Securities Investor Protection Corporation
Securities Investor Protection Corporation
Gary Shorter
Specialist in Business and Government Relations
Government and Finance Division
Summary
This report outlines the financial safety net provided for individual investors in
stocks, bonds, and mutual funds held at securities firms, which somewhat resembles
deposit insurance and insurance guaranty funds. Its implementing body, the Securities
Investor Protection Corporation (SIPC), authorized by Congress, is actually a
nongovernmental corporation. The Securities and Exchange Commission (SEC)
oversees it. In the post-Enron/WorldCom financial climate of distrust of Wall Street,
its protection remains important. Although not in the public eye recently, SIPC has paid
out or facilitated investor restitutions of large amounts over time. This report will be
updated periodically.
Background
The Securities Investor Protection Corporation (SIPC) is a nonprofit, quasi-public,
quasi-industry, nongovernmental corporation. When securities firms become incapable
of performing their custodial obligations for customers, SIPC is responsible for ensuring
that customers recover cash and securities that they had entrusted to the firms. It protects
the “position” of registered securities, that is, the number of shares of a specified
corporation, etc., rather than any given dollar value of them. SIPC coverage is $500,000
value per customer, of which cash may be up to $100,000.1
The late 1960s saw a marked rise in securities trading volume, exposing major
inadequacies in the systems that processed securities trades and provided centralized
clearing. Bottlenecks and paralysis plagued the processing of trades, producing
significant accounting and reporting abuses. The subsequent stock market decline pushed
many securities firms into financial difficulties as many firms merged, failed, or ceased
operating. Some firms used customer property for their own trading, while others
experienced procedural breakdowns in the management of customer accounts, resulting
in customer losses of millions of dollars. In 1970, to avoid a recurrence of these events
and the potentially negative consequences for investor confidence in the securities
1 SIPC’s website, containing much of the following data, is found at [http://www.sipc.org].
markets, Congress amended the Securities Exchange Act of 1934 by adding the Securities
Investor Protection Act of 1970 (SIPA),2 and significantly changed it via the Securities
Investor Protection Act Amendments of 1978.3 The Securities and Exchange
Commission (SEC) has oversight over the resulting SIPC and its bylaws. SIPA gives the
SEC authority to review, disapprove, and even impose SIPC bylaws and rules.
SIPC is not a government agency and it is not a regulatory authority. It is a nonprofit,
membership corporation, funded by securities brokerages. SIPC has a seven-member
public board of directors. The Secretary of the Treasury and Federal Reserve Board each
appoints one, and the President appoints the remaining five, subject to Senate
confirmation. Of the President’s appointees, three are from the securities industry and
two represent the general public. The latter become SIPC’s chairman and vice chairman.
Brokerages belonging to stock exchanges and other organized markets automatically
become members when they register with the SEC; the statute requires each to pay an
annual assessment to SIPC. Part of their assessment, currently a flat $150 annually, is for
administrative costs and part goes into the SIPC fund, which is used to compensate
investors. (In many past years, assessments were based on members’ revenues.) If the
fund should prove inadequate, SIPC may also call upon a standby line of credit of $1
billion from the U.S. Treasury, which only the SEC can activate, and another $1 billion
line of credit with banks.
Purpose
With a mandate to help maintain investor confidence in the securities markets, SIPC
provides protection to customers for securities and cash left with failed securities firms.
It insures customer assets (registered securities and cash) against losses of up to $500,000
at the time of a firm’s collapse, of which up to $100,000 may be covered cash. Covered
non-cash assets include registered stocks, bonds, notes, mutual funds, and money market
mutual funds as “positions” (number of shares and identified bonds, etc.) rather than
fixed-dollar values of them. Congress has designed SIPC to recover a prorated position
for customers out of the remaining assets of failed firms, paying remaining covered claims
up to the statutory limits if necessary to fill any shortfalls.
Typically, the SEC or a self-regulatory organization like the New York Stock
Exchange or the NASDR (the regulatory arm of the National Association of Securities
Dealers) alerts SIPC when a securities firm that is a SIPC member is in serious financial
difficulty. SIPC normally responds by filing an administrative petition in a federal court
to liquidate the firm. The court will usually appoint a SIPC-recommended trustee,
although SIPC will sometimes itself be the trustee where liabilities are limited and
collapse affects fewer than 500 customers. When the liquidation proceedings are
removed to a U.S. bankruptcy court, the trustee notifies the firm’s customers and attempts
to sell or transfer customer accounts to viable SIPC members. If the firm’s customers are
unable to recover missing funds or securities from the firm, they may file claims, which
2 P.L. 91-598, Dec. 30, 1970, 84 Stat. 1636; codified at 15 U.S.C. §§78ccc — 78lll.
3 P.L. 95-283, May 21, 1978, 92 Stat. 249.
SIPC and the trustee then either accept or reject. To the extent that failed firms are unable
to meet accepted customer claims, SIPC advances funds up to statutory amounts noted
above. SIPC will not directly compensate for losses in commodities, precious metals,
derivatives, investment contracts, limited partnerships, or any other “securities” that are
not registered.
The corporation notes that since 1970, 99% of eligible investors have gotten their
investments back via SIPC. It has distributed more than $14 billion, aiding perhaps
625,000 investors. Around $400 million (less than 3%) came from the SIPC Fund, with
the vast majority of disbursements having been recovered from liquidations, etc. SIPC’s
fund balance exceeds $1.2 billion, and it has an additional $1 billion line of credit with
banks, and the same as a draw upon the Treasury noted above, allowing it to resolve cases
directly if necessary. It has about 6,500 member firms, yet has had to take on only around
six new cases a year for a decade, far less than the large case load in its initial years of
operation. In dollar terms, it made its largest distributions to customers in 2001, following
stresses in the stock market. The largest number of its proceedings occurred in 1972.
SIPC does not, however, insure against market losses, unlike governmental fixed-
dollar protection for depository institutions and insurance companies. Positions delivered
to investors may have gone up or down after resolution of collapsed securities firms, and
thus, except the cash portion, fluctuate in value. Surveys find many small investors
believing that the federal government insures their accounts against market losses,
however. The SEC and SIPC have tried to address these misconceptions. In addition,
some believe that it covers losses due to securities fraud, etc., which it does not do unless
an errant covered firm collapses.4
For years, securities firms could purchase excess SIPC coverage, supplementing the
governmental coverage up to customer protections of many millions of dollars. The
insurance policies varied in coverage, but as “surety bonds,” promised to cover gigantic
losses. Carriers generally stopped writing excess SIPC policies in 2003, fearing Enron-
like surety bond claims. As the policies expire, their original insurers generally have not
renewed them; brokerages typically no longer advertise multi-million-dollar account
protection. Looking to remedy this situation, a consortium of 14 large brokerages has
formed a captive insurer called the Customer Asset Protection Co. They have designed
the new insurer to restore account excess coverage, as a “surety bond” activated when a
customer’s claim exceeds the SIPC amount.5
Major Issues
SIPC has confronted several major criticisms. Among them are (1) whether it
imposes unreasonable requirements on investors for redress from failed brokers who
conducted unauthorized trades; (2) whether its overall mission is too restrictive,
particularly with respect to stock fraud; and (3) whether SEC oversight is strong enough.
4 “Investors Whose Funds Embezzled Had SIPC Claim for Securities, Not Cash,” BNA’s
Securities Regulation and Law Report, June 28, 2004, p. 1166.
5 “CAPCO,” at website [http://www.capcoexcess.com/USA/index.html].
Concerns That SIPC Imposes Unreasonable Documentation
Requirements for Claims of Unauthorized Trading
SIPC is obligated to pay for losses generated by unauthorized trading by failed
firms. Yet some have criticized it for the large number of denied claims in this area.
SIPC has historically denied claims for unauthorized trades unless customers complained
in writing to the firm within a few days of the trade, and then giving SIPC proof of
correspondence. Because most securities orders and associated transactions occur over
the phone, some observers have said that expecting unsophisticated investors to make
written complaints is unreasonable. Courts have generally upheld SIPC’s requirement for
hard documentation, which SIPC officials say is necessary to ensure accuracy of claims
and to minimize false allegations. Nevertheless, some argue that SIPC could probably
document unauthorized trades through other means, such as telephone complaints. Under
SEC supervision, SIPC has adopted written guidance for reviewing unauthorized trading
cl ai m s . 6
Expanding SIPC’s Mission to Cover Fraud
An investor believing to have been victimized by a brokerage firm scam can file a
claim with a National Association of Securities Dealers (NASD) arbitration court. (The
NASD has primary regulatory jurisdiction over brokerage firms.) If the NASD arbitration
panel rules for the investor, its decision then requires the firm to reimburse the losses.
Yet if the brokerage firm has filed for bankruptcy protection, SIPC then takes on the
claim. SIPC recompenses investor funds stolen or used for unauthorized trading. It does
not, however, have jurisdiction over other fraud such as broker refusal to sell a security
or making false claims about a security. Entrance of many relatively unsophisticated
investors in the securities markets appears to have led to increasing brokerage fraud.
Some industry observers, including state securities regulators, have argued that,
consequently, SIPC needs to broaden its mandate to include these kinds of securities
fraud.
SIPC and industry officials had opposed broadening SIPC’s mission, maintaining
that investors should be held accountable for their risk taking. They are also concerned
that insurance against securities fraud would fuel the misconception that SIPC covers
market loss. They question whether the large number of well-behaved brokers should pay
the added costs of insuring investors who invest with “bad” brokers. They are also
concerned that reconfiguring SIPC’s mission to redress securities fraud could imperil
SIPC’s reserve fund, requiring higher payments from its members (which they would pass
on to their customers), and increasing the risk that SIPC might tap into the U.S. Treasury.
Proponents of reform, however, counter that a negligible yearly assessment of $150
finances the SIPC fund, far less than many trading commissions, and thus the Corporation
could greatly increase it. SIPC officials have, however, said that they would accept
broadening its mandate, conditioned upon congressional amendment of SIPA.
6 U.S. Government Accountability Office. Follow-Up on GAO Recommendations Concerning the
Securities Investor Protection Corporation, GAO-04-848R, July 9, 2004, p. 7.
Recent incidents of fraud have led SIPC to issue warnings that con artists are posing
as actual SIPC members on the internet, seeking to defraud investors by providing
fictitious computer addresses. The result is a kind of brokerage identity theft.
SEC Oversight of SIPC
In 2001, a Government Accountability Office (GAO) report7 criticized SEC
oversight of SIPC. Among other things, the report stated that the overseeing agency too
infrequently conducted on-site examinations of SIPC, that the examinations were too
limited in scope, and that the agency had no formal mechanisms for sharing SIPC-
generated information (investor complaints, status of liquidations) among the various SEC
divisions and offices. GAO also noted that public and private bodies may not have
sufficiently mentioned the exact coverage of SIPC protection to investors, especially
brokerages.
In 2003, GAO released its first followup report,8 finding that the SEC had taken steps
to implement its recommendations. GAO’s recommended disclosures to investors about
SIPC coverage had generally become effective on SEC, SIPC, self-regulatory
organization, and brokerage websites. SIPC had added links to other sites in its brochure
offering information about investment fraud. GAO found, however, that investors could
benefit from more specific links to investor education information including any
remaining excess SIPC insurance coverage. Since then, investor education efforts have
involved self-regulatory organizations, working with the SEC and SIPC, to give
customers better information on SIPC and its limitations.
SEC and SIPC representatives generally agreed with the 2003 report’s findings and
recommendations. As noted above, GAO issued another followup document in 2004,
noting their generally affirmative responses addressing prior concerns over SIPC
practices. Concern remains that brokerages are not required to give new customers the
SIPC’s brochure called How SIPC Protects You, however.9
7 U.S. Government Accountability Office, Securities Investor Protection: Steps Needed to Better
Disclose SIPC Policies to Investors, GAO-01-653, May 25, 2001, 95 p.
8 U.S. Government Accountability Office, Securities Investor Protection: Update on Matters
Related to the Securities Investor Protection Corporation, GAO-03-811, July 11, 2003, 42 p.
9 U.S. Government Accountability Office. Follow-Up on GAO Recommendations Concerning the
Securities Investor Protection Corporation, GAO-04-848R, July 9, 2004, p. 7.