oversight in recent
years. The Office of Management and Budget (OMB) estimates the Federal
Government supports over $3 trillion in loans and guarantees. Those
loans and guarantees are often shrouded by indirect Government support
and unreasonable assumptions in Government accounting practices.\1\
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\1\ See, e.g., Federal Accounting Standards Advisory Board,
``Memorandum: Public Hearing on Reporting Entity,'' August 20, 2013,
http://www.fasab.gov/pdffiles/tab-a2_august-2013.pdf.
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I submit that the Securities Investor Protection Corporation's
(SIPC) provision of securities custody insurance should be an
appropriate part of that conversation. Government officials appoint
SIPC directors and SIPC enjoys access to a $2.5 billion line of credit
with the Department of the Treasury. Some may argue that statutory
language that ``SIPC shall not be an agency or establishment of the
United States Government'' suggests otherwise.\2\ We all recall how
similar statutory language governing the Government-Sponsored
Enterprises proved meaningless when those companies were placed in
Federal conservatorship.
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\2\ Securities Investor Protection Act of 1970, 15 U.S.C. 78ccc.
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Today I will argue that privatization of SIPC is the best solution
to protect American taxpayers, I will identify unexplored solutions for
victims of Ponzi schemes. Though I argue privatization is the first
best solution, I am glad to constructively engage in this
Subcommittee's discussion about additional SIPC reforms.
REFORMING THE GOVERNMENT MONOPOLY
Most broker-dealers and members of national exchanges are required
by statute to be members of SIPC, and SIPC is funded by assessments on
its membership. SIPC thereby enjoys a statutory monopoly over the
provision of securities custody insurance beneath the ceiling of its
coverage.
Some of my fellow panelists may argue that SIPC serves an important
role as a specialized liquidator of broker-dealers. Assuming that
argument is true, it remains a tall leap of logic to further contend
that a Government monopoly in the provision of securities custody
insurance is thereby warranted.
SIPC's board is currently composed of private sector and Government
members. I submit that privatization of SIPC's insurance function is
the first best solution to the problems presented by the current
structure of the SIPC. We might begin by lowering the ceiling of
coverage.
I find it hard to accept that a market failure necessitates a
Government monopoly in this space. In fact, there are underwriters at
Lloyd's that sell ``excess of SIPC'' coverage for the portion of this
market not crowded out by SIPC.\3\
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\3\ TIAA-CREF, ``SIPC and Excess of SIPC Asset Protection Guide,''
2015, https://www.tiaa-cref.org/public/pdf/forms/SIPC_Reference_
Guide_FINAL.pdf.
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In the absence of full privatization, the public-private
composition of SIPC's board should not be viewed as a second best
option, It would be better to officially recognize SIPC for the
Government entity that it is, remove the private-sector board members,
establish a similar level of congressional accountability for SIPC to
that required of other Government agencies, and impose a term limit on
its CEO.
THE PROBLEM OF PONZI SCHEME VICTIMS
The controversy and subsequent litigation between the SEC and SIPC
with respect to the Allen Stanford Ponzi scheme, and issues with
respect to Bernie Madoff victim claims, also suggest that a warning
label should be provided as part of the legend describing SIPC
coverage. This label would warn customers, ``SIPC coverage only applies
under limited circumstances, and SIPC reserves the right to deny claims
despite reasonable expectations of coverage.'' SIPC won the Stanford
litigation as a result of regrettable stipulations of fact by the SEC.
In the related Madoff litigation, SIPC utilized an aggressive valuation
methodology from among a range of methods used in prior cases.
My impression of both cases was that they were close calls that
might have come out either way. It is nevertheless also clear to me
that SIPC's aggressive litigation position was designed to minimize
claims to a fund that was unprepared for those claims, which suggests a
clear conflict of interest for the receivers hired by SIPC and for SIPC
itself.
I am not here today to re-litigate those cases or to endorse
legislation that might ultimately result in new assessments by SIPC. I
sympathize with the victims, and I recognize they have been subjected
to unusually aggressive legal posturing by SIPC, but I worry about
action that might only further entrench SIPC's insurance monopoly.
I would suggest instead that this Subcommittee consider whether
undistributed funds in the SEC's Fair Funds program or in the Consumer
Financial Protection Bureau's settlement awards would better serve the
purpose of making these victims whole.
I thank you for the opportunity to testify, and I look forward to
answering your questions.
______
PREPARED STATEMENT OF JAMES W. GIDDENS
Partner, Hughes Hubbard & Reed LLP, and Trustee, SIPA Liquidations of
Lehman Brothers Inc. and MF Global Inc.
September 30, 2015
Chairman Crapo, Ranking Member Warner, and Members of the
Subcommittee: Thank you for inviting me to testify. My name is James
Giddens, and I chair the Corporate Reorganization and Bankruptcy Group
at Hughes Hubbard & Reed LLP. I have worked on issues related to the
Securities Investor Protection Act (SIPA) for more than 45 years, most
recently as the Trustee for the liquidations of Lehman Brothers Inc.
and MF Global Inc.--the two largest liquidations under SIPA and two of
the largest bankruptcies of any kind in history.
I welcome the opportunity to bring this experience and perspective
to discuss how SIPA and the Securities Investor Protection Corporation
(SIPC) have handled the most complex broker-dealer failures, as well as
to submit for consideration areas for improvement in the statute and
related laws and regulations.
Lehman Brothers Inc. SIPA Liquidation
Two weeks ago marked the seventh anniversary of Lehman's collapse.
Thus far, Lehman's broker-dealer customers and creditors have received
$114 billion in distributions. This represents the largest distribution
across the worldwide Lehman insolvency proceedings. Importantly, more
than 110,000 retail customers, including mom-and-pop investors from all
walks of life and from all across the country, received 100 percent of
their property within days of the bankruptcy due to the unique account
transfer process under SIPA.
This swift return of customer property was critical to restoring
stability to the financial system during a time of great doubt and
avoiding the potential for further financial collapse. The return of
customer property could not have happened without SIPA's account
transfer provisions and the ability of the transfers to be backstopped
by the SIPC fund. Indeed, it took hundreds of professionals working
hand-in-hand with regulators to accomplish this extraordinary task and
nearly 2 years to completely reconcile transferred accounts. A claims
process for these accounts--the result in any other kind of bankruptcy
proceeding--would have taken years longer.
At a recent court hearing, the Honorable Shelley Chapman, United
States Bankruptcy Judge for the Southern District of New York, called
the distributions ``an incredibly extraordinary accomplishment in this
case.'' I, and, more importantly the customers and creditors who had
their funds restored, agree.
MF Global Inc. SIPA Liquidation
When MF Global collapsed on Halloween of 2011 with revelations of
more than $1.6 billion of missing commodity customer property, a near
full return of property to customers and creditors was doubtful. My
counsel and I testified about the MF Global case before the full Senate
Banking Committee, the Senate Agriculture Committee, the House
Agriculture Committee, and the House Financial Services Committee. I am
grateful for the support of all of these Committees as we worked under
SIPA to recover funds for customers and creditors, and together we
achieved a favorable outcome for customers.
The efforts to recover property around the globe required scores of
professionals, the invaluable assistance of U.S. regulators, and
cooperation from foreign insolvency administrators. In conjunction with
the painstaking resolution of complex claims and the approval of
innovative motions by the United States Bankruptcy Court, 36,000
securities and commodities customers, many of whom were farmers and
ranchers, received 100 percent distributions on their claims.
Secured creditors also received 100 percent distributions on their
claims, and a final 95 percent distribution to non-affiliated unsecured
creditors is now in the process of being completed--all within less
than 4 years from the commencement of the proceeding.
Distributions to customers in these two liquidations far exceeded
initial expectations and demonstrate the flexibility and effectiveness
of SIPA in complex, large broker-dealer failures.
Considerations
While SIPA has proven to be a successful mechanism for liquidating
broker-dealers and is indeed viewed as a model for the prompt return of
customer property in different jurisdictions around the world, there is
room for modernization and improvement.
The considerations that follow stem from my and my counsel's
experience in Lehman, MF Global and several other liquidations and from
my involvement, along with investor advocates, regulatory specialists
and academic experts, in a Task Force that issued recommendations for
modernizing SIPA.
Specifically, the SIPC Modernization Task Force report included 15
recommendations on how to amend and improve SIPA. In addition, my own
investigation reports in the Lehman and MF Global liquidations included
eight and six recommendations respectively on improvements to SIPA and
related laws and regulations.
I incorporate these three extensive, public documents into my
testimony today, and I urge the Subcommittee to consider all 29 of the
reform proposals in detail. Among the recommendations in these reports,
I would like to highlight the following eight potential reforms for
your consideration in particular:
Task Force Recommendations
1) Increase Maximum Coverage to $1.3 million
Increasing SIPC's maximum coverage from $500,000 to $1.3 million,
and tying future coverage limits to inflation, would reflect a
significant increase in protection for customers and is consistent with
the level of protection that is necessary to protect nonprofessional
investors.
2) Eliminate the Distinction in the Levels of Protection for Cash
and Securities
Eliminating the distinction between claims for cash and claims for
securities resolves potential disparate treatment of customers and
increases the amount of protection available to customers of broker-
dealers. Currently, the level of protection per customer is capped at
$500,000, up to $250,000 of which may be in satisfaction of a
customer's cash claim. This distinction leads to arbitrary resolution
of claims between customers, may no longer reflect the way that cash
and securities are held at broker-dealers, and has created confusion
over the way that claims based on fictitious securities are treated.
3) International Cooperation
The collapse of MF Global and Lehman revealed significant gaps
between protections afforded customers in U.S. and foreign countries,
such as the United Kingdom, arising largely from differences in
insolvency laws and the absence of clear legal precedent. Though there
may not be a one-size-fits-all solution for these issues, customers
would benefit from greater harmonization of rules governing the
segregation of customer funds and treatment of omnibus accounts.
Lehman Investigation Report Recommendations
4) Pre-Planning
More pre-liquidation disaster planning, both on an individual
broker-dealer and industry-wide basis, including a broker-dealer's
``living will'' and emergency plan, should alleviate the type of
information gap that I and my staff confronted in the Lehman
liquidation. Such pre-planning would indicate the categories of
customer accounts and associated assets that would need to be protected
and set forth how possible scenarios would be dealt with, ranging from
complete liquidation of all customer accounts to total or partial
account transfer solutions, with details of key operational steps and
the core assets that would have to remain to assure effective
liquidation of customer accounts.
5) Increase in SIPC Borrowing Authority
In addition to increasing SIPC's maximum coverage as noted above,
consideration should also be given to expanding the borrowing and
guarantee authority available to SIPC trustees or other liquidators and
to permitting more flexibility for use of those funds. While the
previously existing SIPC fund had more than sufficed to meet the
demands of all previous SIPA liquidations, the Lehman and Madoff
liquidations in particular demonstrate that the failure of a single
major SIPC member broker-dealer could require at least the temporary
availability of much more substantial sums to support the quick and
efficient return of customer property.
6) Earlier Involvement of a Customer Representative
A party with potential responsibility for customers interests--
whether SIPC, a putative trustee, a regulator, or a combination of all
of these--should be involved in the negotiations related to the sale of
a failed broker-dealer. Parties representing customer interests should,
with better planning and access to information, bargain against a clear
baseline of what needs to be transferred and avoid subsequent
uncertainty and surprises.
As experienced in the Lehman case, the seller's immediate focus is
likely to be its own post-transaction survival; the purchaser's is with
the customers and assets it is taking on, not those it is leaving
behind.
MF Global Inc. Investigation Report and Prior Senate Banking Committee
Testimony Recommendations
7) Strict Liability for Senior Officers and Directors
Because regulations require futures commission merchants (FCMs) to
segregate customer funds at all times, it may be appropriate to impose
civil fines in the event of a regulatory shortfall on the officers and
directors who are responsible for signing the firm's financial
statements. Where there is a shortfall in customer funds, Congress
should consider making the officers and directors of the company
accountable and personally and civilly liable for their certifications
without any requirement of proving intent and without permitting them
to defend on the basis that they delegated these essential duties and
responsibilities to others.
8) Commodities Customer Protection Fund
The liquidation of MF Global would have played out differently had
there been even a modest protection fund for commodities customers--
that is, a separate and distinct analog to SIPA in the FCM arena that
learns from and builds on SIPA's record of success. A fund limited to
protecting these smaller accounts--representing many farmers and
ranchers--could be of relatively modest size, but would suffice to make
these customers whole very quickly even in a case with a shortfall the
size of MF Global's. With such a fund in existence, three-quarters of
MF Global's commodities customers could have been made whole within
days of the bankruptcy filing.
Conclusion
Since 1970, the SIPA statute has succeeded in protecting customers
of SIPC-member brokerage firms, and I believe strongly that the statute
has met its policy goals. In particular, the Lehman and MF Global
liquidations are an indication that SIPA, SIPC, and the concept of the
liquidation trustee work to protect customers and return assets to them
as quickly as possible in a manner that is fair and consistent with the
law. With consideration given to modernizing elements of the statute
and related laws and regulations, I believe the shared goal of
continuing and strengthening protection of investors, particularly
nonprofessional investors, can be achieved.
Thank you Chairman Crapo, Ranking Member Warner, and other Members
of the Subcommittee for the opportunity to testify before you and to
submit this testimony for the full record of the hearing.
Additional Material Supplied for the Record
PREPARED STATEMENT OF RICHARD R. CHEATHAM
September 30, 2015
I'm a 72-year-old lawyer in Atlanta, officially retired at 1/1/2015
but still actively consulting with those who became responsible for my
former clients. I obtained my undergraduate degree from the University
of Virginia and my law degree from Harvard. I was fully active for
slightly more than 45 years in a large firm practice representing
primarily commercial banking institutions in corporate and regulatory
matters.
I am also a slightly embarrassed victim of the Allen Stanford Ponzi
scheme. I have a good excuse. My broker had and used discretionary
authority. Prior to having a heart attack in 2007 I managed my own
investments. Like many lawyers, I clearly see all risks and cannot
bring myself to invest in anything not guaranteed by the full faith and
credit of the U.S. Government. After the heart attack, realizing I
might actually be required to retire, I gave discretionary authority to
a contemporary of mine who I trusted. He later retired and left his
clients in the care of his two sons. Against my better judgment, I kept
my account with the sons, principally because I had a son just starting
out and empathy kept me from communicating or acting on a lack of
confidence in youth and inexperience. Subsequently, exercising their
discretionary authority, without any action or instruction by me, the
sons sold $300,000 of my securities held by the Stanford SIPC insured
firm and caused the proceeds to be transferred to the Stanford Ponzi
scheme.
Before the SEC sued SIPC I had not paid much attention to the
possibility of SIPC coverage. I was attempting to recover my losses
from my individual brokers' insurance policies, an attempt so far
frustrated by an injunction issued at the SEC's request in the Texas
Receivership proceeding. I was vaguely aware that the SEC had initially
taken the position that SIPC did not cover the Stanford victims, but I
had not attempted to look at the coverage issue myself.
However, shortly after the SEC filed suit, I looked at some
documents in the case to get a feel for what was going on. I don't
recall exactly what I looked at, the complaint and answer or documents
associated with some motion, but those documents made it apparent that
SIPC was attempting to defend by creating a largely fictional factual
scenario in which the Stanford scheme could be characterized as an
investment gone bad rather than an intentional theft. SIPC also
asserted, in an effort to avoid the SIPA ``customer'' definition, that
the Stanford victims had dealt directly with the Antiguan bank and that
no funds or custody securities held by the SIPC member were involved.
That fictional scenario characterized the subject investment as a CD in
an offshore bank. According to that scenario Stanford securities
brokers ``counseled investors to purchase certificates of deposit from
an Antiguan bank . . . [and t]he Antiguan bank's CDs eventually became
worthless.''
The real facts are that the Antiguan bank was just the cover story
for a massive Ponzi scheme theft. The CD's did not ``become''
worthless. The principal shareholder of the SIPC insured brokerage firm
was using the funds generated by his firm's brokers (compensated by
above market commissions) for personal purposes and to cover his prior
thefts. Legally, that knowledge was imputable to the brokers who
executed the thefts. The CDs were worthless and fictional from the get-
go, just like Bernie Madoff's fake statements depicting fictional
investments in his Ponzi scheme whose victims were protected by SIPC.
To avoid the SIPA ``customer'' definition, SIPC's creative
``facts'' assumed that each purchaser of the ``CDs'' opened an account
with the offshore bank and sent a separate check or wire transfer
directly to that bank and received a CD in return. The suggestion being
that the transaction was wholly apart from and independent of the
victim's relationship with the insured brokerage firm. That was
certainly not true in my case. I had my ``self-directed IRA'' at
Stanford. It was moved there from Morgan Keegan when my brokers changed
firms. The Stanford brokerage firm was the fiduciary custodian of my
securities and funds. As with any IRA I had no direct control over the
funds and could not write a check or direct a wire transfer from my
account with the SIPC insured firm. Without any action on my part, my
Stanford brokers caused the sale of $300,000 in my securities held by
Stanford and ``invested'' the proceeds in the fake ``Stanford CDs.'' In
other words Stanford, the SIPC member, sold my custody securities and
gave the proceeds to Alan Stanford for his personal use. Those facts
support undeniable coverage by SIPC.
After looking at SEC/SIPC the case documents, I called Matthew
Martens who was listed in the pleadings as the SEC's lead counsel. The
purpose of the call was to describe my fact situation to make the SEC
aware that SIPC's version of the facts was simply not true, at least
for a substantial number of victims. The SEC only gets one shot to
force SIPC to cover claims against an insured defunct broker. If the
facts support the claim of any customer for SIPC insurance, the SEC can
force a SIPC receivership and let each individual customer make his/her
claim. I wanted to make sure that the SEC knew that there were Stanford
victims who did not fit within SIPC's hypothetical scenario. To my
surprise Martens answered the call. I told him who I am and fully
described the facts surrounding my becoming a Stanford victim. I told
him I thought my facts and those of other IRA beneficiaries were
``perfect'' to demonstrate that funds and/or custody securities had
been delivered to the SIPC member contrary to SIPC's theory of the
case. He sounded appreciative and gave me the impression he was taking
down my contact information. He assured me that I would receive a call
from SEC staff.
I never received a call from SEC staff. That didn't bother me. I
had just wanted to make sure the SEC was aware of fact patterns like
mine to prevent its falling for the SIPC story line. I was sure that
many, if not most, other victims had fact patterns more like mine than
like SIPC's hypothetical.
Months later when I read the District Court's decision I was
dumbfounded by the description of the fact stipulation that the SEC had
agreed to in the case. The stipulation simply mimicked SIPC's creative
hypothetical. Because of my conversation with Marten's I knew that the
SEC was fully aware that the facts it stipulated simply were not true
for all, perhaps most, of the Stanford victims, that the actual facts
surrounding my ``investment,'' and I assumed many others, were
inconsistent with the factual assumptions included in the District
Court's analysis. As a lawyer I understood that the SEC/SIPC fact
stipulation, if it became ``final'' in the District Court case, would
be dispositive on the issue of SIPC insurance for all the Stanford
victims. Stanford victims could not sue SIPC directly, only the SEC
could enforce their congressionally created rights. Also, under the
universally recognized principle of res judicata, the SEC only gets
``one bite at the apple.'' It has the right to bring one lawsuit to
force SIPC to live up to its statutory obligations. The facts
established in that lawsuit are binding on everyone forever. The SEC
cannot bring a second suit hoping to prove a different set of facts
supporting its claim.
After I read the decision, I called one of the law firms
representing large groups of Stanford victims in various class actions
to encourage it to intervene in the District Court case before it
became final in order to contest the fact stipulation. Otherwise all
Stanford victims would be bound by the stipulation in any efforts to
recover their losses from SIPC insurance. The law firm, which wasn't
involved in SIPC coverage issues, didn't seem interested. Thus, I
reluctantly filed an intervention myself, reciting my facts and
demonstrating why I believed the District Court would reach a different
decision on ``real facts'' as opposed to the stipulated facts.
I didn't have much hope that my intervention would accomplish
anything. Judges are understandably disinclined to question the
competence or good faith of Federal administrative agencies.
Nevertheless, the issue was critical to SIPC coverage for the Stanford
victims. I had to try to do whatever I could. In my intervention
petition I described my facts and made what I thought was a compelling
case for a result different from the one Judge Wilkins reached on the
stipulated facts.
In its response to my intervention, the SEC did not really argue
that I was wrong on the merits. It essentially conceded that my facts
were materially different from the stipulated facts and, by
implication, that my facts might result in a different outcome. The SEC
then cynically assured the District Judge that it would review my facts
and, if warranted, commence a new action against SIPC to force a
receivership with SIPC coverage. To me that response was an intentional
misrepresentation by the SEC to the District Court. The SEC had known
my facts for months. It did not need to investigate those facts. They
were not that complicated. In addition, bringing a later action in an
effort to prevail against SIPC on a different set of facts was
precluded by res judicata.
In my reply to the SEC's opposition to my motion to intervene I
pointed out that the SEC had known my facts for months and that a later
action based on different facts would be precluded. However, Judge
Wilkins never read my reply. I filed my reply late on Friday before
Labor Day weekend. The Judge issued an order denying my intervention on
Tuesday after the Monday holiday. As a pro se litigant I had to file a
paper response, rather than an electronic one which would have been
available to the Judge over the weekend. The Judge couldn't have seen
my reply until that Tuesday. It's not realistic to assume that the
judge read and considered my reply and then wrote and entered on the
same day an order that never mentions my reply. He had obviously
already written the decision and was just waiting for the time for my
reply to expire before entering it.
I don't blame Judge Wilkins. Then, if I were a judge and the SEC
assured me that it would protect an intervener's interests, I would
have denied the intervention. Interveners are often ``nut cases.''
That's especially true in cases where a
Government agency charged with protecting a group of citizens is acting
within its expertise and someone mere citizen wants to add in his two
cents. The District Judge undoubtedly believed that the SEC would and
could do what it said.
It was obvious that I couldn't get the District Judge's attention
in the face of unprincipled SEC opposition. I had 30 days before the
decision denying my intervention became final. My only chance was to
see if I could get the SEC to correct its false assertions.
Accordingly, on September 11, 2012, I sent an email to the SEC's David
Mendel with a copy to Matthew Martens, as follows:
I was not surprised that Judge Wilkins did not read my reply
brief after both the SEC and SIPC opposed the motion.
As I told you before, I still can't figure out where the SEC is
coming from in this proceeding.
I didn't know this when I filed my motion, but the Receiver's
Web site indicates that there were more than 1,400 Stanford
Trust Company victims of the Ponzi scheme. Given the way the
scheme operated, each of those victims had his/er IRA with SGC.
While I recognize that the IRA relationship with an introducing
broker is somewhat ambiguous, there is little doubt that SGC
had control over those IRA funds sufficient to meet the
``entrusting'' test applied by Judge Wilkins. Contrary to
paragraph 3 of your stipulation, none of those victims opened
an account with SIBL and none of those victims wrote a check or
wired funds to SIBL. In each case SGC, on its own, transferred
money from the victim's IRA with either Pershing or J.P. Morgan
and had funds wired from the custody broker to a third party
bank (the bank recipients varied I am told). Where the funds
went from there, I can only guess, but SGC certainly knew and
I'll bet any amount that they ended up in the Ponzi scheme.
I don't think the SEC can sue SIPC again based on a different
set of facts, though I'm certainly open to listening to your
contrary theory if you have one. I suspect your suggestion to
the contrary convinced Judge Wilkins to deny my motion without
even reading my reply. If I appeal Judge Wilkins' order denying
my motion, the Court of Appeals may overrule Judge Wilkins'
denial, but the odds are against it. The Court of Appeals
might, however, be influenced by the undisputed record that my
facts are true and leave open my claims (but perhaps not others
who didn't intervene). I don't see much hope for the 1,399
other IRA victims unless the SEC moves now to reconsider the
denial of my motion and blows the fact stipulation.
There is some chance that the SEC can get a reversal of Judge
Wilkins' `entrusting' analysis, though I am doubtful in the DC
Circuit. As I said in my reply, I agree with your conclusions.
However, to me the `entrusting' issue is a slippery slope. It
sounds reasonably convincing on the stipulated facts, but not
at all on the IRA facts. If you start your analysis with the
IRA facts, you realize that your analysis on the stipulated
facts is wrong. The SEC/SIPC fact stipulation starts at the
bottom of the slippery slope and hopes that the judge will
slide up.
The SEC can minimize its exposure here by moving that Judge
Wilkins reconsider his denial of my motion and essentially
reopening the case. If the trial court record closes as it is
there are very serious publicity and pending litigation risks
for the SEC that you can imagine as well as I can. I'm not
going away and this issue is not going away. I am prepared to
take the issue as far as I can. $300,000 is a lot of money to
me, and I don't have time to earn it back. I'm almost 70 and
have time on my hands. I'm not a part of any Stanford victims
group and really don't have any sympathy with such heavy-
handedness. I don't even know (or want to know) any Louisiana
Republicans. I'm not a mindless crusader. I am a pragmatic
lawyer who prefers solutions that are in everyone's best
interest. But, if that is unachievable, I can be a pig-headed
lawyer who doesn't tire easily.
I'm on your side and, consistent with protecting the IRA
victims, will do anything to advance our common cause.
Mendel and Martens did not reply. Not easily put off, I followed up
with an email on September 21, 2012, as follows:
It has been well over a week since I sent you the email below.
Yet, I have no response. Rule imposed time limits on motions to
reconsider Judge Wilkins' September 4 order denying my motion
to intervene are running. My patience is not limited solely by
my psyche.
I've reached out to you a couple of times in an effort to
commence a dialogue about ways we might achieve common goals
without acrimony. I recognize that my motion to intervene could
be interpreted as critical of your competence and/or good
faith. My initial assumption has been that your agreement to
the fact stipulation was an innocent mistake. I know you are
both very busy. We all make mistakes, particularly in matters
that are low on our priority lists.
Because the SEC initially decided not to bring this action, it
has been asserted that the SEC only did so in response to
political pressure. In that context, I can understand the SEC's
possible ambivalence about the outcome. Politicians will claim
credit if the suit is successful, and if you lose, the SEC's
initial reluctance will appear more credible. I am sure that
ambivalence impacts the SEC's priorities and your consequent
attention to this litigation.
I understand your reluctance to begin a dialogue. If I were
you, I would prefer that I just fade away. But, I won't. There
is a possibility that no one will notice anything I file with
the courts and that you will not be embarrassed by it. Given
the emails I've received from Stanford victims I've never heard
of, I doubt that. I do not intend to file anything embarrassing
to you unless you force my hand.
At page 5 of your memorandum in opposition to my motion to
intervene, you made the following statement:
`None of this is to say that there is no opportunity for Mr.
Cheatham's situation to be addressed under SIPA. Consistent
with SIPA, the Commission will consider Mr. Cheatham's factual
situation, investigate his claims as necessary, and, if the
Commission deems it appropriate, refer the facts to SIPC for
appropriate action, including potentially a liquidation
proceeding.'
That statement, based on my understanding of the law, is
materially misleading in that it fails to disclose that even if
the SEC took the action specified, unless the SEC prevails in
this action based on the stipulated facts, SIPC could (and
undoubtedly would) summarily deny any recommendation with
respect to my claim by the SEC. If so, the SEC could not sue
SIPC to overturn that summary denial. SIPC's success in this
action would preclude any subsequent action by the SEC to seek
the same remedy under principles of res judicata without regard
to any differences between my facts and the SEC/SIPC stipulated
facts.
Based on the foregoing misleading representation by the United
States of America Government agency with principal
responsibility for the protection of investors and the
assurance of securities market integrity, I would have done
exactly what Judge Wilkins did and denied my motion to
intervene. I have asked you to provide me with whatever support
you have that demonstrates the truth of your statement. You
have not.
In my view, if your statement about your future ability to
protect my interests and those of others similarly situated is
not supportable, you are legally required to so inform Judge
Wilkins.
Again I received no response. Undaunted, I sent another email to
Mendel and Martens, this time simply directing them to the page at the
DC Bar's Web site setting out its ethics rule 3.3:
Rule 3.3--Candor to Tribunal
(a) A lawyer shall not knowingly:
(1) Make a false statement of fact or law to a tribunal or fail
to correct a false statement of material fact or law previously
made to the tribunal by the lawyer, unless correction would
require disclosure of information that is prohibited by Rule
1.6; [3] Legal argument based on a knowingly false representation of
law constitutes dishonesty toward the tribunal. A lawyer is not
required to make a disinterested exposition of the law, but
must recognize the existence of pertinent legal authorities.
Furthermore, as stated in subparagraph (a)(3), an advocate has
a duty to disclose directly adverse authority in the
controlling jurisdiction that has not been disclosed by the
opposing party and that is dispositive of a question at issue.
The underlying concept is that legal argument is a discussion
seeking to determine the legal premises properly applicable to
the case.
Finally, a response from Martens:
We received your emails of September 11, September 21, and
October 1, 2012. While we are aware of your disagreement with
our litigating positions, we stand by the briefs filed and the
stipulations entered into by the SEC in the SIPC matter. The
stipulations are a fair representation of the facts as we
understand them. We do not think that your particular
circumstances, as described in your communications with us and
in your District Court filings, change our analysis of the
proper litigation posture for this case. And, for the reasons
stated in our response to your motion to intervene, we do not
think you met the appropriate standard for intervention in the
District Court.
That said, SEC staff are gathering relevant records that
pertain to you so that a determination can be made as to
whether to refer your set of facts to SIPC for appropriate
action. We are unaware of conclusive authority (nor have you
cited any such authority, even in your Reply brief) that would
foreclose the SEC from seeking additional action from SIPC with
regard to holders of SIBL CDs on a materially different set of
facts. If there is a res judicata defense that might be lodged
against such a second effort, we do not think that we misled
the Court in any way with respect to the potential existence of
such a defense.
We understand your frustration with the outcome in the District
Court. However, we disagree with your suggestions that I or
other SEC attorneys have not met our professional
responsibilities in this matter.
Another lie: ``The stipulations are a fair representation of the
facts as we understand them.'' The statement that there is no
``conclusive authority'' that res judicata would bar a subsequent
action is a bit more subtle. It is possible that the U.S. Supreme Court
could hold that the SEC's action against SIPC is an exception to the
time honored principle of res judicata, but the odds against that are
more than a million to one. I am not aware of any exception to the
principles of candor that excuses probable lies that are not
``conclusively'' false. Finally, the SEC was not ``gathering relevant
records'' that pertained to me. I had many of those records and was
never asked for them by the SEC.
I was virtually certain that the Court of Appeals would affirm
Judge Wilkins' decision based on the SEC/SIPC fact stipulation. It was
obvious to me that the SEC legal staff had been totally captured by the
securities industry. It did not surprise me that Martens soon left the
SEC to join WilmerHale where he represents the industry. He probably
made more than my $300,000 in his first 3 months, but it will be a long
time before he earns more than was lost by the other 1,399 Stanford IRA
customers he shafted.
______
PREPARED STATEMENT OF LAURENCE KOTLIKOFF
Senate Committee on Banking, Housing and Urban Affairs Field Hearing
Baton Rouge, Louisiana
August 3, 2015
Mr. Chairman, I deeply appreciate your invitation to participate in
this hearing of the Senate Committee on Banking and Urban Affairs to
review the performance of the Securities Investor Protection
Corporation (SIPC) following the failure of Stanford Group Company
(SGC), the SIPC member broker-dealer, which played a strategically
important role in Allen Stanford's massive fraud by which he stole the
investment deposits of some 8,000 customers for his private, personal
use.
Like most Americans who place funds with a federally registered
brokerage firm for investment in national and international equity and
debt securities, I had paid little attention to the performance of SIPC
in its administration of the Securities Investor Protection Act of 1970
(SIPA), assuming the advertised protection of up to $500,000 per
account would be readily available should the failure of your broker
occur. However, the failure of Bernard Madoff's firm following his
confession of Ponzi fraud--in which I personally know victims who
suffered serious financial loss, with no help from SIPC--opened my eyes
to the unsettling and shameful reality of SIPC's quick recourse to
self-preservation mode.
If there were any lingering doubts as to self preservation being
SIPC's prime motivation for its decisionmaking, they should be put to
rest by its obstinate refusal to initiate a liquidation in the Stanford
Financial Group fraud--capped by its arrogant judicial challenge to the
directive from its plenary oversight authority, the Securities and
Exchange Commission (SEC).
Certainly many of your colleagues, with constituencies untouched by
either of these massive Ponzi frauds, simply have not acquainted
themselves with the extent of SIPC's departure from the congressionally
intended objectives of SIPA in 1970. That legislation was the product
of earnest cooperation and constructive negotiation between the
securities industry's leadership and the Congress with the active
participation of the Nixon Administration's Treasury Department and the
SEC. The statute was enacted in response to a rash of broker-dealer
failures in order to boost investor confidence.
Today, no investor can be confident their assets are protected by
SIPC as Congress intended when SIPA was enacted.
Senator Vitter, I commend you for holding this field hearing to
build a record to educate your colleagues. I also commend the esteemed
Chairman of the Senate Banking Committee, Senator Richard Shelby, for
authorizing you to do so. It is vitally important for the national
public to understand how SIPC's flawed administration of SIPA has
denied the customer-victims of Allen Stanford's fraud the protection
from total financial loss they have rightfully expected. As you well
know, the personal suffering of your own constituents is a direct
consequence of SIPC's narrow, hyper-technical perspective of its
mission under SIPA's remedial provisions.
It is also vitally important that the public and your colleagues in
Congress have a clear understanding of SIPC's misguided conduct and
likewise the remarkably erroneous judicial decisions that have affirmed
SIPC's actions--or in the Stanford case--glaring inaction.
It is absolutely beyond dispute that the preeminent congressional
objective in the passage of SIPA was to bring stability to the national
securities markets through the restoration--and then maintenance--of
the general public's confidence in participating as investors in equity
and debt securities. Maintaining that public confidence is even more
important in 2015 than it was 1970 because of the exponential growth of
the rank and file investors who participate in the securities market as
a means of building a secure financial future.
It should be duly noted that SIPA was enacted as an amendment to
the Federal securities laws and not as an amendment to the Federal
Bankruptcy Act. Not only did SIPA establish a special liquidation
process for failed SEC-registered and regulated broker dealer firms,
but it included special provisions not available in a traditional
bankruptcy liquidation administered under the U.S. Bankruptcy Code.
These provisions were specially designed to maintain public confidence
in securities investment and, thereby, stabilize the structure of our
capital markets by giving priority to broker-dealer customer claims
over all other unsecured creditors in the liquidation process.
The three most unique and critical features of SIPA that
differentiate a SIPC-administered liquidation from a traditional
bankruptcy proceeding are:
(1) The SIPC Fund, capitalized by annual assessments of the
securities firms, which provides a resource for mitigating losses not
recoverable from the debtor's estate up to a cap of $500,000 per
customer account;
(2) ``Customer property,'' a privileged division of the debtor's
estate, with prioritized claims allocations placing the brokerage
firm's customers ahead of all other unsecured creditors; and
(3) Repeated directives throughout the statute for promptness in
actions for processing customer claims, due to the significant
disruption to the financial affairs of individual customers.
For SIPA to fulfill its priority objective of maintaining public
confidence in our securities markets, it is essential for SIPC and the
Federal courts to be attentive to giving effect to these special
features that are provided for in the unique liquidation proceedings
administered under SIPA. Conflating SIPA's unique provisions, which are
utterly separate from those of a traditional bankruptcy proceeding, is
contrary to the very spirit in which SIPA was enacted.
Yet that is exactly what SIPC has done, and it has done so in the
name of self-preservation--at the expense of innocent brokerage
customers who entrust their savings to a SIPC-member firm.
SIPC's principal, self-serving misapplication of SIPA in the
Stanford case was most evident in its abuse of discretion in its
interpretation of the term ``customer.'' SIPC chose to dance on the
head of a pin by advancing legal arguments that gave credibility to a
fraudulent shell company organized under the laws of Antigua and
Barbuda, Stanford International Bank (SIB), rather than accepting the
factual finding of U.S. Federal courts that landed Allen Stanford in
prison with a 110-year sentence and a $6 billion forfeiture fine.
By not recognizing the Stanford fraud as a closely controlled,
unified scheme in which SGC served as the engine of a massive scheme
created solely to misappropriate customer funds, SIPC was able to argue
that the SIB CD investors were not SGC customers. SIPC, in its self-
preservation mode, shockingly made legal arguments in direct conflict
with the factual findings in numerous judicial proceedings in the
District Court for the Northern District of Texas, and affirmed by the
Fifth Circuit Court of Appeals.
Instead of accepting the findings of the other Courts, SIPC argued
the legitimacy of SIB, and insisted it was a completely separate entity
from the SIPC-member, SGC. By making this argument, SIPC had found its
loophole to deny protection to investors whose funds were stolen by the
owner of one of its member firms. SIPC determined those investors were
SGC clients, but not its ``customers'' under SIPA, which SIPC
astonishingly deemed a ``statutory term of art'' Congress used when
enacting SIPC's singular guiding statute--SIPA. The SEC, in the true
spirit of SIPA, disagreed.
Allen Stanford owned and controlled the Stanford Financial Group of
Companies, which included numerous corporate entities, including SGC
and SIB. The U.S. Courts all the way up to the Supreme Court had
already determined and/or acknowledged that ALL of Stanford entities
operated as one unified, fraudulent enterprise operating out of
Houston, Texas. SIPC disagreed.
While the District Court overseeing the Receivership proceedings of
the Stanford entities determined that corporate disregard doctrine
applied to SIB because, ``It would defy logic and run afoul of equity
to treat a fictitious corporation as a real entity.'' But SIPC was not
looking to see the logic.
The Receivership Court stated, ``This Court will not engage in
semantics that obfuscate the purpose of the statute'' (in this
instance, the Chapter 15 provision under the U.S. Bankruptcy Code).
SIPC deemed itself a higher authority than the Receivership Court, and
chose to engage in semantics in order to obfuscate the purpose of its
guiding statute.
The Receivership Court determined that ``not aggregating the
entities . . . would perpetuate an injustice.'' SIPC chose to
perpetuate an injustice.
SIPC found none of the factual findings in dozens of civil
litigation proceedings related to the liquidation of the Stanford
estate to be persuasive. Instead, SIPC refused to accept the holistic
view of Stanford's fraudulent enterprise and remained adamant in its
refusal to initiate a liquidation of SGC, the broker-dealer entity,
with which all U.S. purchasers of the SIB CDs were obligated to sign
customer agreements.
Faced with an implacably negative SIPC, customers of a failed
broker-dealer such as SGC have only one avenue of recourse to have
their cause reviewed by a Federal court--and that is to petition the
SEC. The Stanford Victims Coalition (SVC), to its great credit, refused
to surrender to SIPC's arrogant obstinacy to recognize the facts in the
Stanford case. The SVC generated thousands of pages of documentary
evidence of the pivotal role played by the SIPC-member broker-dealer in
the conduct of the fraud. With strong support from more than 100
Members of Congress, led by you, Senator Vitter, and Senator Cassidy,
the SEC agreed with the view of Federal District Court that the
Stanford fraud had to be viewed as a singular entity that acted through
its most logical and obvious pubic interface--SGC, the SIPC-member
broker dealer. By obliging prospective investors to register as
customers of SGC, Stanford was assured that a sales force of FINRA
Registered Representatives who would have direct access to wield their
sales magic (and of course to be compensated generously from the
customers' deposited funds).
Using its express authority under SIPA, which gives unquestioned
vitality to SEC's role as plenary oversight authority over SIPC, the
SEC Commissioners voted to direct SIPC to initiate a SIPA liquidation
of SGC. After months of fruitless discussion with SIPC and its
appointed Board, the SEC turned again to the statute and applied to the
Federal District Court in the District of Columbia for an order in
support of its directive for SIPC to initiate a liquidation of SGC.
This marked the first time in the 44 years of SIPA's history that the
SEC had felt compelled to exercise this extraordinary power in its
oversight authority.
The next chapter of this inconceivable saga should surely infuriate
a preponderant majority in the Congress, and awaken all to their sworn
obligation to ensure that the intent of the Congress--most particularly
in remedial statutes such as SIPA--is faithfully fulfilled by those
charged with administrative responsibility. In an act of indescribable
arrogance and disobedience, SIPC refused to comply with the SEC's
directive and formally contested the SEC's application for an order
enforcing its directive to SIPC. The SEC had no choice but to invoke
its legislative authority to initiate an enforcement action against
SIPC by filing a lawsuit for its blatant failure to discharge its
obligations under SIPA.
Regrettably, SIPC's insolent and irresponsible performance in this
case has been eclipsed by decisions of both the District Court and the
Circuit Court of Appeals for the District of Columbia upholding SIPC's
legal challenge and denying the SEC's application for a Court order to
enforce its directive to SIPC. The two Courts take different
interpretive reasoning to reach the same indefensible conclusion. What
their decisions have in common, other than outcome, is the application
of SIPC-manipulated interpretations of SIPA that are completely devoid
of logic and commonsense. Both decisions benefited from an inexplicable
trial-level error by SEC counsel, by entering into a stipulation of
facts, which erroneously asserted that SGC customers had direct contact
with SIB and made their payments directly to SIB. The reality is that
the contact was exclusively with SGC, and payments were executed on
SGC's instruction.
It is vitally important for the Congress to understand the faulty
interpretive reasoning of each Courts--particularly so because the
Circuit Court's decision is now the current controlling case law
concerning the extent of the authority granted by the Congress to the
SEC in the oversight of SIPC's operations. Beginning with the District
Court, it devoted most of its interpretative efforts to a determination
of the standard of proof, which the SEC must meet to obtain the Court
order enforcing its directive to SIPC. Since the SEC's request was
unprecedented, there was no guiding case law, and SIPC used that
reality to its advantage. Was the standard to be based on ``probable
cause,'' the standard applicable to SIPC applications to initiate SIPA
liquidation? No, the Court decided that ``due process'' required a
sterner burden, namely, ``a preponderance of the evidence.'' It reached
that conclusion by reasoning that since SIPC is a private entity funded
by private firms, it should be accorded the same ``due process''
applicable to other private parties within the SEC's regulatory ambit--
for example, a securities firm facing an enforcement action for alleged
violation of the Federal securities laws. Even one trained in the
``dismal science'' rather than the law might conclude that the Court's
reasoning doesn't pass the ``apples and oranges'' test. But that
tortured reasoning, coupled with the SEC's stipulation blunder, was
enough for the District Court to deny the SEC's application and
effectively neuter the SEC's directive to its subsidiary agency.
The SEC took the matter to the Circuit Court of Appeals. Certainly
this Court would see the folly of the District Court's analysis. And it
did, but it also conjured a folly of its own. It didn't bother with the
``standard of proof'' issue. Moreover, it seemed to embrace the unified
enterprise view that within Stanford's controlled empire, all of its
parts were essentially interchangeable. But what appeared to be an
enlightened view suddenly darkened when the Court embraced an equitable
theory of consolidation by which a customer's legal relationship with
the SIB as a CD holder is transferred to the broker-dealer, SGC. This
finding opened the door for SIPC's back-up legal argument.
SIPC argued that ``if'' equitable consolidation was considered by
the Court, the fact the CDs were ``debt instruments''--as many
securities are--the CD investor was ``lending'' money to the SIB; and
therefore a claim with SIB for debt owed to its customers would be
equivalent to a claim for SGC's debt--triggering a rarely used customer
exclusion provision under SIPA which restricts claims that are for the
for the overhead of the broker dealer. This exclusion was created in an
amendment to SIPA to address claims for creditors who intentionally
loaned funds to a brokerage firm that then became insolvent. Basically,
the amendment to create this particular customer exclusion was to
maintain the priority status a SIPA liquidation affords to investors
who purchase securities from a brokerage firm over creditors who became
a part owner of the firm--in other words, to protect those who invested
WITH a brokerage firm, rather than IN a brokerage firm. By the way,
SIPC advanced this same legal argument in at least three other very
similar cases, which three different Circuit Courts deemed an invalid
argument because--just like in the SIB CD purchasers--the customer's
expectation was they were purchasing securities, not lending their
money to their broker. Buttressing that argument three different times
in three different cases didn't stop SIPC from making a last-ditch
attempt to shun its obligation to protect investors. Such legal
jabberwocky is adored by SIPC and its hired counsel, who make millions
of dollars in profit in order to further SIPC self-preservation
culture. Customer perspective and reasonable expectations be damned, it
is what works for SIPC that counts.
At the end of all the excuses, which did pan out for SIPC merely
because it out-lawyered the SEC, SIPC protection for securities
investors cannot possibly deliver the confidence-building benefits
contemplated by the Congress because investors are subject to highly
technical rules and exclusions never intended when SIPA was enacted.
Such an approach destroys the remedial purposes of the statute.
Additionally, Congress never intended to give legislative deference
to a non-Government authority over the SEC. The result is SIPC
operating above the law without regard for the intent of the remedial
statute that created the organization.
Senator Vitter, I like to believe that our elected representatives
much prefer commonsense over arcane legal theories. If I'm correct,
then you and your colleagues will conclude that a Congress which, in
drafting the SIPA, made repeated calls for prompt action would not give
the SEC the express authority to direct SIPC to initiate a
liquidation--then turn on a dime to give SIPC the right to challenge
that directive. Such an inconsistency is sharply at odds with the
intent for SIPA liquidations to proceed with promptness in order to
protect investors and facilitate investor confidence. Moreover, it is
highly destructive of the SEC's legal authority as plenary overseer of
SIPC.
In conclusion, I'd like to express my strong support for S. 67: The
Restoring Main Street Investor Protection and Confidence Act of 2015,
which you have introduced in the Senate as a companion to the
legislation authored in the House of Representatives by Congressman
Garrett and Congresswoman Maloney, the Chairman and Ranking Member of
the House Subcommittee on Capital Markets and Government Sponsored
Enterprises. Passage of this legislation is urgently needed in order
for investors across this country to be protected not only from thieves
like Stanford and Madoff, but also from SIPC. Until Congress acts to
restore the confidence building purposes of SIPA and to rectify the
deeply flawed decision of the Second Circuit in the Madoff case and the
equally problematic decision of the DC Circuit Court of Appeals in the
Stanford case. Until then, the rank and file investor must be made
aware of their own Government's lack of authority to force SIPC to
protect their missing assets if their brokerage firm becomes insolvent.
These investors must also keep in mind what level of protection covers
his or her account if their brokerage firm fails and SIPC and its
Trustee are permitted to value their Net Equity after the fact by using
an absurd cash-in minus cash-out methodology Madoff customers have been
stuck with.
Regrettably, until your legislation is enacted, that is the very
real uncertain state of affairs confronting American investors. I
earnestly hope that you and Chairman Shelby and your original co-
sponsor from the 113th Congress, Senator Schumer will begin serious
discussions among yourselves and with the co-sponsors of the House
companion legislation, H.R. 1982, aimed at moving the legislation. It
is my sincere belief that SIPC's misguided administration of SIPA and
the Circuit Courts of Appeals' decisions affirming SIPC's actions pose
a very real threat to U.S. investors. And the victims of the Madoff and
Stanford frauds, numbering a total of over 10,000 innocent account
holders including thousands of your own constituents here in
Louisiana--most of whom are at, or near, retirement--have suffered for
6 years waiting for a just resolution of their victimization by SIPC.
Please awaken your colleagues to their plight. Thank you again for this
public hearing.