[Congressional Record (Bound Edition), Volume 157 (2011), Part 2]
[Extensions of Remarks]
[Pages 2658-2660]
[From the U.S. Government Publishing Office, www.gpo.gov]




      RE-INTRODUCTION OF THE EQUITABLE TREATMENT OF INVESTORS ACT

                           HON. SCOTT GARRETT

                             of new jersey

                    in the house of representatives

                      Thursday, February 17, 2011

  Mr. GARRETT. Mr. Speaker, late in the 111th Congress, I introduced, 
with co-sponsors, Mr. King of New York and Ms. Ros-Lehtinen of Florida, 
the Equitable Treatment of Investors Act (H.R. 6531). This bill 
reaffirmed and clarified the key protections for securities investors 
intended by Congress in the 1970 enactment of the Securities Investor 
Protection Act (SIPA) and major amendments to that Act in 1978.
  Today I reintroduce that legislation with clarifying amendments. The 
central purpose of the legislation is to reaffirm the original 
Congressional intent on two key aspects of the administration of SIPA 
in the liquidation of a bankrupt broker-dealer firm. First, as a 
general matter, the determination of customer ``net equity'' shall rely 
on the final account statement received from the debtor prior to 
closing, plus any additional supporting documents, such as trade 
confirmations. Second, and again as a general matter, avoidance 
actions, or ``clawbacks'', to recover property transferred to the 
customer prior to closing shall be prohibited. While I emphasize these 
clarifications simply reaffirm current law, the actions and 
interpretations of SIPA being made by the Securities Investor 
Protection Corporation (SIPC) and the Trustee appointed for the Bernard 
L. Madoff Investment Securities LLC (BLMIS) liquidation proceeding make 
the passage of this legislation important and necessary.
  In this legislation, there are important exceptions to those two 
general customer protections that deny that beneficial treatment to any 
customer who knew of or was complicit in the fraudulent activity of the 
debtor and to any customer who, as a registered professional in the 
securities markets, with the requisite knowledge of these matters, knew 
or should have known of the debtor's fraudulent activities and failed 
to notify appropriate regulatory authorities. This portion of the 
bill's language is meant to assure that SIPC and the receivership 
Trustee have fully adequate legal powers to act against customers 
undeserving of SIPA's investor protections.
  While this clarifying legislation is intended to have general 
application to all broker-dealer bankruptcies involving debtor fraud, 
introduction at this time is directly related to the failure of SIPC 
and its Trustee to fairly and adequately act to provide statutorily 
mandated and intended SIPA protections to the several thousand innocent 
customers defrauded by Bernard Madoff in the operations of his 
investment advisory and broker-dealer firm, BLMIS. Compounding the 
grievous shortcomings of SIPC to respond promptly and usefully to these 
customers' financial plight is the well-documented failures by the SEC 
and FINRA, the regulatory overseers of BLMIS, to detect and end the 
Madoff fraud over a period of 25 or more years.
  Given the colossal regulatory oversight failure and SIPC neglect in 
assessing broker-dealer firms at a level commensurate with the dramatic 
growth of the securities markets and the participating broker-dealer 
firms, it would be reasonable to expect that SIPC and the SEC would 
have made exceptional efforts to make a rapid and comprehensive 
response to the financial needs of the Madoff victims. That has not 
been the case. Quite the contrary, in fact, has occurred. SIPC has 
denied protection to over half the accounts at closing, in direct 
violation of the legal mandates of SIPA as currently in affect; 
provided full protection to only 25% of accounts; taken nearly two 
years to pay advances to the limited group deemed eligible; and 
threatened to claw back funds from roughly 1000 innocent customers.
  So that my colleagues may judge for themselves the urgent need for 
this Congressional intervention, let me highlight key factors 
supporting this need for action.
  The legislative record surrounding the enactments of the 1970 Act and 
the 1978 amendments is replete with statements from the legislative 
floor managers, active supporters, committee reports, the Treasury, the 
SEC, and securities industry spokespeople likening the intended SIPC 
protection to the bank customer protection offered by the FDIC. 
Likewise, the legislative history emphasizes protection of all innocent 
customers from brokerage failure, with particular mention of small, 
unsophisticated customers, and the need for prompt action by SIPC in 
payment of advances for relief of individuals, understandably 
devastated by the sudden loss of key financial assets.
  Critically, Congress recognized the need for restoring investor 
confidence in the financial markets at a time when the financial 
industry was under tremendous duress and overwhelmed by the paperwork 
crunch caused by the processing of physical securities. Theft and 
misplacement of securities, failures of

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trade executions, and insolvencies were commonplace. Amidst the 
backdrop of several popular Ponzi schemes and brokerage failures was 
SIPC born.
  For the customer of a bankrupt broker-dealer firm to qualify for SIPC 
protection, it is necessary for the customer's account at closing to 
have a positive ``net equity'' determined by subtracting any 
outstanding obligation of the customer to the firm from the amount the 
firm ``owed'' the customer. For the forty years of SIPC's existence, it 
has been the standard practice in making that simple calculation to use 
the firm's most recent account statement to the customer, usually 
supported by trade confirmations, if any, relevant to the final 
statement's presentation of holdings and values. Not surprisingly, this 
is the outcome required by law. Under the legal regime governing the 
relationship between brokers and customers, it is indisputable that the 
broker owes the customer the amount reflected on the customer's account 
statement. Indeed, in a world where customers and, generally speaking, 
brokers do not hold physical securities, it could not be any other way.
  Given the move away from the possession and trading ownership of 
actual securities to a ``book entry'' system based on the essential 
trust of validity of those account statements, no customer would, 
therefore, have any reason to believe they would not be protected based 
upon their account statements and confirmations. In the SIPC 
receivership for the Madoff firm, however, the practices have been 
inconsistent with the law and quite different and contrary to the 
repeated assertions of SIPC and its Trustee, never to the ultimate 
benefit of the innocent individual customer.
  Rather than using the customer's final account statement--consistent 
with ``reasonable expectations'' of a customer--the SIPC Trustee has 
ignored the statutory requirement of SIPA and has devised a ``cash-in/
cash-out'' formulation (CICO) to determine a customer's ``net equity''. 
To suggest that the Securities Investor Protection Act would have the 
effect of denying customers their legal right to rely on their account 
statement is counterintuitive. This formulation was developed from a 
position of hindsight once the Trustee, his lawyers, and forensic 
accountants were inside the Madoff firm and learned that no trades had 
been made by the firm for customers.
  Even though customers had regularly received monthly account 
statements showing trades and holdings in ``real securities'' (often 
blue chips in the Dow 100) that were supported periodically by trade 
confirmations in those stocks, the Trustee declared that all 
transactions were ``fictitious'' and that statutory words such as 
``owed'' and ``positions'' had no meaning. He further has asserted that 
in a Ponzi scheme the customer has no basis for ``reasonable 
expectation''--a public utterance which will destroy the public's 
confidence in our securities markets at odds with SIPA's primary policy 
objective.
  To execute the Trustee's CICO formulation it is necessary to examine 
every customer account over the entire term of the relationship (for 
many spanning 20 to 30 years) to sum up total deposits and total 
withdrawals (without providing any return on investment--even a 
standard rate). If deposits exceed withdrawals the customer has a ``net 
equity'' and qualifies for SIPC protection under CICO. If withdrawals 
exceed deposits over the life of the relationship, the customer is 
declared ineligible for SIPC relief and may be targeted for 
``clawback'' of the net withdrawals.
  How, you may ask, could the Trustee ignore the SIPA definition of 
``net equity'' and proceed to institute ``clawback'' actions? The 
answer lies in SIPA's incorporation by reference of provisions and 
powers under the Federal Bankruptcy Code. However, the Bankruptcy Code 
does not permit ``clawbacks'' of amounts paid by a broker to a customer 
to satisfy the broker's legal obligations to the customer--our 
securities system could not work any other way. Again, SIPC and the 
Trustee are disregarding the clear body of law to further harm the 
Madoff victims.
  Let us now examine the results of this receivership to date to 
determine just how equitable its performance has been.
  At closing, the approximately 4900 accounts of BLMIS that have filed 
claims for relief with SIPC had aggregate final statement values of 
roughly $57 Billion. Of that 4900, well less than half of those 
accounts (2053) have been determined eligible for SIPA protection under 
the Trustee's CICO formulation. Only 1207 of those eligible accounts 
will receive full SIPA relief benefits--advance payment of $500,000 and 
a priority status to the distribution of recovered ``customer funds'' 
up to the remaining balance of the CICO-approved claim. 846 of the 
approved claims will receive advance payments averaging $200,000; and 
because the advances fully satisfy the CICO claim these accounts have 
no priority status with respect to customer funds. 2728 accounts 
receive no relief (advances or priority status) under SIPA.
  These numbers, derived from SIPC responses to the House Financial 
Services Subcommittee on Capital Markets, portray an outcome 
distressingly out of step with Congress' intent for SIPA protection.
  The overall record of performance in providing investment protection 
in this case is even worse. The bulk of advance payments to eligible 
accountholders were distributed in the last quarter of 2010, fully two 
years after the closing of BLMIS. There is absolutely no way to square 
that performance with the clear mandate in Section 9(a) of SIPA for 
``prompt payment'' of advances--a mandate which recognized that most 
customers, victimized by bankruptcy of their broker-dealer, will be in 
dire need of urgent financial relief.
  Now let us turn our attention to the ``clawback'' suits against 
innocent customers who over the course of their investment relationship 
withdrew what they rightly believed to be earnings for normal real life 
purposes--income to support retirement, payment of Federal, State, and 
local taxes, helping a child with a home purchase, assisting a 
grandchild with college costs etc.--only now to find the Trustee 
demanding a return of some of those disbursements.
  What the Trustee now suggests as relief for all the Madoff victims, 
those who have received no SIPA financial protection (over half) and 
those receiving inadequate and dilatory relief, is the opportunity to 
file fraud claims against the ``general'' bankruptcy estate, when and 
if assets are assigned to it. For most of the innocent customers, now 
in desperate financial condition and fraught with daily anxiety, such 
relief is temporally distant with challenging prospects for success. In 
a general bankruptcy proceeding these individuals, many of them aged, 
will be competing with claimants (financial institutions and the like) 
with far greater resources and top-line legal representation.
  To his credit, the Trustee, with aid provided by the U.S. Attorney's 
office, has assembled some significant assets from parties complicit 
with the debtor. The innocent customers of Madoff should without 
question have the first and priority claim for relief in the 
distribution of those assets. That is the clear intent of SIPA in 
establishing claims to ``customer funds'' before assets move into the 
general bankruptcy estate. Had the Trustee, at the outset of this 
receivership, followed historic SIPC practices using customer final 
statements to determine ``net equity'', then all of these innocent 
customers would now be eligible for the distribution of ``customer 
funds'' under some equitable plan devised by the Trustee with the 
approval of the Bankruptcy Court. Moreover, they would be protected and 
assisted in their distress by full advances from the SIPC Fund, which 
has the resources to provide such relief.
  Two additional matters need to be understood by my colleagues. 
Because the use of the CICO methodology reduced dramatically the number 
of customers qualifying for advances from the SIPC Fund (an entity 
funded by the broker-dealer community and expressly established for the 
early relief of customers), that Fund has benefited by a savings of 
over $1 billion. To make this outcome more unacceptable, the failure to 
distribute those funds means that customer refund claims to the IRS for 
``theft losses'' will be increased by some $300 million. Thus the 
broker-dealer community's responsibility gets passed on to the American 
taxpayer.
  The conduct of this receivership has been pitifully inadequate in 
fulfilling the protections of the Madoff victims contemplated by 
Congress in 1970 and 1978. The processes employed by the Trustee, from 
the standpoint of the typical customer, have been needlessly time 
consuming and remarkably expensive. In its most recent response to the 
Capital Markets Subcommittee, SIPC advises that the Trustee, his law 
firm, and other consultants have been paid some $288 million over two 
years and contemplate billing for another $1 billion over the next four 
years. All the while, many Madoff victims are scrambling to exist.
  It is my earnest hope that an overwhelming majority of my colleagues 
will join me in supporting this legislation, which is so important, not 
only for the protection of many innocent investors, but also for 
encouraging investment going forward, which is critical to the economic 
renewal our country needs.

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