Securities Investor Protection Corporation

The Securities Investor Protection Corporation (SIPC /ˈsɪpᵻk/) is a federally mandated, non-profit, member-funded, United States corporation created under the Securities Investor Protection Act (SIPA) of 1970[1] and mandates membership of most US-registered broker-dealers. It is not a Self-regulatory organization (SRO).[2] "The SIPC fund, which constitutes an insurance program, is designed to protect the customers of brokers or dealers subject to the SIPA from loss in case of financial failure of the member. The fund is supported by assessments upon its members. If the fund should become inadequate, the SIPA authorizes borrowing against the U.S. Treasury. An analogy could be made to the role of the Federal Deposit Insurance Corporation (FDIC) in the banking industry."[3]

SIPC is required to report to, and be overseen by, the Securities and Exchange Commission. "Pursuant to SIPA, the Commission also has delegated authority to conduct inspections of SIPC, review SIPC annual reports, and approve SIPC’s bylaws, rules, and any amendments to the bylaws and rules."[4] As the SIPC states on its website, "Though created by the Securities Investor Protection Act (15 U.S.C. § 78aaa et seq., as amended), SIPC is neither a government agency nor a regulatory authority. It is a nonprofit, membership corporation, funded by its member securities broker-dealers."[5]

History

Enactment

In response to the near collapse of the financial markets in 1970, Congress chose to enact legislation that could prevent an escalation of brokerage firm insolvencies and help stabilize the financial markets. In December 1970, Senator Muskie resumed discussion of S.2348, which proposed creation of the Federal Broker Dealer Insurance Corporation (which became the Securities Investor Protection Corporation), a compromise with the House version H.R.19333 followed, and the bill passed. President Richard Nixon signed the bill into law on December 30, 1970. Excerpts from the President's statement made clear the goals of the legislation:[6]

"I AM SIGNING today the Securities Investor Protection Act of 1970. This legislation establishes the Securities Investor Protection Corporation (SIPC), a private nonprofit corporation, which will insure the securities and cash left with brokerage firms by investors against loss from financial difficulties or failure of such firms.... I urged the formation of a corporation to afford protection to small investors.... Just as the Federal Deposit Insurance Corporation protects the user of banking services from the danger of bank failure, so will the Securities Investor Protection Corporation protect the user of investment services from the danger of brokerage firm failure.
"This act protects the customer, not the broker, since only the customer is paid in the event of firm failure. It does not cover the equity risk that is always present in stock market investment, but it will assure the investor that the solvency of the individual firm with which he deals will not be cause for concern. It protects the small investor, not the large investor, since there is a limit on reimbursable losses. And it assures that the widow, the retired couple, the small investor who have invested their life savings in securities will not suffer loss because of an operating failure in the mechanisms of the marketplace.""

The Paperwork Crunch and financial crisis

The SIPC was born in the shadow of the "Paperwork Crunch" of 1968-70 as a means to restore confidence in the U.S. securities market.[7] During this period,

"An explosion in the volume of trading had occurred. A system designed to handle an average three million share trading day was incapable of dealing with the thirteen million share trading day common in the late 1960's. The resultant breakdown in the securities processing mechanism caused chaos as the number of errors in recording transactions multiplied.... In December 1968, member firms of the New York Stock Exchange had $4.4 billion in "fails to deliver" and $4.7 billion in "fails to receive." Brokers and dealers were finding it difficult, if not impossible, to ascertain their own financial condition.... This operational and financial crisis forced more than one hundred brokerage firms into liquidation causing thousands of customers to be seriously disadvantaged."[8]

In response, the Securities Investor Protection Act of 1970 was enacted as a way to quell investor insecurity and save the securities market from a financial crisis. In his introduction of the Securities Investor Protection Act to the floor of the Senate, Senator Edmund Muskie stated:

"The economic function of the securities markets is to channel individual institutional savings to private industry and thereby contribute to the growth of capital investment. Without strong capital markets it would be difficult for our national economy to sustain continued growth.... Securities brokers support the proper functioning of these markets by maintaining a constant flow of debt and equity instruments. The continued financial wellbeing of the economy thus depends, in part, on public willingness to entrust assets to the securities industry."[9]

Functions

The SIPC serves two primary roles in the event that a broker-dealer fails. First, the SIPC acts to organize the distribution of customer cash and securities to investors. Second, to the extent a customer's cash and/or securities are unavailable, the SIPC provides insurance coverage up to $500,000 of the customer's net equity balance, including up to $250,000 in cash.[5][10] In most cases where a brokerage firm has failed or is on the brink of failure, SIPC first seeks to transfer customer accounts to another brokerage firm. Should that process fail, the insolvent firm will be liquidated.[3] In order to state a claim, the investor is required to show that their economic loss arose because of the insolvency of their broker-dealer and not because of fraud,[11] misrepresentation,[12] or bad investment decisions. In certain circumstances, securities or cash may not exist in full based upon a customer's statement. In this case, protection is also extended to investors whose "securities may have been lost, improperly hypothecated, misappropriated, never purchased, or even stolen".[13]

While customers' cash and most types of securities - such as notes, stocks, bonds and certificates of deposit - are protected, other items such as commodity or futures contracts are not covered. Investment contracts, certificates of interest, participations in profit-sharing agreements, and oil, gas, or mineral royalties or leases are not covered unless registered with the Securities and Exchange Commission.[14]

Organization

"SIPC is led by seven directors, some appointed by the President of the United States, and others by the member firms. It employs a staff of only twenty-nine and does not advertise job openings on its website. In 2007, total employee compensation and benefits were $5.8 million."[15]

Caveats and clarifications

Although modeled loosely on the Federal Deposit Insurance Corporation (FDIC) which protects bank customers, unlike the FDIC where accounts are protected against loss of value, SIPC does not protect against market fluctuations or changes in market value. It does not protect against losses in the securities markets, identity theft, or other 3rd-party fraud.[16] Unlike the FDIC, SIPC also does not provide protection where there are claims against solvent brokers or dealers.[17] It provides a form of protection for investors against losses that arise when broker-dealers, with whom they are doing business, become insolvent.[18] Claims against solvent brokers and dealers are typically managed by the securities' industry SROs: the Financial Industry Regulatory Authority (FINRA) and the Commodity Futures Trading Commission (CFTC).

The limitations of SIPC protection caused significant confusion among a number of investors following the collapse of Bear Stearns and Lehman Brothers[19] and perhaps, most prominently, following the exposure of Bernard Madoff's and Allen Stanford and the Stanford Financial Group ponzi scheme frauds.

In the Madoff fraud where securities had allegedly not actually been purchased, SIPC and the SIPC Trustee challenged and disposed of the claims of approximately one-half of customers of the Madoff firm, arguing that over the course of time those investors had withdrawn more funds than had been invested, resulting in a negative "net equity", and therefore, not eligible for SIPC protection.[20]

Inasmuch as SIPC does not insure the underlying value of the financial asset it protects, investors bear the risk of the market. In addition, investors also bear any losses of account value that exceed the current amount of SIPC protection, namely $500,000 for securities. For example, if an investor buys 100 shares of XYZ company from a brokerage firm and the firm declares bankruptcy or merges with another, the 100 shares of XYZ still belong to the investor and should be recoverable. However, if the value of XYZ declines, SIPC does not insure the difference. In other words, the $500,000 limit is to protect against broker malfeasance, not poor investment decisions and changes in the market value of securities. In addition, SIPC may protect investors against unauthorized trades in their account, while the failure to execute a trade is not covered. Again, this only pertains to an insolvent broker or dealer.

Under rules of the regulatory SRO governing brokers and dealers—the Financial Industry Regulatory Authority (FINRA), the investors' and the brokerage firms' assets must be segregated; they may not be commingled. It could be a civil and/or criminal violation if an investor's assets were inappropriately commingled. If the firm files for bankruptcy, provided the assets have been appropriately segregated, the investor's assets should be recoverable, beyond SIPC's current protection limit of $500,000, of the net equity, per account and $250,000 for cash claims. However, as noted above, not all asset types are covered by SIPC, such as annuities. Investors should check applicable rules at www.sec.gov and www.sipc.org, before investing. They should also discuss SIPC coverage and other safeguards which exist with respect to their investments, with their broker.

There may be ways to help protect assets, for example, confirm that your broker is a member of SIPC by visiting www.sipc.org, looking for the SIPC link on your broker's website, or looking for the SIPC logo on your customer account statement;[21] invest only with reputable firms; open multiple accounts (individual, joint, IRA, Roth) with the same firm; or, if possible, limit the amount invested with each firm to the SIPC covered limit.

See also

References

  1. ↑ Title 15 U.S.C. §78aaa et seq., as amended
  2. ↑ "SIPC - Investor FAQ". SIPC. Retrieved 2014-08-20.
  3. 1 2 "SIPA. Securities Investor Protection Act". United States Courts. Retrieved 2013-12-12.
  4. ↑ SEC, "SEC's Oversight of the Securities Investor Protection Corporation's Activities" (Mar. 30, 2011), p. 4. Title 15 U.S.C. §78ccc-ggg, et seq.
  5. 1 2 "www.sipc.org/brochure". Sipc.org. Retrieved 2011-03-12.
  6. ↑ "Richard Nixon. Statement on Signing the Securities Investor Protection Act of 1970. December 30, 1970". University of California at Santa Barbara. Retrieved 2013-12-22.
  7. ↑ Thomas W. Joo, Who Watches the Watchers? The Securities Investors Protection Act, Investor Confidence, and the Subsidization of Failure, 71 S. CAL. L. REV. 1071, 1077; H.R. Rep. No. 92-1519
  8. ↑ Guttman, Egon (Summer 1980). "TOWARD THE UNCERTIFICATED SECURITY: A CONGRESSIONAL LEAD FOR STATES TO FOLLOW". Washington and Lee Law Review. XXXVII (3): 717–38.
  9. ↑ S.Rep.No 91-1218, at 2
  10. ↑ Originally SIPC protection was limited to $50,000 for securities. SIPA was amended in 1978 and raised the securities' protection to $500,000, where it remains today. Dodd-Frank increased the cash protection to $250,000 in 2010
  11. ↑ Securities' and Exchange Commission v. S.J. Salmon & Co., Inc., 375 F.Supp.867 (S.D.N.Y., 1974).
  12. ↑ In re Bell & Beckwith, 124 B.R. 35 (Bankr. N.D. Ohio 1990).
  13. ↑ S. Rep. No. 95-763 (1978), as reprinted in 1978 U.S.C.C.A.N. 764, 765; H.R. Rep. 95-746 at 21 (1977) |title=SIPC Chairman Owens in reports to House and Senate
  14. ↑ "www.sipc.org/covers". Sipc.org. Retrieved 2011-03-12.
  15. ↑ "financecareers.com". Financecareers.about.com. 2010-06-14. Retrieved 2011-03-12.
  16. ↑ "Brokerage Identity Theft Warning". SIPC. 2003-12-11. Retrieved 2011-03-12.
  17. ↑ "www.sipc.org/notfdic". Sipc.org. Retrieved 2011-03-12.
  18. ↑ 1970 U.S.C.C.A.N. 5254, 5255 H.R. REP.No.91-1613
  19. ↑ For a general discussion, see Steven Lessard, E.U. RE-HYPOTHOCATION AND LEHMAN BROTHERS BANKRUPTCY: CHANGES THAT MUST BE MADE TO THE MIFID, Appearing in Folsom, Gordon, Spangle, INTERNATIONAL BUSINESS TRANSACTIONS PRACTITIONERS TREATISE (2010 Treatise Supplement)
  20. ↑ "Madoff Recovery Initiative Claims Status". Madoff Trustee/Baker & Hostetler. Retrieved 2013-10-12.
  21. ↑ "www.sipc.org/q7". Sipc.org. Retrieved 2011-03-12.

Further reading

External links

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