The following represents a comment received on the post The Wealthy Beg. I thought it important enough to deserve a post. It provides an explanation of SIPC and how it works. The author corrects some impressions conveyed by my post that were originally reported in the Bloomberg article.
Thanks to Mr. Friedman for setting the record straight. His comment was included with the original post.
Thank you for allowing replies to your blog. The issues here are being somewhat distorted by your presentation of what you believe are the facts here. First, nobody is asking to be whole or beyond being made whole as you reported. There is a maximum limit, just like FDIC has a maximum limit as to what a person can possibly expect to be gotten back. Secondly, you must familiarize yourself with the SIPA law of 1970 that created SIPC before you are unduly influenced by the rantings of Stephen Harbeck, the President of SIPC.
In its 40 year history, and based upon the law, if a broker/dealer goes bankrupt, it is SIPC’s responsibility to first try to recover the shares of the investor and return it to them. If not all of the shares can be recovered (note: regardless of whether or not they were ever purchased), than it is SIPC’s responsibility to go out to the open market and purchase those shares. Nothing in the SIPC statute addresses what it cost those investors in the first place.
Let’s take a simple example. An investor bought 100 shares of IBM for $50. So, he paid $5,000. The broker goes bankrupt, and the shares cannot be recovered. SIPC comes in and buys 100 shares of IBM. If the share price is $25, then SIPC spends $2,500. If the share price is currently $100, then SIPC spends $10,000. There is no mention about how much the investor originally paid. It doesn’t matter, and they don’t care. SIPC “insures” what the balance was at the time of the default, not what the investor paid. So, if the investor had a losing position on the stock, they don’t get back their original cost, they get back the market value of the stock at the time SIPC buys it. There is no profiting on a bankruptcy.
When FDIC comes in when a bank folds, how much do the depositors get back (up to the maximum)? They get back their account statement on the day of default. That’s more than they originally invested. Right? Especially if they never took out the interest income. What if the bank had a Ponzi scheme going and all the interest earned was phony? How much would FDIC then pay? It would still be the account balance. Same with how SIPC was set up.
You should also be aware that while you are knocking the “well to do,” there are thousands of “Joe and Jill Sixpack” Madoff investors who were left destitute, who had worked hard all their lives and thought they were investing with a company that the SEC gave a clean bill of health to numerous times. They thought that the Chairman of the NASDAQ exhange was an honest person.
Please don’t throw around the word “Chutzpah” when the victims are trying to get the government to enforce on SIPC the laws that have always existed. Please be aware that the securities industry never complained when they sucked in millions of investors by promising them all SIPC protection up to $500,000 per account, when these same companies knew very well that all they paid PER COMPANY for 19 years was a mere $150. That’s NOT $150 per account, but one payment of $150 per company to supposedly protect all of their customers. You do the math. How can that possibly protect more than a few people? Only in a perfect world where there are no claims. Yet, people, not knowing any better felt protected, that they could leave the securities in street name.
The ultimate irony is that if there was no SIPC, there would never have been a “Madoff.” Madoff needed SIPC to pull off his scam.