Yesterday, the House Committee on Financial Services’ Subcommittee on Capital Markets held a hearing entitled “Assessing the Limitations of the Securities Investor Protection Act.” The hearing focused on the responses of the Securities Investor Protection Corporation (SIPC) to the Madoff Ponzi scheme and the Stanford Financial fraud and potential improvements to the Securities Investor Protection Act (SIPA) going forward.

Testifying before the subcommittee were the following witnesses, who are also members of the SIPC Modernization Task Force (Task Force):

  • Joseph Borg, Director, Alabama Securities Commission
  • Orlan Johnson, Chairman of the Board, Securities Investor Protection Corporation
  • John Coffee, Adolf A. Berle Professor of Law, Columbia Law School
  • Ira Hammerman, Senior Managing Director and General Counsel, Securities Industry and Financial Markets Association (SIFMA)
  • Steven Caruso, Partner, Maddox, Hargett, & Caruso

In his opening remarks, Subcommittee Chairman Paul E. Kanjorski (D-PA) highlighted certain provisions of the Dodd-Frank Act intended to increase investor protections and identified additional questions to consider in further enhancing the protections under SIPA. According to Chairman Kanjorski, (1) “we must explore the issue of expanding SIPA’s coverage [to investment advisors] as investment advisers may also commit fraud,” (2) “we must also consider what responsibility SIPC has to honor the broker statements that customers receive,” (3) “we must consider the best way to change the tone of SIPC and refocus this body on maintaining confidence in the financial system and promoting investor protection” and (4) “[t]o the extent possible, we ought to also explore how SIPC could learn from the success of the Federal Deposit Insurance Corporation in maintaining the public’s trust.”

Mr. Johnson, as chairman of SIPC and the Task Force, discussed his goals for a “comprehensive review of SIPC” and the recent work of the Task Force. According to Mr. Johnson, “the Task Force consists of a wide range of experts and is in the midst of its review and consideration of possible statutory, procedural and other reforms to SIPA and SIPC.” With respect to the Task Force review, Mr. Johnson stressed that “everything is on the table.” He said that he hopes to have a full set of recommendations from the Task Force sometime in the early part of the first quarter of 2011.

Mr. Borg expressed concerns about certain aspects of SIPC’s current operations. He supported an increase in coverage from the current $500 thousand to $1 million and favored an increase in the SIPC’s line of credit from Treasury to $5 billion matched with reserves of $5 billion and a shift from a term loan to a revolving loan. He also supported a minimum assessment of “at least $1,000 and preferably in the range of $2,000 to $2,500.” He disagreed with the “disparate protection” of SIPA between claims for cash and claims for securities. Finally, Mr. Borg supported additional “investor education efforts,” noting that “a constant and systemic notification (education) effort will be required.”

Professor Coffee discussed certain changes he supported with new legislation and certain areas that should not be changed. With respect to proposed changes, he supported expanding the definition of “customer” under SIPA “to cover a variety of beneficial or indirect holders on a ‘pass through’ basis.” Like Mr. Borg, he also supported the elimination of the “difference between the ceiling on securities losses … and the ceiling on cash losses,” noting that “it produces unjustifiable disparities in treatment” and “could give rise to perverse incentives.” However, Professor Coffee also stressed the importance of differentiating between the “Net Winners” and “Net Losers” and argued that H.R. 5032, the proposed Ponzi Scheme Investors Protection Act of 2010, “subordinates the interests of Net Losers to those of Net Winners.” Professor Coffee also disapproved of “limiting the powers of the SIPC trustee to sue the Net Winners in a ponzi scheme.”

Mr. Hammerman, on behalf of SIFMA, stressed that “SIPA is not intended to protect investors against losses on their investments, only against losses of their investments in the event of a broker-dealer failure.” According to Hammerman, “SIFMA strongly opposes the SIPA amendment proposed by Representative John Culberson (R-TX) in the fiscal year 2011 Financial Services and General Government Appropriations Act as it would extend SIPC’s protection to cover, for the first time, fraud by the issuer of certain securities … purchased by the customer which are neither lost nor stolen but in fact in the holders’ possession.” He further noted that “[t]he amendment would significantly expand SIPC coverage, for benefit of one narrow class of investors.”

Mr. Caruso identified two questions to consider: “what do we do to keep anything tragic from happening as we move forward” and “what do we do to remedy what has happened to investors in Madoff and Stanford and a host of other situations ….” Like several other panelists, Caruso also supported “eliminat[ing] the distinction between cash and securities.” With respect to past victims, he urged Congress “to introduce legislation in addition to the tax relief that would provide a means of restitution away from the SIPC process.”

During the hearing, both Democratic and Republican subcommittee members made strong statements in support of the victims of the Madoff Ponzi scheme and the Stanford Financial fraud. Congressman Gary Ackerman (D-NY), who led most of the hearing, made several passionate comments advocating for the victims and for increased investor protections going forward. Congressman Pete King (R-NY) questioned why “the [Madoff] trustee is acting as a prosecutor of victims” and “that they are now being subjected to the same type of treatment as defendants are put through in massive criminal conspiracies.” The committee members also focused on the fairness of the use of “clawbacks” by the trustee and SIPC’s role in the appointment process for trustees.