Follow-Up on GAO Recommendations Concerning the Securities
Investor Protection Corporation (09-JUL-04, GAO-04-848R).
This letter responds to a Congressional request that GAO report
on the status of our recommendations relating to the Securities
and Exchange Commission's (SEC) oversight of the Securities
Investor Protection Corporation (SIPC) and investor education. As
requested, this letter also includes information on SIPC's
progress in implementing SEC's recommendations from its January
2003 examination of SIPC and the status of excess SIPC coverage.
Specifically, GAO'S objectives were to (1) determine the status
of our recommendations to SEC and SIPC from our two previous
reports on SIPC, (2) review recent actions SIPC has taken to
address recommendations from the 2003 SEC examination report, and
(3) determine the status of excess SIPC coverage after three U.S.
insurers ceased offering the product.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-04-848R
ACCNO: A10896
TITLE: Follow-Up on GAO Recommendations Concerning the
Securities Investor Protection Corporation
DATE: 07/09/2004
SUBJECT: Insurance companies
Investments
Regulatory agencies
Securities
Securities regulation
Information disclosure
Internal controls
Investment insurance
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GAO-04-848R
United States General Accounting Office Washington, DC 20548
July 9, 2004
The Honorable John D. Dingell Ranking Minority Member Committee on Energy
and Commerce House of Representatives
The Honorable Barney Frank Ranking Minority Member Committee on Financial
Services House of Representatives
The Honorable Paul E. Kanjorski Ranking Minority Member Subcommittee on
Capital Markets,
Insurance and Government Sponsored Enterprises Committee on Financial
Services House of Representatives
Subject: Follow-Up on GAO Recommendations Concerning the Securities
Investor Protection Corporation
The Securities Investor Protection Act of 1970 (SIPA), which established
the Securities Investor Protection Corporation (SIPC) to provide certain
financial protections to the customers of insolvent securities firms, gave
the Securities and Exchange Commission (SEC) responsibility to oversee
SIPC. Our May 2001 report Securities Investor Protection: Steps Needed to
Better Disclose SIPC Policies to Investors stated that both SIPC and SEC
could better disclose information on SIPC's policies, practices, and
coverage to investors.1 In July 2003 we reported that SEC had taken steps
to improve its oversight of SIPC and that both SEC and SIPC had enhanced
their efforts to educate investors but additional steps were needed.2 In
that report, we
o noted that both entities could still do more to disseminate
information to investors about SIPC and how to avoid investment fraud;
1U.S. General Accounting Office, Securities Investor Protection: Steps
Needed to Better Disclose SIPC
Policies to Investors, GAO-01-653 (Washington, D.C.: May 25, 2001).
2U.S. General Accounting Office, Securities Investor Protection: Update on
Matters Related to the
Securities Investor Protection Corporation, GAO-03-811 (Washington, D.C.:
July 11, 2003).
o summarized a 2003 SEC examination report of SIPC that recommended,
among other things, that SIPC improve its controls over trustee fees and
establish guidance to determine the validity of unauthorized trading
claims;3
o found that three of the four major insurance companies that offered
excess SIPC insurance-private insurance that securities firms can purchase
to cover claims that are in excess of the $500,000 (which includes
$100,000 cash) limits set by SIPA-had stopped underwriting such policies;
and
o found that disclosures were lacking concerning the scope and terms of
excess SIPC coverage and the claims process.
This letter responds to your August 11, 2003, request that we report on
the status of our recommendations relating to SEC's oversight of SIPC and
investor education. As requested, this letter also includes information on
SIPC's progress in implementing SEC's recommendations from its January
2003 examination of SIPC and the status of excess SIPC coverage.
Specifically, our objectives were to (1) determine the status of our
recommendations to SEC and SIPC from our two previous reports on SIPC, (2)
review recent actions SIPC has taken to address recommendations from the
2003 SEC examination report, and (3) determine the status of excess SIPC
coverage after three U.S. insurers ceased offering the product.
To determine the status of our recommendations to SEC and SIPC, we
interviewed officials from SEC, SIPC, the New York Stock Exchange (NYSE),
and the National Association of Securities Dealers (NASD) and reviewed
sections of SIPC's Trustee Guide and other relevant documents. To review
SIPC's progress in implementing SEC's recommendations, we interviewed
representatives from SEC's Office of Compliance, Inspections, and
Examinations (OCIE) and reviewed sections of SIPC's Trustee Guide
regarding SIPC's policies on documentation of fees and services and record
retention. To determine the status of excess SIPC coverage, we interviewed
officials representing the only two insurers currently offering the
product, the Customer Assets Protection Company (CAPCO), a consortium of
14 large securities firms created in response to the three insurance
companies leaving the market; and Lloyd's of London. We conducted our work
from April through June 2004 in accordance with generally accepted
government auditing standards.
Results in Brief
SEC has implemented three of the five outstanding recommendations from our
previous two reports on SIPC and is still responding to two of them, and
SIPC has implemented our recommendation. First, in response to our
recommendation that SEC establish a formal procedure to share information
about SIPC among its various divisions and offices, SEC held a few formal
meetings and subsequently determined that holding informal meetings on an
as needed basis was more effective. In our discussions, SEC
3A trade is considered as unauthorized when the securities firm buys or
sells securities from a customer's account without approval.
staff representing the various divisions and offices involved with SIPC
issues agreed that this format allowed for the sharing of relevant
information; therefore, we considered this to be an effective response to
our recommendation. Second, SEC has implemented our two recommendations
aimed at improving the information that securities firms provide to
investors about excess SIPC protection. As recommended, SEC directed the
selfregulatory organizations (SRO)-NYSE and NASD-to send notices to member
firms instructing them to tell their customers about any changes in or
loss of excess SIPC protection and to provide them with meaningful
disclosures about the protections the policies now offer. However, SEC is
still in the process of responding to our recommendations requiring (1)
that clearing firms include information on account statements about
documenting unauthorized trades in writing and (2) that securities firms
distribute SIPC brochures to new customers. SIPC has also taken steps to
implement our recommendation on improving investor awareness of SIPC and
cautioning investors to avoid unintentionally ratifying an unauthorized
trade. As recommended, SIPC has updated its brochure and Web site to
provide links to specific Web pages to help investors access relevant
information about investment fraud and other potentially useful
information on investing.
SEC staff are currently following up on SEC's recommendations to SIPC
contained in the SEC's examination report of SIPC dated January 2003.
Although SEC staff are in the process of determining whether all of SIPC's
responses to their 2003 recommendations are adequate, their preliminary
findings indicate that SIPC has taken steps to improve its policies and
operations. In response to SEC's recommendations, SIPC has updated its
Trustee Guide to include (1) additional guidance on establishing valid
unauthorized trading claims, (2) additional requirements for trustees and
counsel concerning record keeping and filing of invoices for their
services and expenses, and (3) a requirement governing record retention on
liquidation proceedings.
Currently, only two insurers underwrite excess SIPC policies-CAPCO and
Lloyd's of London. After three major domestic insurers discontinued
offering excess SIPC coverage in December 2003, a consortium of 14
securities firms organized and capitalized CAPCO to offer excess SIPC
coverage to customers of the securities firms. CAPCO's policy is similar
to those previously offered by the domestic insurers. To help the
securities firms provide meaningful disclosures on the level of coverage,
CAPCO designed its Web site to include information on its excess SIPC
policy, instructions on filing claims for excess coverage, a sample copy
of the policy, and a sample claim form.
We provided a copy of the draft report to SEC and SIPC for comment and
both SEC and SIPC generally agreed with the contents of our report.
Background
SIPC's statutory mission is to promote confidence in securities markets by
allowing for the prompt return of missing customer cash or securities held
at a failed securities firm. As required under law, SIPC either liquidates
a failed securities firm itself (in cases where the liabilities are
limited and there are fewer than 500 customers) or a trustee selected by
SIPC and appointed by the court liquidates the securities firm. When
possible, accounts at a failed securities firm are transferred to another
securities firm, and when necessary, SIPC or a trustee attempt to satisfy
the "net equity" claims of customers.4 SIPC is not intended to keep
securities firms from failing or to shield investors from losses caused by
changes in the market value of securities.
Customers of a failed brokerage firm will receive all securities (such as
stocks and bonds) that are already registered in their name or are in the
process of being registered. After this first step, the firm's remaining
customer assets are then divided on a pro rata basis, with funds shared in
proportion to the size of claims. If sufficient funds are not available in
the firm's customer accounts to satisfy claims within these limits, the
reserve funds of SIPC are used to supplement the distribution, up to a
ceiling of $500,000 per customer, including a maximum of $100,000 for cash
claims. For example, if only 98 percent of a liquidated firm's customer
assets could be accounted for, customers would receive 98 percent each of
their net equity claims. Thus, a customer with net equity of $10 million
would receive 98 percent, or $9.8 million. SIPC would then use its reserve
fund to purchase $200,000 in securities, assuming that the customer had a
valid claim for securities, and the customer would recover the entire $10
million.
To protect customers who have claims in excess of the SIPC limit, insurers
began offering excess SIPC coverage to securities firms. However, such
claims above the SIPA limit have been rare. The amount of customer funds
recovered determines if the investor will have a loss and whether excess
SIPC coverage would be triggered. For example, if the trustee determined
that 50 percent of the customer assets were missing, a customer who is
owed $1 million in assets would receive a $500,000 pro rata share from the
estate and an advance from SIPC at its statutory limit of $500,000.
However, a customer with $5 million in net equity with the same 50 percent
pro rata share would receive a pro rata share of $2.5 million from the
firm's customer assets and an SIPC advance of $500,000, and would have an
unsatisfied net equity claim of $2 million that could be eligible for
excess SIPC coverage, if offered by the securities firm. Conversely, a
customer with $5 million in assets and a pro rata share of 90 percent or
higher would be made whole by SIPC.
SIPA gives SEC oversight responsibility for SIPC. SEC must approve all
proposed changes to rules or bylaws and may require SIPC to adopt, amend,
or repeal any of them. In addition, SIPA authorizes SEC to conduct
inspections and examinations of SIPC and requires SIPC to furnish any
reports and records that SEC believes fulfill the purposes of SIPA, are
necessary or appropriate, or are "in the public interest." A number of the
SEC's divisions and offices have various responsibilities with respect to
SIPC, with the Division of Market Regulation having the primary
responsibility for ensuring SIPC's compliance with SIPA.
4SIPA generally defines net equity as the value of cash or securities in a
customer's account as of the filing date, less any money owed to the firm,
plus any indebtedness the customer has paid back with the trustee's
approval within 60 days after notice of the liquidation proceeding was
published. The filing date typically is the date that SIPC applies to a
federal district court for any order initiating proceedings.
SEC and SIPC Have Taken Steps to Address Our Recommendations
Our 2003 report on SIPC noted that SEC and SIPC had made significant
progress toward addressing our concerns about SEC's oversight of SIPC and
the information SEC and SIPC provided to investors about SIPC's policies
and practices. However, we also found that additional work needed to be
done. Since then, SEC has taken actions to address all five of the
outstanding recommendations either directly or indirectly by delegating
implementation to the SROs. SIPC has also responded fully to our
recommendation.
SEC Has Worked with the SROs to Address Our Recommendations
First, we recommended in our 2001 report that SEC implement a
recommendation made by the SEC's Inspector General in a 2000 review that
the Division of Market Regulation, the Division of Enforcement, the
Northeast Regional Office (NERO), and OCIE conduct periodic briefings to
share information related to SIPC. When our 2003 report was issued, SEC
officials said they had begun to hold quarterly meetings but questioned
whether these meetings were useful. The SEC officials said that holding
informal meetings as SIPC issues arise would be more effective. During
this review, SEC officials said they have since met several times when
SIPC-related issues have arisen. For example, officials representing
General Counsel, Market Regulation, OCIE, and NERO have met a few times in
2004 to discuss the progress of OCIE's recent follow-up work at SIPC. In
the view of the SEC officials involved, a reasonable amount of
coordination on SIPC issues has occurred across SEC offices. Officials
from several SEC offices, including Market Regulation, General Counsel,
and NERO, agreed that in their view periodic meetings, as the need arises,
provided effective oversight of SIPC. As long as all of the relevant SEC
units continue to meet and share information about SIPC-related issues,
this approach effectively responds to the concern our recommendation was
intended to address.
Second, to ensure that investors were told about any changes in their
excess SIPC coverage, in 2003 we recommended that SEC and the SROs monitor
how securities firms informed customers of any changes in or loss of
protection. In March 2003, SEC had begun a limited review of SIPC-related
issues. However, because most of the securities firms that had excess SIPC
coverage were NYSE members, SEC asked NYSE to gather information about
excess SIPC coverage and information about the policies. When several
underwriters decided to stop providing coverage, SEC suspended most of its
review activity. Given the concerns that we and others had raised about
excess SIPC coverage, in 2003 SEC agreed to work with the SROs on our
recommendation. In July 2003, both NASD and NYSE instructed their member
firms to provide customers with 30 days' notice before any reduction in or
termination of the securities firms' excess SIPC coverage.
Next, we recommended in 2003 that SEC and the SROs ensure that securities
firms offering excess SIPC coverage provide investors with meaningful
disclosures about the protections the policies offer. According to SEC and
CAPCO officials, in response to our findings CAPCO began including in its
policies a more detailed explanation of how and when claims for excess
SIPC coverage would be paid. Our review of CAPCO's Web site
revealed that it had posted a detailed description of policy coverage and
a sample copy of the policy and had included procedures for filing a claim
and a copy of the claim form. In addition, an NYSE official said that its
examiners reviewed a member firm's Web site during an examination of the
securities firm to ensure that the Web site contained meaningful
disclosures about excess SIPC protection.
Fourth, we recommended in 2001 that SEC, in conjunction with the SROs,
establish a uniform disclosure rule requiring clearing securities firms to
put a standard statement about documenting unauthorized trading claims on
their trade confirmations, other account statements, or both. According to
SEC officials, both NASD and NYSE are supportive of this recommendation
and will implement it through rule making. As of June 25, 2004, according
to an SEC official, NASD had begun to draft the rule but had not submitted
the draft rule to SEC.
Lastly, we recommended in 2001 that SEC require SIPC member securities
firms to provide the SIPC brochure to their customers when they open an
account and encourage firms to distribute the brochure to existing
customers more widely. This recommendation was an additional step aimed at
educating and better informing customers about how to protect their
investments and the extent of SIPC coverage. The updated SIPC
informational brochure, called How SIPC Protects You, provides useful
5
information about SIPC and its coverage. However, SIPC bylaws and SEC
rules do not require SIPC members to distribute the brochure to their
customers; only SEC or the SROs can institute such a requirement. SEC
included this recommendation in its April 15, 2003, letter about SIPC
issues to NYSE and NASD and asked them to explore how it could be
implemented through SRO rule making and notices to members. According to
SEC and SRO officials, the SROs will not be fully implementing the
recommendation because, among other things, they are concerned that the
cost of purchasing the brochures would outweigh the benefits and have
instead decided to require the securities firms to add a telephone number
on the new account document that interested customers can call for
information on SIPC. The SIPC brochures are available to securities firms
for customer distribution, but at a cost. A SIPC official told us that
SIPC prints only a small number of the brochures for responding to public
requests that it
6
receives and for the federal distribution center located in Colorado. The
brochures are available to the securities firms through NASD and the
Securities Industry Association (SIA). SIPC sends a copy of the brochure
to NASD and SIA, which are responsible for the printing and the cost of
the brochures. According to an NASD official, securities firms must pay
NASD $15 per 25 brochures, plus shipping costs. Similarly, SIA charges 75
cents per brochure, plus shipping costs. We continue to believe it is
important for investors to be adequately informed about SIPC and its
coverage and that there may be other alternatives to getting the SIPC
brochure to clients. However, if the SROs decide that the costs outweigh
the benefits for member firms to include the SIPC brochure with every new
account package, then at a minimum the SROs may want to consider
5For a copy of SIPC's brochure, see http://www.sipc.org/how/brochure.cfm.
6The Pueblo Public Documents Distribution Center is a branch of the
Superintendent of Documents,
Government Printing Office.
encouraging securities firms to provide their customers with both SIPC's
telephone number and Web site address on a new account document.
SIPC Has Taken Steps to Improve Investor Education
In our 2003 report, we made one recommendation to SIPC to take an
additional step to ensure that investors had access to information and
guidance that would help them protect themselves against fraud and
unauthorized trading. Specifically, we recommended that SIPC revise its
brochure to provide links to informative pages on relevant Web sites. In
responding to our recommendation, SIPC provided a reference in its
brochure to the SIPC Web site, which has been updated to provide links to
the Web pages it cites. This approach addresses the intent of our
recommendation.
SIPC Has Taken Steps to Address SEC's 2003 Recommendations
In January 2003, SEC completed an examination assessing SIPC's policies
and procedures for liquidating failed securities firms. The examination
identified several areas that needed improving and made recommendations to
that effort. As of July 2004, SEC staff were following up with SIPC to
determine whether the actions it had taken adequately addressed the
recommendations. SEC representatives said their preliminary findings
indicated that SIPC had begun to take steps to address SEC's 2003
recommendations.
o SEC found that SIPC should continue to review the information it
provides to investors about its policies and practices. For example, SEC
found that some statements in SIPC's brochure and on its Web site might
overstate the extent of SIPC coverage and mislead investors. In response,
SIPC has included in its new brochure statements clarifying the extent of
SIPC coverage. Further, SIPC has undertaken other investor education
initiatives to inform the public of its mission and the protection offered
under SIPA and to explain SIPC's role in protecting customers. These
initiatives include, among others, radio and television public service
announcements to publicize the extent of protection and a training program
on SIPC and proceedings for a securities firm liquidation that was
presented to the District of Columbia Bar Association.
o SEC found that there was insufficient guidance for SIPC personnel and
trustees to follow when determining whether claimants had established
valid unauthorized trading claims, one of the principle sources of
investor complaints. As recommended, SIPC adopted written guidance in its
Trustee Guide for reviewing unauthorized trading claims.
o SEC also found that SIPC had inadequate controls over the fees and
expenses awarded to trustees and their counsel. To address SEC's concern,
SIPC is in the process of enhancing its controls for reviewing and
assessing fees. First, it has updated the Trustee Guide to require
trustees and counsel in SIPC cases to submit quarterly invoices and
arrange billing records into project categories. In addition, SIPC has
implemented procedures requiring SIPC personnel to document discussions
with trustees and counsel regarding fee applications and to note any
differences in the amounts requested and the amounts recommended for
payment.
o In addition, SEC found that SIPC lacked a retention policy for records
generated in liquidations with an outside trustee. In response to SEC's
recommendation, SIPC updated its Trustee Guide to include a requirement
that outside trustees retain records of liquidation proceedings for 5
years from the date the proceeding closes.
Two Insurers Underwrite Excess SIPC Policies
In 2003, we reported that three of the four major insurance companies that
underwrite excess SIPC policies would stop offering this product that
year. Although no claims had been paid since the coverage was first
offered in the 1970s and many had viewed the coverage as a marketing or
advertising cost, some securities firms felt that excess SIPC coverage
policies increased investor confidence in the securities firms. As a
result of the three insurers leaving the market, many of the securities
firms that offered excess SIPC coverage began exploring several options,
including letting the coverage expire, purchasing coverage from the
remaining underwriter-Lloyd's of London-or creating a
7
"captive" insurance company to provide the coverage. Since that time,
several large clearing and carrying securities firms that are NASD members
have purchased excess SIPC coverage from Lloyd's. In addition, in December
2003 a consortium of 14 NYSE member firms organized and capitalized CAPCO,
an insurance company licensed in the state of New York. According to
CAPCO's December 2003 press release, the excess SIPC coverage offered by
CAPCO will be similar to the excess SIPC coverage previously available
from the domestic insurers.
The policies underwritten by the two insurers differ in two areas. In
addition to a cap on the amount of coverage per customer, one insurer
capped the overall exposure-one policy we reviewed established an
aggregate cap of $250 million-regardless of the total amount of customer
claims. The other insurer did not set any specific dollar limits. The two
insurers also had different customer bases that would be eligible for
protection. Like SIPC coverage, which excludes certain customers such as
officers and directors of the failed securities firm, one insurer also
excluded these customers. Conversely, the other insurer extended coverage
to officers and directors of the failed securities firm as long as they
were not involved with any fraud that had contributed to the securities
firm's demise.
Agency Comments
We provided a copy of the draft report to SEC and SIPC for comment. SEC
and SIPC generally agreed with the contents of our report and provided us
with written comments, which are reprinted in enclosures I and II,
respectively. In addition, both SEC and SIPC
7A captive insurance company is a type of self-insurance whereby an
insurance company insures all or part of the risks of its parent. This
company is created when a business or a group of businesses form a
corporation to insure or reinsure their own risk.
provided us with technical comments, which we incorporated into this
report where
appropriate.
As agreed with your offices, unless you publicly release its contents
earlier, we plan no
further distribution of this report until 30 days from its issue date. At
that time, we will
send copies of this report to the Chairman, House Committee on Energy and
Commerce;
the Chairman, House Committee on Financial Services; and the Chairman,
Subcommittee
on Capital Markets, Insurance and Government Sponsored Enterprises, House
Committee on Financial Services. We will also send copies to the Chairman
of SEC and
the Chairman of SIPC and make copies available to others upon request. In
addition, the
report will be available at no charge on the GAO Web site at
http://www.gao.gov.
Please call me or Karen Tremba, Assistant Director, at (202) 512-8678 if
you or your staff
have any questions concerning this report. Nancy Eibeck also contributed
to this report.
Orice M. Williams
Acting Director, Financial Markets
and Community Investment
Enclosures
Enclosure I
Comments from the Securities and Exchange Commission
Enclosure II
Comments from the Securities Investor Protection Corporation
(250194)
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