[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
A LEGISLATIVE PROPOSAL TO AMEND THE
SECURITIES INVESTOR PROTECTION ACT
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
NOVEMBER 21, 2013
__________
Printed for the use of the Committee on Financial Services
Serial No. 113-53
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HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
GARY G. MILLER, California, Vice MAXINE WATERS, California, Ranking
Chairman Member
SPENCER BACHUS, Alabama, Chairman CAROLYN B. MALONEY, New York
Emeritus NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California AL GREEN, Texas
STEVAN PEARCE, New Mexico EMANUEL CLEAVER, Missouri
BILL POSEY, Florida GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK, KEITH ELLISON, Minnesota
Pennsylvania ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia JAMES A. HIMES, Connecticut
BLAINE LUETKEMEYER, Missouri GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan JOHN C. CARNEY, Jr., Delaware
SEAN P. DUFFY, Wisconsin TERRI A. SEWELL, Alabama
ROBERT HURT, Virginia BILL FOSTER, Illinois
MICHAEL G. GRIMM, New York DANIEL T. KILDEE, Michigan
STEVE STIVERS, Ohio PATRICK MURPHY, Florida
STEPHEN LEE FINCHER, Tennessee JOHN K. DELANEY, Maryland
MARLIN A. STUTZMAN, Indiana KYRSTEN SINEMA, Arizona
MICK MULVANEY, South Carolina JOYCE BEATTY, Ohio
RANDY HULTGREN, Illinois DENNY HECK, Washington
DENNIS A. ROSS, Florida
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas
KEITH J. ROTHFUS, Pennsylvania
Shannon McGahn, Staff Director
James H. Clinger, Chief Counsel
Subcommittee on Capital Markets and Government Sponsored Enterprises
SCOTT GARRETT, New Jersey, Chairman
ROBERT HURT, Virginia, Vice CAROLYN B. MALONEY, New York,
Chairman Ranking Member
SPENCER BACHUS, Alabama BRAD SHERMAN, California
PETER T. KING, New York RUBEN HINOJOSA, Texas
EDWARD R. ROYCE, California STEPHEN F. LYNCH, Massachusetts
FRANK D. LUCAS, Oklahoma GWEN MOORE, Wisconsin
RANDY NEUGEBAUER, Texas ED PERLMUTTER, Colorado
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California JAMES A. HIMES, Connecticut
LYNN A. WESTMORELAND, Georgia GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan KEITH ELLISON, Minnesota
MICHAEL G. GRIMM, New York MELVIN L. WATT, North Carolina
STEVE STIVERS, Ohio BILL FOSTER, Illinois
STEPHEN LEE FINCHER, Tennessee JOHN C. CARNEY, Jr., Delaware
MICK MULVANEY, South Carolina TERRI A. SEWELL, Alabama
RANDY HULTGREN, Illinois DANIEL T. KILDEE, Michigan
DENNIS A. ROSS, Florida
ANN WAGNER, Missouri
C O N T E N T S
----------
Page
Hearing held on:
November 21, 2013............................................ 1
Appendix:
November 21, 2013............................................ 35
WITNESSES
Thursday, November 21, 2013
Friedman, Neil, a customer of Bernard L. Madoff Investment
Securities..................................................... 18
Hammerman, Ira D., Executive Vice President and General Counsel,
Securities Industry and Financial Markets Association (SIFMA).. 9
Harbeck, Stephen P., President and CEO, the Securities Investor
Protection Corporation (SIPC).................................. 7
Kogutt, Angela Shaw, Director and Founder, the Stanford Victims
Coalition...................................................... 11
Shean, Suzanne, a customer of Stanford International Bank........ 16
Stein, Ron, President, the Network for Investor Action and
Protection (NIAP).............................................. 13
APPENDIX
Prepared statements:
Friedman, Neil................................................... 36
Hammerman, Ira D................................................. 39
Harbeck, Stephen P............................................... 50
Kogutt, Angela Shaw.............................................. 67
Shean, Suzanne................................................... 125
Stein, Ron....................................................... 151
Additional Material Submitted for the Record
Garrett, Hon. Scott:
Written statement of the Financial Services Institute........ 156
GAO report entitled, ``Securities Investor Protection, The
Regulatory Framework Has Minimized SIPC's Losses,'' dated
September 1992............................................. 163
Email from Stephen P. Harbeck, dated May 21, 2009............ 171
Harbeck, Stephen P.:
Written responses to questions submitted by Representative
Hultgren................................................... 172
A LEGISLATIVE PROPOSAL TO AMEND THE
SECURITIES INVESTOR PROTECTION ACT
----------
Thursday, November 21, 2013
U.S. House of Representatives,
Subcommittee on Capital Markets and
Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 9:30 a.m., in
room 2128, Rayburn House Office Building, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Hurt, Neugebauer,
Huizenga, Mulvaney, Hultgren, Ross; Maloney, Sherman,
Perlmutter, Scott, Peters, Watt, and Carney.
Chairman Garrett. Good morning, everyone. The Subcommittee
on Capital Markets and Government Sponsored Enterprises will
come to order.
Today's hearing is entitled, ``A Legislative Proposal to
Amend the Securities Investor Protection Act.'' I thank all the
members of the panel.
And before we turn to the panel, we will begin with opening
statements. I recognize myself for 10 minutes.
Today's hearing is to further examine legislation
introduced by myself and also by Ranking Member Maloney, H.R.
3482, the Restoring Main Street Investor Protection and
Confidence Act.
I want to begin by directly recognizing and commending the
esteemed gentlelady from New York, my colleague, for all of her
hard work and dedication to this bill and to this issue as
well. It has been an honor, and it has been a privilege to work
closely with her on this very important issue. I also do want
to thank the panelists for coming, especially our two victims
who have felt the full brunt of the two largest financial
frauds in our Nation's history.
I also want to specifically thank all of my fellow members
of the committee, and the broader Congress as well, who have
formally cosponsored this legislation that we are discussing
today. I think right now we are at about one quarter of the
committee on the bill. I hope that number continues to rise as
Members learn more about this important subject.
I also want to express my sincere thanks to Senators David
Vitter and Chuck Schumer for introducing companion legislation
in the U.S. Senate. Hopefully, now, with this bicameral
support, it will aid us in coming to a more expedited
resolution to this problem.
Now, I want to make it absolutely clear that I am not
advocating for this legislation because I am trying to score
any political points. I am supporting this legislation because
I have studied the law, reviewed past precedent, and analyzed
the original congressional intent. And it is very clear to me
that SIPC and the trustees are not applying the law as intended
by Congress, and they are not adhering to their own past
precedent, which has been affirmed by the courts. So the
purpose of this legislation today is to reaffirm the original
intent of the law and to correct the misapplication of the law
by SIPC and the trustees.
It is not some retroactive change of the law. It is a
reaffirmation of it. SIPC now argues that it is nothing like
FDIC insurance. Yet years ago, President Nixon's original
signing statement of SIPA stated, ``Just as the Federal Deposit
Insurance Corporation protects the users of banking services
from the danger of bank failures, so will the Securities
Investor Protection Corporation protect the users of investment
services from the danger of brokerage firm failure.''
In case that was not convincing enough, I also found this
quote from Senator Edmund Muskie during the Senate
deliberations of SIPA legislation. He said, ``Mr. President,
since 1934, the United States has insured bank deposits under
the FDIC and the Federal Savings and Loan Corporation. These
insurance programs protect bank depositors from loss of their
savings because of bank failures. And the existence of this
deposit insurance has become a source of confidence in the
soundness of our savings institutions. S. 2348, the Securities
Investor Protection Act of 1970, would accomplish a similar
purpose for security investors by protecting them from losses
because of the failure of their brokers.''
If that wasn't enough, Senator Harrison Williams from New
Jersey, then the chairman of the Senate Securities
Subcommittee, stated the legislation ``would establish a
Federal brokers-dealers insurance corporation. Granted, it is
not the FDIC, but the FBDIC is pretty darn close to it.''
I have a 2009 email from from Mr. Harbeck to congressional
staff, where in it, he directly compared SIPC to FDIC. I would
like to later insert that in the record.
In Mr. Hammerman's testimony, he suggested SIPC was never
intended to cover frauds, and said the legislation was ``to
introduce a new public policy for SIPA and SIPC, namely
insuring investors against the risk of loss due to securities
fraud.''
Yet when going over the reason for the legislation, Senator
Muskie specifically said, ``There remain some very basic
problems within certain parts of the securities industry. There
are problems of obsolete management techniques, careless
business practices, inadequate self-regulation, and occasional
fraudulent activities. All of these account for some part of
the industry's financial difficulties today.''
To add further clarification to this topic, the head of the
New York Stock Exchange, Robert Haack, wrote to the SEC at the
time to provide their analysis of the potential loss to new
SIPC funds. The letter states, ``I should make it clear,
however, that no one can, in our opinion, make a realistic or
useful evaluation of the potential dollar exposure to SIPC
because there is no known way to measure the liability which
might be faced in the event of a broker-dealer failure. The
fraud of Allied Crude Vegetable Oil against Ira Haupt, for
example, caused the loss of $27 million, which in no way could
be anticipated in advance.''
In 1992, GAO conducted a report on the operations of the
program and said, ``Within the last 6 years, 26 of the 39 SIPC
liquidations have involved failures due to fraud.'' They also
stated in the report, ``In essence, SIPC is a backup line of
protection to be called upon generally in the event of fraud or
breakdown of other regulatory protections.''
With all that, I struggle to see how we are putting a new
public policy objective of fraud protection on SIPC when the
record is this long and this clear that protecting investors
from fraud was a core function of the original statute and has
been applied that way throughout its existence.
Again, turning to Mr. Harbeck's testimony, he suggests that
following a final account statement to determine a customer's
net equity somehow legitimizes a Ponzi scheme. SIPC argued for,
and the Second Circuit Court agreed, to support using the exact
same methodology in the New York Times securitization Ponzi
scheme resolution in 2004. That New York Times case is very
similar, almost identical, to the Madoff case. You see, time
and time again, SIPC changes the rules and its story after the
fact when it suits its own purposes.
The clear truth and the long and exhaustive record makes it
clear that SIPC is an insurance program set up by Congress to
protect investors and to ensure the appropriate functioning of
our Nation's securities markets, especially in the case of
fraud. So, regardless of your views about the original
appropriateness of programs like these, it is a current duty as
elected Representatives to ensure the law is followed and
administered as originally intended by Congress, and that
investors receive the protection they are promised. The
legislation before us is designed to improve protections of
securities investors, particularly the regular retail investor
lacking professional expertise in the market. It is the direct
outgrowth of a stunning regulatory failure to detect and
promptly respond to massive frauds and failures of SEC
registered broker-dealers, as in the Madoff and Stanford cases,
or now in the McGinn Smith case, which destroyed the principal
savings of over 12,000 investors. The devastation of these
losses has been compounded by the failure of SIPC to fulfill
its obligation as intended by Congress back in 1970.
So the provisions are commonsense reform in the bill,
specifically to do these things: one, remove the inconsistences
in the application of SIPC coverage, which have led to greater
confusion; two, to assure the SIPC protective benefits goes to
innocent customers; three, limit the exposure of taxpayers by
establishing new accountability measures for SIPC's borrowing
authority; four, avoid overtechnical legal interpretation at
odds with SIPA's remedial objectives and the original spirit
and intent of the law; five, improve the fiduciary character of
SIPA's liquidations; six, strengthen SEC's plenary oversight of
SIPA; and finally, direct the SEC and FINRA to give high
priority to inspection procedures which verify and validate the
accuracy and authenticity of information provided by broker-
dealers to their customers.
All of these proposed amendments seek to assure that SIPA
is administered with constant attention to the perspective and
the reasonable expectations of the broker-dealer customers,
those whose confidence's marked participation SIPA is intended
to engender and maintain. Now, a point too often overlooked is
that SIPA, while using many of the established practices of the
Bankruptcy Code, is unconditionally an amendment to the Federal
securities law meant to strengthen the efficient operation of
the capital markets by maintaining the confidence of the retail
user. It is the backbone of the system. Accordingly, the bill
seeks for the future administration of SIPA to clarify that
securities law primarily shall have the operative recognition.
Now, Mr. Harbeck, your written statement this morning
further emboldened me in my determination to put SIPC back on
the right course in carrying out SIPA's grand objective of
deploying its resources to help the financially devastated,
innocent and unsophisticated victims of broker-dealers in
bankruptcy, including fraud, such as those who are with us this
morning, rather than lawyering up to see how narrowly it can
interpret the law's remedial objectives. It is basically your
complete confidence in SIPC performing as the 1970 Congress
intended that troubles me.
I don't doubt for a second that you believe with genuine
conviction that SIPC actions are absolutely correct, not only
with SIPA's letter, but the spirit of the law. And I don't
question your integrity for a moment. But I am deeply disturbed
by your satisfaction with SIPC's performance in these massive
fraud cases, which have thankfully captured the attention of
Congress now with profound concern. Our bill seeks to reaffirm
the original intent of Congress in the enactment of SIPA, to
make reforms in its administration for the future and, above
all else, to change the culture of SIPC to one that seeks to
fulfill and not hinder SIPA's remedial purposes.
I will close by saying I am thankful to a lot of people
today. I said so at the beginning of my statement. But with all
the victims and their families still reeling from these frauds,
I must say that this is not a thankful day. But I will be
thankful once SIPC is reformed and the original intent of
Congress is reaffirmed.
With that, I conclude, and I now turn to the cosponsor of
this legislation, the gentlelady from New York.
Mrs. Maloney. Thank you very much, Mr. Chairman, not only
for holding this hearing, but for your tireless work on this
really important bill. We, unfortunately, share the same
situation of representing many people who were hurt by these
Ponzi schemes. And I know how hard that you focused on trying
to help them.
And I welcome all of our panelists, particularly our two
victims, who will help put a human face on what we are arguing
about today and debating today. Unfortunately, when Bernie
Madoff and Allen Stanford's massive Ponzi schemes came crashing
down, they exposed several key flaws in the Securities Investor
Protection Corporation and how it operates. Our bill attempts
to fix these flaws and would reaffirm the primary purpose of
the Securities Investor Protection Act, which is to protect
customers of broker-dealers and to maintain investor confidence
in our securities markets.
SIPC is supposed to maintain this confidence by winding
down failed broker-dealers in a fair and equitable manner,
which above all means protecting innocent customers' assets.
Unfortunately, in the Madoff case, SIPC and the trustees have
pursued a highly aggressive strategy that in my opinion has
unfairly punished some of my constituents who are innocent
customers, and has almost certainly reduced investor confidence
in our securities markets.
In some cases, former Madoff customers who had withdrawn
their money many, many years before the firm's failure learned
for the first time that their money was being clawed back only
when the trustees filed a lawsuit against them. This is hardly
the way to promote confidence in the securities market. And our
bill would put a stop to these tactics.
Now, SIPC has argued that these clawbacks are allowed under
the Federal Bankruptcy Code. But it is important to remember
that Congress enacted the Securities Investor Protection Act in
the 1970s because the Bankruptcy Code was not very useful for
winding down broker-dealers. Congress recognized that broker-
dealers, like commercial banks, are fundamentally different
from regular, nonfinancial companies. And just as commercial
banks are liquidated by the FDIC, broker-dealers need to be
liquidated by SIPC.
It is important to recognize that broker-dealers are
different because they are heavily regulated by the SEC, which
examines their books and records to make sure that customer
money is actually there, makes routine on-site inspections, and
requires annual audits of the broker-dealer. It is this seal of
approval from the government that customers rely on, and which
allows investors to place their confidence in the country's
securities markets. They can have confidence in our securities
markets because they have confidence in the SEC. Also, because
they have confidence that if their broker-dealer fails, they
will be protected by SIPC and treated fairly.
The account statements are also good enough for the
government to rely on. After all, these customers pay taxes to
the IRS on the profits that they see on their account
statements. Now, SIPC says that they can claim a tax deduction
on this IRS payment in the case of a clawback, but most of
these people are retired and don't have the income to have a
tax deduction. In addition, customers make all of their
financial decisions based on the financial statements that they
receive from their brokers, which tell them how much money is
in their account. For SIPC and the trustee to come in years
later, in some cases 10, 20, 30 years later and say, sorry, you
actually can't rely on these financial statements that the
government has essentially been signing off on for years, they
are wrong. SIPC should not be able to claw back money that
innocent customers had withdrawn years ago. Our bill would
prevent these unfair clawbacks of money that innocent customers
had long ago withdrawn. It would, however, still allow
clawbacks in cases where an investor actually knew about the
fraud when they withdrew their money. That is the way it should
be. Innocent people should be protected, while customers who
knew about the fraud do not receive the benefit of government
protection.
The time has now come to reform SIPC. And I believe that
our bill is a good starting point toward a lively debate on
this issue. I thank the chairman and all of our participants,
my colleagues, for being here today. And I thank particularly
the chairman's, I would say inspiring, leadership on this. He
has been very dedicated in working on this issue for a long
time.
And I yield to Mr. Sherman for 2 minutes.
Mr. Sherman. I want to thank the Chair and the ranking
member for these hearings. They have studied this issue, and
know far more about it than many of us on the subcommittee.
There seems to be a general agreement that the limits on SIPC
insurance should be clear and should be prospective. And the
payout from any insurance company needs to be limited by the
limit of the insurance rather than limited only by our empathy
for the insured beneficiary. The FDIC faces many of the same
issues because the limit is per customer, in effect, or per
depositor. If Three Brothers Moving and Storage Company has a
$750,000 deposit at a bank, they only have $250,000 of FDIC
insurance. If three brothers each open up a quarter million
dollar account at the same bank, those three brothers
collectively have $750,000. The account name matters. The
entity that is making the investment matters. And whether it be
a partnership, a trust, or a corporation, we cannot allow
General Motors to have $100 million of FDIC insurance just
because General Motors has millions of shareholders.
We have cases in progress now, and I think they ought to be
decided based on what the law was at the relevant time. And I
would count on judicial and quasi-judicial entities to make
that determination without a lot of help from Congress. But
that doesn't mean that there won't be future Madoffs, and
future Lehman Brothers, and future circumstances for which we
can't do a much better job in providing. And I look forward to
learning more here, even though I will have to leave early
because I have another hearing. Thank you.
Mrs. Maloney. I now yield 1 minute to Mr. Perlmutter.
Mr. Perlmutter. I thank the ranking member. And I thank the
chairman for bringing this bill forward. I do think that there
are some fundamental questions that we can't forget. The old
saying is that bad facts make for bad law. And we have to watch
out that we don't do something here that is a problem. Because
trying to address a Ponzi scheme, which is a sham, a phony deal
from the very outset, and the numbers are not real, and there
is sympathy for the people who are drawn into the fraud,
obviously. But does the taxpayer in Montana who has nothing do
with the folks who were defrauded in Boulder, Colorado, is it
their responsibility to cover the fraud? Madoff and Stanford
bilked thousands of people of a lot of money. And it was all a
house of cards. And somebody who gets into the fraud early gets
to benefit from it against the people who got in late. And so,
these are very different circumstances.
I appreciate the panelists today and their testimony. I
appreciate the sponsors for bringing this. But we have to watch
this whole area very closely.
With that, I yield back.
Mrs. Maloney. I thank the gentleman, and I yield back the
balance of my time.
Chairman Garrett. The gentlelady yields back. The
gentlelady's side went over a little bit.
Because one of our Members may not be here later, I ask
unanimous consent to yield 30 seconds to Mr. Mulvaney, without
objection.
Mr. Mulvaney. I appreciate that, and I thank the chairman
and the ranking member.
And I thank the panelists for being here today.
In the event I am not able to return, I did want to go on
record on one important thing that affects SIPC. It is a little
outside of the topic today, but is still very important. I am
not sure if folks are aware that SIPC, along with groups like
the Tobacco Trust Fund, FDA user fee accounts, the Public
Company Audit Oversight Board, the Financial Accounting
Standings Board, all of those groups had specific user fee
funds sequestered. I think it was an unintended consequence of
the sequester. The sequester was designed to limit the use of
general account funds, not user-fee funds. What we have is
groups that are counting on user fees to operate their various
institutions that have been sequestered. All the more reason
not to have voted for the sequester in the first place.
But in any event, I want to tell SIPC that I am
sympathetic, and tell the other groups that I am sympathetic.
And as we try and figure out a way to work out various fixes to
the sequester, I hope we focus attention on the fact that user
fees were unintentionally sequestered as well, and I think that
is wrong. Thank you, Mr. Chairman.
Chairman Garrett. I thank the gentleman.
With the time for opening statements now expired, we will
turn to statements from the panel. And again, I wish to say
thank you to all of the members of the panel who are here today
for this very important topic. We will run down the aisle as we
do. Your complete written statements have been made a part of
the record. We will now yield to you 5 minutes for a summary of
your statements.
Many of you have never been here before. There are lights
in front of you to indicate how much time you have. It will be
green when you start. It will turn yellow when you have one
minute left. And it will turn red when you are supposed to have
concluded. I also ask each one of you when you do speak,
because I am a little hard of hearing up here sometimes, to
make sure your microphone is turned on, and that your
microphone is pulled close to you, like Mr. Hammerman is doing
right now, good, because it doesn't pick up from a far
distance.
So with that being said, we will start with the president
of SIPC, Mr. Harbeck. Good morning. You are recognized for 5
minutes.
STATEMENT OF STEPHEN P. HARBECK, PRESIDENT AND CEO, THE
SECURITIES INVESTOR PROTECTION CORPORATION (SIPC)
Mr. Harbeck. Good morning, Chairman Garrett, Ranking Member
Maloney, and members of the panel. My name is Steve Harbeck. I
am the president of SIPC. I have been with SIPC for 38 years,
the last 10 of which as president.
I will dispense with discussing most of the major
activities of SIPC since the start of the financial crisis
because they are listed in my written statement. However, I do
want to point out one important point, and that is at no point
in the financial crisis was it more important to improve
investor confidence than in September of 2008 and the failure
of Lehman Brothers. SIPC stepped in to liquidate the brokerage
entity in Lehman Brothers and, with the trustee in place,
transferred 110,000 customer accounts with $92 billion in them
within 10 days. I believe that was absolutely critical to
investor confidence in what was clearly the most dangerous
period of our time since the Depression.
We are here today to talk about a specific bill and more
specifically the performance of SIPC in the Madoff case. I
appreciate particularly Congressman Perlmutter, who has a
bankruptcy background, indicating how difficult these decisions
were. But it is SIPC's belief that to do the greatest good for
the greatest number, consistent with the law, we have done so.
And that we have done so consistently with prior precedent.
What I would like to do is take you through something that
would occur under the bill if it were passed. And let's go to
the Madoff case in particular. If the FBI and the Securities
and Exchange Commission and SIPC had arrived in Mr. Madoff's
office 2 days later than we did, there were $175 million worth
of checks on Mr. Madoff's desk that would have gone to innocent
customers of his choosing. But that would have only left under
$200 million for the trustee to distribute.
And further, under the bill, if you strip it from the
avoiding powers that are specifically given under the existing
statute, specifically given to a trustee, instead of having the
$9 billion that he now has to distribute, he would have less
than $200 million. That is an unintended consequence of the
activities that this bill would sponsor.
I realize how difficult it is for the victims. But the fact
remains that this is a zero-sum game. And if one credits Ponzi
scheme profits that were generated solely in the mind of Mr.
Madoff, and if those profits stand on equal footing with the
net amounts that people have not received back, that means that
dollar for dollar, people who receive those amounts as
profits--those profits would be taken directly from people who
did not receive their own money back. That is bad policy and
bad law. It is not the law and never has been.
In any instance, the first of which was in 1973 in the S.J.
Salmon case, and again in the Adler, Coleman case, and yes,
even in the cases mentioned by the chairman today, the fact is
that at no time have fictional profits ever been recognized
under the Securities Investor Protection Act. That is the
policy, the consistent policy that was also applied in the
Madoff case.
What we have here is the trustee acting, again, to do the
greatest good for the greatest number consistent with the law.
I would like to turn to Ranking Member Maloney's mention of the
fact that the trustee has initiated lawsuits. As soon as he
initiated those lawsuits, he also initiated what he called a
hardship program. Because all a person who has been sued has to
show under the scenario that you correctly laid out, that they
had used the money over time, the trustee did not know that,
but if those facts were brought to his attention, the lawsuit
was summarily dropped. Some people have been ill-advised, in my
view, by their counsel not to enter the hardship program. I
believe that people who can demonstrate the sort of hardship
that you rightly empathize with will have those lawsuits
dismissed.
But make no mistake, the current statute does allow what
are called the avoiding powers. And the entire purpose behind
those avoiding powers is to do equity. The bill strips those
away. I would be pleased to answer your questions.
[The prepared statement of Mr. Harbeck can be found on page
50 of the appendix.]
Chairman Garrett. Thank you.
Mr. Hammerman is now recognized for 5 minutes.
STATEMENT OF IRA D. HAMMERMAN, EXECUTIVE VICE PRESIDENT AND
GENERAL COUNSEL, SECURITIES INDUSTRY AND FINANCIAL MARKETS
ASSOCIATION (SIFMA)
Mr. Hammerman. Chairman Garrett, Ranking Member Maloney,
and members of the subcommittee, I would like to express my
deepest sympathy for the victims of the Madoff and Stanford
schemes. I have family and friends whose financial lives were
adversely impacted on December 11, 2008. And I know from
personal interactions the havoc caused to individuals,
retirees, and wonderful charities by Madoff and the feeder
funds that never even disclosed they were investing in Madoff.
So I understand and in fact applaud the tenacity being
expressed by Chairman Garrett and Ranking Member Maloney as
they seek to help their constituents and the investing public
at large. I also commend you for recognizing more generally the
need to consider changes to SIPA in order to better protect
investors and increase investor confidence in the financial
markets.
I served on the 2012 task force that undertook a
comprehensive review of SIPA. And I agree, there are proposals
for reform that warrant consideration. Any reform proposal
should be made with an analysis of their costs to SIPC, the
members of SIPC, and the investing public. This is particularly
important with respect to the proposed legislation, which would
materially expand SIPC's mandate to provide insurance against
the risk of loss due to securities fraud and fictitious
profits.
Congress enacted SIPA in 1970 in response to the paperwork
crisis of the 1960s, a time when stock certificates routinely
went missing, trade processing errors were common, and there
were multiple failures of brokerage firms. Congress created
SIPC to protect the custody function that broker-dealers
perform. And while it is certainly within the prerogatives of
Congress these 44 years later to expand SIPA's scope to provide
insurance against losses due to securities fraud and fictitious
profits, we believe the costs would be extraordinarily high.
The SIPC Modernization Task Force recommended changes that
would increase the protection available to customers in at
least 3 important ways: increase the cap on advances from
$500,000 to $1.3 million; eliminate the lower cap of $250,000
applicable to customer claims for cash versus securities; and
make individuals eligible for advances with respect to shares
of their pension plans account. These types of changes would
appropriately expand SIPA, while continuing to reflect its core
purpose of protecting investors against the loss of cash or
securities in the event the brokerage firm holding their
property becomes insolvent.
The proposed legislation provides that the assets of a
customer would be determined on the basis of the last account
statement, with customer property in liquidation allocated
accordingly. We have significant concerns with this approach
since customer account statements in situations involving fraud
reflect fictitious transactions and do not truly represent
customers' positions. The property held by a Ponzi scheme is
simply the pooled investments of all the victims of the scheme
less the amounts already misappropriated, and making
distributions based on anything other than the victims' net
investments would be fundamentally unfair.
The net investment method has been used with respect to
fraudulent schemes as far back as the 1920s. It has been
applied by several trustees and courts in SIPA liquidations,
and we believe it should be used to determine net equity for
purposes of allocating customer property in situations
involving fraud.
The proposed legislation would also add to the customer
definition any person whose assets were misappropriated by an
affiliate of a brokerage firm, whether or not the firm had
custody, possession, or control of such assets. Expanding SIPA
in this manner could ultimately result in significant increases
in the costs borne by investors, and in some cases result in
investors losing access to the financial markets altogether.
Regarding the effective date, we question whether
application of the draft bill to active liquidation proceedings
is even feasible. For example, in liquidations in which
distributions have already commenced, it is unclear whether
customers would be required to return assets to the trustee so
that the trustee could redetermine claims and allocations. At a
minimum, retroactive application of the proposed bill would
significantly slow down the current SIPA proceedings.
Finally, it is a very unfortunate fact of life that fraud
exists and that crooks will continue to use the financial
system to find victims because, to quote notorious bank robber
Willie Sutton, that is where the money is. Criminals who steal
investors' hard-earned money and life savings should be
prosecuted and put in jail, but using fraudulent account
statements to insure all of us against the risk of fraud is
quite another undertaking, and its ramifications for businesses
and investors should be carefully analyzed and debated, lest we
inadvertently let the criminals decide which victims recover
what amounts.
Thank you for allowing me the opportunity to testify. I
would be pleased to answer your questions.
[The prepared statement of Mr. Hammerman can be found on
page 39 of the appendix.]
Chairman Garrett. Thank you.
Our next witness is making her way up here, I believe. Take
your time.
Welcome.
And just to recap, since I know you just came in, please
make sure your microphone is on. You will be recognized for 5
minutes. The little lights in front of you are green, yellow,
and red, for that purpose. Your full written statement will be
made a part of the record, and we therefore ask all the
witnesses to give a summary during their 5-minute presentation.
So you are now welcome and recognized for 5 minutes.
STATEMENT OF ANGELA SHAW KOGUTT, DIRECTOR AND FOUNDER, THE
STANFORD VICTIMS COALITION
Ms. Kogutt. Thank you, Chairman Garrett. My name is Angela
Shaw Kogutt, and I am the director and founder of the Stanford
Victims Coalition, a nonprofit advocacy group for the victims
of the Stanford Financial Group Ponzi scheme.
Chairman Garrett, Ranking Member Maloney, thank you for
holding this hearing today to discuss a much-needed amendment
to the Securities Investor Protection Act of 1970. I applaud
you both for your leadership in introducing the Restoring Main
Street Investor Protection and Confidence Act, which has given
hope to thousands of financially devastated investor victims
across the country who feel they have been unfairly denied the
protection of which the SEC has determined they are entitled. I
also thank the distinguished members of the subcommittee who
have already joined H.R. 3482, and I ask those of you here
today to consider this important legislation.
I want to point out right away that I am not the typical
face of the Stanford victims. I am a second generation victim.
Most of the victims are senior citizens, and for the past
almost 5 years now, I have spent a majority of my life serving
as their advocate, hoping to help them recover some of their
losses. I have done this because I am younger than they are and
because they deserve it.
Like thousands of other Stanford victims, my life was
forever changed by the events of February 17, 2009. As we
watched the news and feared the worst in the immediate
aftermath of Madoff's confession, we eventually realized that
Allen Stanford had stolen what two generations of my family
worked 4 generations to build. And he did it through Stanford
Group Company, a registered broker-dealer and member of SIPC.
The SEC had known for more than a decade that Stanford was
operating a Ponzi scheme. While Madoff had outsmarted the SEC,
Stanford hadn't. And the SEC knew for 12 years that he was
using the U.S. broker-dealer to steal customer funds intended
to purchase CDs from Stanford International Bank. In that
timeframe, the Stanford Ponzi scheme grew by $5 billion,
including the investments of every single U.S. citizen who
invested in the CDs.
My father-in-law is an 87-year-old World War II veteran and
a first-generation American who, again, like so many Stanford
victims, was able to live the American dream, only to have it
snatched away practically overnight. In 1965, he started a
manufacturing business with a few thousand dollars borrowed
from family members. He and my mother-in-law put in long hours
for several years, and eventually all three of their sons,
including my husband, joined the business. The family worked
together for more than 3 decades to build the business to more
than 300 employees and close to $20 million a year in revenue.
At that point, the business had outgrown the family, and they
made the decision to sell at just the right time, before the
economic collapse of 2008.
As soon as the sale of the business closed, our lawyer who
handled the transactions suggested we invest with a brokerage
firm that specialized in managing large accounts. She then
recommended what she called a boutique brokerage firm, Stanford
Group Company, which specialized in high-wealth clients. The
family had never heard of Stanford but agreed to a meeting.
Other firms were also considered, but Stanford really stood out
because of their enthusiasm, professionalism, their very high
public profile, the top notch credentials of their advisers,
and what we misinterpreted as genuine and sincere interest in
our investment goals.
What we didn't know is that financial advisers at Stanford
Group Company were hooked on what they internally called bank
crack in the highly lucrative commissions and bonuses they
received for selling the CDs from Stanford International Bank.
Also, little did we know that none of the financial advisers at
Stanford Group Company knew what assets were held, if any, in
Stanford International Bank's investment portfolio.
How someone who has a fiduciary duty to their clients could
recommend putting any of their funds in an investment vehicle
for which they didn't even know the underlying investments
seems extremely questionable, but that was also an inside
secret that Stanford paid them enough to overlook.
Ultimately, a substantial portion of the proceeds of the
sale of my family's business was invested with two Stanford
Group Company financial advisers. At the first meeting, the
family explained that they were very conservative and risk-
averse. One of the advisers, Bill Leighton, was an estate
planning lawyer. The other, Patrick Cruickshank, was a
certified financial planner, and NFL, NBA, and NHL-approved
financial adviser and Series 7 license holder. They told us
their safest, most conservative investment was their exclusive
signature product, the Stanford International Bank CDs for
accredited investors. We learned at the meeting that the entire
Stanford financial group of companies, which included Stanford
Group Company, Stanford International Bank, Stanford Trust
Company, and more than 100 other Stanford entities all owned by
Allen Stanford was headquartered and operated out of Houston,
Texas, and regulated by the SEC and numerous State regulators,
as the SEC had 33 offices across the country and more than 250
financial advisers who are still working in the business today
with no record on their FINRA broker check.
We were also told that the bank's portfolio was managed by
a team of money managers in Memphis, Tennessee, with a company
called Stanford Capital Management, which was also regulated by
the SEC. We were told that the international CDs were better
than investing in a U.S. bank CD because the international CDs
were securities, and they were backed by SIPC, which was up to
$500,000, and the FDIC at the time was only $100,000. Many
Stanford victims made their decision to make that investment
because of the securities product versus the bank product.
It is now almost 5 years later and SIPC has continued to
deny protection of Stanford Group Company customers by saying
we received the securities we purchased through SGC, which
simply is not true. Our money was stolen. How could we have
gotten a security when the owner of the broker-dealer stole our
funds? Allen Stanford is serving a 110-year jail sentence for
stealing our money right here in the United States, not for
committing an Antiguan bank fraud, which has not even been
alleged in the country of Antigua.
In November 2009, the Stanford Victims Coalition formally
asked the SEC to review the SIPC's determination about SGC
customers' right to protection under SIPA. After more than a
year of the SVC suffering the burden of proof and producing
hundreds of SGC customer documents at a time to the SEC only to
have the target moved each time and more documents requested,
it appeared the SEC was obviously avoiding making a
determination. The SVC's members then asked our political
leaders to urge the SEC to make a determination. More than 50
Members of the House and Senate signed on to a letter asking
the SEC to give the SVC an answer. Still, no answer, only
repeated promises that a vote would happen soon, which I have
now learned in SEC language could be months or even years,
given the way they have handled the Stanford case.
Finally, when it appeared this game would go on forever,
while Stanford victims were losing their homes and going
without life necessities, Senator David Vitter blocked the
nomination of an incoming SEC Commissioner until Stanford
victims were given an answer. This was not a political play.
Senator Vitter never told the SEC how to vote. He just asked
them to give the investors an answer, to just take a fair vote
and give us an answer. The vote was taken, and as the SVC and
our counsel had hoped, the SEC determined that SGC customers
were entitled to protection under SIPA because the SIB CDs were
fictitious securities, and SGC customer funds intended to
purchase the CDs were either acquired by Stanford Group Company
to pay the broker-dealer's expenses or were outright stolen by
Allen Stanford.
Chairman Garrett. I am going to ask you--
Ms. Kogutt. In closing, I would just like to say one more
thing. There are thousands of investors who truly are living in
poverty right now. This summer, an article came out in the
Baton Rouge newspaper that a food bank was going under, mainly
because of the devastation caused by the losses in Baton Rouge
of the victims of the Stanford financial fraud. They are living
on donations from charity.
Chairman Garrett. Thank you.
Ms. Kogutt. Thank you for holding this hearing and for
allowing me to speak for the victims.
[The prepared statement of Ms. Kogutt can be found on page
67 of the appendix.]
Chairman Garrett. Thank you.
Mr. Stein, you are now recognized.
STATEMENT OF RON STEIN, PRESIDENT, THE NETWORK FOR INVESTOR
ACTION AND PROTECTION (NIAP)
Mr. Stein. Thank you, Chairman Garrett, Ranking Member
Maloney, and members of the subcommittee. My name is Ron Stein.
I am the president of the Network for Investor Action and
Protection, a national not-for-profit organization dedicated to
improving our Nation's investor protection system. I am also a
registered investment adviser, a certified financial planner,
and a member of the financial services industry in good
standing.
Over 1,000 members of our organization were victims of the
Madoff fraud. I am honored to speak to you today, as others
have done before me, to give voice to the mostly middle-class
investors who were devastated by this fraud, and who are being
stripped of protections from SIPC and the SIPC-appointed
trustee.
Perhaps more, I am here on behalf of small investors,
millions of small investors who have not yet been victimized,
who depend on Congress, the regulatory apparatus, and the
industry for the protection of their life savings should
similar financial disaster befall them.
So where do we stand today, 5 years after, regarding the
Madoff fraud? Frankly, thousands of lives upended with another
thousand being sued, story after dismal story of family
horrors, depression, premature deaths, suicide, loss of medical
care, life savings obliterated, gruesome and devastating
stories.
This is not what Congress intended when it first passed
SIPA law in 1970 amidst the turmoil of hundreds of brokerage
insolvencies, recession, massive theft, fraud, and, yes, Ponzi
schemes. The creation of SIPC, the insurance-like entity, was
the cornerstone of that legislation and an essential step to
providing certainty, confidence, and trust to investors as
Congress was ushering them away from the certainty of their
physical securities to the new, more manageable world of the
investment statement. It goes way beyond a custody function; it
goes to ensuring confidence in the investment markets
themselves.
Now, Congressman Garrett quoted President Nixon and several
others. I would just like to include one additional excerpt
from the original Nixon testimony on signing SIPA legislation
in 1970. He said pertaining to the SIPA law, ``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 has invested their life
savings in securities will not suffer loss because of an
operational failure.''
I would like to point out that neither Nixon nor anyone
else at that time ever said that profits weren't going to be
protected, or mentioned the words ``fictitious profits'' as an
exception to this protection. That is revisionist history.
Following the passage of this legislation in 1970, every
brokerage firm trumpeted SIPC protection to its customers, and
every customer was informed that they are/were protected to the
SIPC limit based on their account statement values should their
broker fail. This was part of every broker's security training,
every one. I know. There were no asterisks. There were no
exceptions. There was no hint of being sued. And it was upon
these promises that the financial services industry was able to
gain the trust of the American public and explode in size.
Now, how do those promises and Congress' intentions comport
with the realities today?
Fact: The majority of Madoff investors will not receive a
penny of the SIPC advance guaranteed by Congress under SIPA
statute as a result of the net investment methodology the
trustee has chosen to use.
Fact: Over 1,000 investors acknowledged as being innocent
by the trustee are being vigorously sued like thieves and
criminals, many having already lost everything.
Fact: Institutions and professional investors are receiving
over 80 percent of the recoveries of customer property. Many of
these entities that the trustee himself has indicated should
have or could have known about the fraud.
Fact: In addition to saving SIPC over $1 billion by the
trustee's own calculations, the trustee and his associated
consultants have similarly been enriched by almost $1 billion,
and that number could grow, and those are funds which could
have gone to those who have been devastated and go to needed
education to prevent further frauds of this nature.
There is simply no rational way to conceive that this is
the outcome that Congress would have preferred were it sitting
here today. Indeed, this is precisely what Congress would have
sought to avoid, and clearly in no way would the American
public have supported a SIPA law in 1970 if this was seen as a
possible outcome.
The implications of this would be disastrous and could be
disastrous to all investors today. What investor in their right
mind could possibly trust that SIPC would be there or, worse,
not sue them for withdrawing funds from their own accounts?
What retirees would want to see their protections reduced just
when they are drawing on their life savings? Once investors
realized their protections don't exist, consider the impact on
the financial services industry as investors withdraw and move
funds from one firm to another.
Let me be clear. I am deeply, deeply troubled as a
financial practitioner about the failures of the regulatory
entities that were charged with the responsibility to protect
or unmask this fraud at a much earlier level. But I am also
deeply distressed that members of my own industry, when they
had the knowledge or the thought or the concern about a fraud,
chose not to come forward. I hope that will change as we go
forward.
But I am truly infuriated at SIPC's lack of response in a
human way to help protect the investors they were charged with
protecting, and that they have thumbed their noses at Congress,
refused to go to Congress when they could have to ask for
guidance in this issue and instead taken it on their own to
create the situation we are in today.
H.R. 3482, the Restoring Main Street Investor Protection
and Confidence Act is an important step to restoring the most
basic protections that investors need at this time. I want to
thank Congressman Garrett for showing tremendous leadership in
this, for Congresswoman Maloney and the rest of the committee
in sharing support, and I truly hope the industry will stand
with us in supporting this very important legislation. Thank
you very much.
[The prepared statement of Mr. Stein can be found on page
151 of the appendix.]
Chairman Garrett. Thank you.
Ms. Shean, welcome, and you are recognized for 5 minutes.
STATEMENT OF SUZANNE SHEAN, A CUSTOMER OF STANFORD
INTERNATIONAL BANK
Ms. Shean. Thank you. I would like to thank Chairman Scott
Garrett and Ranking Member Carolyn Maloney for holding this
hearing today and allowing me to speak about my experience as a
victim of the Stanford Financial Group Ponzi scheme. I would
also like to thank you from the bottom of my heart for giving
victims like me hope for recovering our stolen retirement
savings by introducing H.R. 3482. Thank you also to all the
subcommittee members here who have already joined this
desperately needed bill.
My name is Suzanne Shean, and I am 64 years of age. I live
in Carriere, Mississippi. Allen Stanford and the SIPC member
broker-dealer Stanford Group Company took more than my life
savings of a quarter million dollars invested just 18 months
before the SEC took the Stanford group of companies into
receivership. He took from me what money can't buy. He took my
husband's life, my soul mate, my daughter's daddy, my
grandchildren's granddad, and the life we had together.
When the news of the Stanford scandal broke, I had just had
surgery and was undergoing radiation treatments for breast
cancer. My sweet husband Michael sheltered me from the news for
months during my treatments and recovery. Michael had also had
cancer, colon cancer, and underwent surgery in March of 2008.
The doctors were able to remove it all, and they said he did
not need radiation or chemo or any kind of other treatment, but
being a victim of a Ponzi scheme is like cancer itself. The
stress eats away at you. For some, that happens slowly. For
Michael, it only took 6 months.
His cancer returned with a vengeance and quickly spread
throughout his body. The burden of losing our life savings was
just too much for him, especially when he carried that burden
alone for so long to protect me while I was sick.
He died on April 29, 2011, at the age of 66 years old.
Before Michael died, he worried so much about me and my
future alone without our savings. My greatest hope was that he
would be comforted with the knowledge that SIPC would make
things right for us before he died. That didn't happen.
I only saw my husband cry 3 times in our 43 years of
marriage. Tears of joy at the birth of our daughter in 1969,
tears of helplessness when neighbors had to help me pick him up
after he fell a few weeks before he died, and tears of anguish
when he asked me to forgive him. He had liquidated our IRA
stock market portfolios to invest in safer IRA CDs with
Stanford International Bank, with the Stanford Group Company.
He was inconsolable, but it was not his fault. The safety net
created to protect investors like us had failed to do so.
During our whole lives together, Michael and I worked so
hard to put money away so we could retire one day and enjoy our
golden years. For him to die thinking that was all in vain is
an abomination of the very soul of our society.
Discovering that the SEC knew Stanford Group Company was
involved in a Ponzi scheme for more than a decade before we
invested with them added insult to injury. The double whammy of
SIPC announcing it had absolved itself from protecting us was
just inconceivable.
I am now forced to work two jobs to keep my home. As a
working widow under 66 years of age, I am not entitled to my
husband's Social Security checks because my salary is over
$17,000 a year. I should be enjoying my grandchildren and the
fruits of my labor for these past 64 years. Instead, retirement
is not an option now that our entire IRA is gone.
What will happen to me when I can no longer work? The 1
percent recovered by the Stanford receiver after almost 5 years
will just about cover one house note and my trip here today.
Michael and I were very conservative investors, and we
entrusted Stanford Group Company, a registered broker-dealer
and SIPC member, to invest our IRA funds safely. We were told
because we had an IRA that Stanford Trust in Louisiana would
hold custody of our investments, and we felt comfortable with
this investment because every aspect was being managed in the
United States and regulated by government.
But what we didn't know did hurt us. We had no idea that
Stanford Trust Company was created by SGC as a way to tap into
a whole new source of money to feed the Ponzi scheme. Hundreds
of millions of dollars of innocent investors' IRA funds were
lost. The Stanford Trust Company was a subsidiary company of
SGC and was created as a State-regulated entity solely to evade
oversight by the Federal Government. The Louisiana Attorney
General's Office later explained that SGC employees operated
the trust company and even served as its board of directors. In
short, SGC held custody of our CDs, and our savings never left
the United States and never went to purchase securities of any
kind.
We were shocked when we found out that SIPC announced we
didn't qualify for protection because we weren't customers of
SGC because it supposedly didn't hold custody of the fictitious
Stanford International Bank CDs. But we had a customer contract
with SGC, and our account numbers begin with STSGC. What SIPC
was telling us seemed like hyper-technical legalese designed
solely to avoid covering our losses, despite other similar SIPC
cases in which investors were protected. SIPC was behaving as
if it was a private insurance company with government immunity,
and they have gotten away with it so far at the expense of
thousands of victims just like me.
Here we are, innocent investors, who used a SIPC member
broker to purchase securities that come to find out didn't even
exist, and SIPC is treating us as their enemy. The CDs were an
imaginary investment vehicle designed to take money from
Stanford's right hand, Stanford Group Company, and steal it
with its left hand, Stanford International Bank. In short, we
have been victimized again and again, first by the SEC for not
stopping Stanford Group Company when they were aware of
misappropriations of customer funds and other fraudulent
activities, and then by Allen Stanford himself, who stole our
money, and then a third time by SIPC because they have told us
Allen Stanford stole our money the wrong way.
Chairman Garrett. Ms. Shean, I would ask you to come to a
conclusion.
Ms. Shean. Okay. I beg you to please close the loopholes in
the law that SIPC has manipulated in order to protect it. It
means Michael--I will never have Michael back, but I know his
soul will rest in peace if he knew I was taken care of. That
would mean the world to me. I am a survivor. Yesterday was my
5th year anniversary of being cancer free. Please don't take
hope away from me. Thank you for your time and your attention.
It has been my honor to share my story with you today.
[The prepared statement of Ms. Shean can be found on page
125 of the appendix.]
Chairman Garrett. Thank you, Ms. Shean.
And finally, Mr. Friedman is recognized for 5 minutes.
STATEMENT OF NEIL FRIEDMAN, A CUSTOMER OF BERNARD L. MADOFF
INVESTMENT SECURITIES
Mr. Friedman. Thank you, Mr. Chairman, and members of the
subcommittee, for the opportunity to be here and to tell my
story. My greatest loss is something that SIPC would never
cover, the loss of my wife after 53 years of marriage. I am 79
years old. I am a veteran of Korea, and I am left with two
wonderful children and four grandchildren. My daughter has MS.
My children relied upon me and my account--although it was not
large, because I by no means was considered rich--to take care
of them if they needed it. I put in--let me go back to my story
on how I got involved, if I may, with Madoff.
A friend of mine in 1962 had a daughter the age of my son
who played in a playground together. Their father was Bernie
Madoff's CPA, Jerry Horowitz, and Jerry and I were strictly
friends until I went into my own business, which was
subsequently in the middle of the 1960s, when I opened a life
insurance agency, and he became my CPA. Jerry had been
investing with Madoff well before the 1980s, and so I felt that
his due diligence, with the SEC as a backup and SIPC as a last
resort would take care that if we lost everything, we would at
least recover something. I put in my pension plan assets. I
even sold Madoff in the early 1980s a retirement program and
had free access to his office at 1 Wall Street, walked around,
knew all the employees, and was never aware of anything that
was not honorable.
I am a graduate of NYU. I graduated as an accountant, hated
that as a profession, and ended up in the insurance business,
which was more personable. I grew moderately, I marketed with
16 different life insurance companies across the United States,
actually specializing in impaired risks as well as competitive
products. And I was able to amass, I guess, well, the balance
was about $2 million in my retirement program, which my
employees had the option of not partaking in, thank God, and my
personal savings.
I am now living on Social Security, with a little money in
the bank, which primarily was the result of refunds from
Internal Revenue for the taxes I paid in my, was forced to pay
mandatory at 70 and a half to withdraw moneys. In essence, that
is my story. I got a part-time job, maybe 1 day a week or 2 or
whatever they needed me, and I really have no source of income
other than Social Security, which is $1,400 a month. I had to
put my house in a reverse mortgage just so I could stay there.
I would not live with my children. And I thank you all for
this.
[The prepared statement of Mr. Friedman can be found on
page 36 of the appendix.]
Chairman Garrett. I thank you for your testimony, and I
thank everyone for the testimony, and so we will go to
questioning now. I guess I will begin with Mr. Harbeck. Would
you agree that when SIPA was passed in 1970, the creation of
the SIPC fund capitalized by industry assessments was the
feature given the most attention in the Floor discussion in the
House and the Senate?
Mr. Harbeck. I am not sure I understand.
Chairman Garrett. In other words, the establishment of the
fund, the focus was in large part in setting up a fund because
it provided liquidations at broker-dealer firms with another
source of relief coming from the assessments.
Mr. Harbeck. That was absolutely one of the major
components of the bill, yes, sir.
Chairman Garrett. Right. So, by doing that, you are going
beyond conventional bankruptcy to try to do what, to mitigate
losses, correct?
Mr. Harbeck. That is correct.
Chairman Garrett. And so in providing for the supplemental
relief to customers of failed broker-dealers, is it correct to
say that the overarching congressional purpose was to restore
and maintain the confidence of investors, particularly
nonprofessional investors, in their continued participation in
capital markets for the benefit of the economy?
Mr. Harbeck. That is also correct.
Chairman Garrett. Right. So, a couple of points taken from
that.
Mr. Stein, what was the number you gave as far as where the
distribution is at this point as far as between regular just
retail investors versus institutional investors?
Mr. Stein. Over 80 percent.
Mr. Harbeck. I would love to address that, if I may.
Mr. Stein. Over 80 percent of the funds in terms of dollar
amount will be going to institutional investors based upon the
recovery numbers that the trustee and SIPC have provided.
Chairman Garrett. And is it true--overall, have the
majority of people who have been taken advantage of in the
Madoff situation received compensation payments or have the
majority not received payments?
Mr. Stein. The majority have--first of all, talking about
direct investors, if we added indirect investors, the number of
those who have received relief is fractional, but the majority
of investors have not received any SIPC protection whatsoever,
and significant numbers of those who have received protection
have had those protections, those amounts reduced significantly
because of the net investment method adopted by the trustee.
Chairman Garrett. And I should probably take this moment
just to be clear here that we are talking about two, I don't
want to call it pots of money here, but two avenues of money of
relief, right? One is advances, correct me if I am wrong on any
of this, the advances which basically comes from the industry-
generated fees, right? And the other is the recaptured or
recovered money when the trustee goes out and re-collects,
collects the money from the bad actors in this; is that
correct?
Mr. Stein. Yes.
Chairman Garrett. Right. So there are two pots of money
here. And in the legislation before us, essentially we are
talking about making sure that--we are really not making any
changes with regard to the recovered money? I will go to Mr.
Stein for that.
Mr. Stein. The trustee is given a significant range of
opportunity to apply what methodology he feels is most
appropriate regarding the recoveries of customer property, but
regarding SIPC advances themselves, this legislation is making
clear that the trustee does not have the right to change the
intent of SIPA law to suit the purposes of the SIPA fund or any
other rationalization he can come up with to do so.
Chairman Garrett. Right. Mr. Hammerman, I do sincerely
appreciate your opening comment with regard to your concern for
the victims and also for your statements and your association
to try to work with us on this legislation, I do appreciate
that. One comment that you did make, though--you did say this
point, you said that fraud is a fact of life, and you said
something that has been with us always, words to that effect
you said. Ponzi schemes, I guess, have been with us always. You
didn't say that, but I guess that means that you would agree
with that in one way, shape or form or another, right?
So if that is the case, then back in 1970 when they created
this law, and they created the fund, created the whole--and the
focus was on the SIPC fund, they must have known at that point
in time that Ponzi schemes existed, but I didn't see anything
in the original law, and I certainly didn't see anything in the
Senate discussions on this where they created a Ponzi
exemption. When did that come about?
Mr. Hammerman. Mr. Chairman, there is no Ponzi exemption,
as you explain. The way I understand it is the way it would
work is if you as a customer gave, let's say, $100,000 to a
brokerage firm with the expectation that the brokerage firm
would buy securities for you--
Chairman Garrett. Right.
Mr. Hammerman. --in the account, and then that brokerage
firm turns out to be a Ponzi scheme, for example, then you
would be covered for that $100,000 of cash that you gave for
the purpose of buying securities, full stop.
What would not be covered is, let's say you gave that
$100,000 and the monthly statement--
Chairman Garrett. But that was--I know where you are going
to go with this, but that was not said in the original law.
Isn't that just a creation of later court cases?
Mr. Hammerman. That is not my understanding, but I am not
an expert in SIPC and the court cases.
Chairman Garrett. Okay. And I am going to be mindful of the
time because we are coming up on votes, so--I have a whole
series of other questions, but I will return probably in a
second round to the gentlelady from New York.
Mrs. Maloney. Thank you, Mr. Chairman.
And I thank all the panelists, and I think the basic
question is, what does SIPC insure? And going forward, what
should it insure in the future? How do we make that clear to
investors? Because we heard from victims that in the case of
Stanford, they weren't insured in anything.
Is that correct, Ms. Kogutt? SIPC did not insure or give
any paybacks at all to the Stanford victims, right?
Ms. Kogutt. None whatsoever.
Mrs. Maloney. None whatsoever.
Ms. Kogutt. We actually haven't even been able to file
claims because there is no liquidation, so we have had no right
of a judicial review of if our claims are valid or not.
Mrs. Maloney. So this is a tremendous problem going
forward, and in terms of Madoff, were payments done in Madoff
or not from SIPC?
Mr. Stein. Yes. Approximately half of the Madoff direct
customers received SIPC compensation.
Mrs. Maloney. What, $500,000 for securities, or what
compensation did they get?
Mr. Stein. Up to $500,000. The average payment is a little
less than that. But for those who were fortunate enough, and I
say that very carefully, when they were fortunate enough not to
have needed to pull funds out of their plan to live on, they
were able to receive SIPC compensation, and that gets to the
fundamental problem, and the public policy debacle that SIPC
and the trustee are representing here.
Witness, as Exhibit A, what Mr. Friedman has experienced.
Here is a man who has put his whole life savings into a
retirement plan. He retires with the intention of being able to
live off that savings, and because he has withdrawn money to
live off those savings, precisely as Congress would have wanted
him to do, precisely as he needed to do, he is being tortured
because those funds are being denied him. Any penny he has
taken out in his retirement has been deducted from the amount
of money that he has put in. So basically anybody who is
utilizing a retirement experience, who has been withdrawing
funds for the cost of living over any period of time, has
probably exceeded even the amount of money that they have
contributed over their lifetime to their savings. We are
actually having--we are actually reducing protections for those
people precisely for whom we should be going out of our way to
improve protections, and that is an unfortunate consequence.
Mrs. Maloney. Also they are saying if it is a Ponzi scheme,
you are not covered. Obviously, they didn't know it was a Ponzi
scheme; the government didn't know it was a Ponzi scheme. And
so, I think a crucial issue, and I guess I want to ask Mr.
Hammerman, what does SIPC cover now, and if you could get it
back to us in writing, and what do you think it should cover in
the future? And obviously, the situation of Stanford, of where
no determination and an outrageous Ponzi scheme, I would like
to know from Mrs. Kogutt in writing where you say the SEC knew
about this Ponzi scheme for 12 years, if anyone knew about it
and didn't report it or stop it, that is a criminal offense.
So, that is a whole other subject. We are looking at the SIPC
moneys now. So who do you think--what does it cover now, and
what should it cover? And if you could answer some of the
salient issues that the victims raised to you today.
Mr. Hammerman. Ranking Member Maloney, as I tried to
explain in answering the chairman's question, I believe today,
SIPC would cover an investor who put in, let's say, $100,000
with a brokerage firm with the expectation that the brokerage
firm was going to purchase securities, and if that brokerage
firm turned out to be a Ponzi scheme, that amount of money
would be covered and advanced by SIPC.
When you asked about what it should cover going forward, I
think that raises an entirely appropriate--
Mrs. Maloney. Mr. Hammerman, that is not what she testified
to. That is not with the Stanford people. They bought
securities. They bought CDs that apparently the SEC and other
people knew about, and then they are told that is not
applicable.
Mr. Hammerman. Ranking Member Maloney, I do not profess to
be an expert or extremely familiar with every underlying fact
with Stanford. From my limited understanding, the investors
invested in CDs issued by an Antiguan bank. Now, they may
have--that is my understanding of what happened, and what
foreign--
Mrs. Maloney. At the very least, going forward, it should
be clear--
Mr. Hammerman. No, going forward--
Mrs. Maloney. --any CD from a foreign bank, that nothing
from a foreign bank is covered because they can't even get it
resolved in the foreign bank, they won't even acknowledge that
there was a problem. So the main thing is investors have to
know what they are getting, and they were totally misled. They
thought it was insured, that they would have this protection,
and going forward, we made a mistake, it is in a foreign bank,
you are not covered. So, I think we have to be clear at the
very least going forward that people know what their situation
is.
Mr. Hammerman. I agree. I am sorry, Mr. Chairman?
I was just going to say I agree on a going-forward basis
that we need to be clear, and there is a public policy issue
about insuring against all sorts of financial fraud. The FBI
estimates $40 billion of financial fraud a year. They also
estimate $1 billion to $3 billion in micro cap securities
fraud, and the question is, what are we going to be--
Chairman Garrett. Thank you. I know there is--but I want to
get to the gentleman from Virginia.
Mr. Hurt. Thank you, Mr. Chairman.
I want to first of all thank the chairman for holding this
hearing.
And I want to thank each of you for being here. This is
sort of rare in Washington, it seems to me, where you have
folks who are not necessarily represented by moneyed interests
here testifying before your Congress, a Congress that you own,
about how to improve a law that clearly has been implemented in
a way that is less than perfect. So I want to, as a former
prosecutor who has dealt with people who have been the victim
of theft, outright theft, thank you for joining us today. I
thank the chairman for spearheading an effort to try to improve
the way this works.
I guess I would like to begin with Mr. Harbeck, who it
sounds like you have been with SIPC for 38 years total. Mr.
Stein in his opening statement and in his written testimony
indicated, and the chairman alluded to this, indicated that as
a fact that institutions and professional investors were
receiving over 80 percent of the recoveries in the Madoff case.
Over $9 billion has been recovered, and that is a striking--I
think that is a striking fact as stated.
Mr. Harbeck, I would like to know if you think that is--
first, do you agree with that, and second, if that is true, do
you think that is consistent with what the intent of this law
was as passed?
Mr. Harbeck. Let's connect the dots. Thank you for the
opportunity to do so.
Mr. Hurt. Yes, but please be--
Mr. Harbeck. The answer, sir, is that if an institution
such as a pension fund has a claim with Mr. Madoff, and the
pension fund has a thousand indirect victims of Mr. Madoff, by
paying that institution, one gets the money to the indirects.
That is precisely how the system works. The pension fund had
the contract with Mr. Madoff. If it had a $10 million pension
fund with Mr. Madoff--
Mr. Hurt. Okay.
Mr. Harbeck. They have already gotten 4.2 back.
Mr. Hurt. Do you believe that has been applied fairly, and
is that the way the law is intended to work?
Mr. Harbeck. Yes, sir.
Mr. Hurt. Mr. Stein, do you have a response to that?
Mr. Stein. I think the first response is that it doesn't
take into consideration the fact that you have 1,000-plus
victims who have been denied any SIPC protection whatsoever, so
let's just start there, that whether or not funds are going to
a pension fund is immaterial to the moneys that SIPC should be
advancing to those small, middle-income investors who invested
directly with a regulated registered broker-dealer, as Congress
and the financial service industry intended.
Getting to the issue of a pension fund, a very small
percentage of the total dollars that have been distributed to
the institutional investors are going to pension funds, which
is not to say that pension funds shouldn't receive their
distribution, but Mr. Harbeck uses an example of an entity that
is receiving a benefit. And in using that particular example,
he misleads the committee as to the most, what constitutes the
majority of the entities that are receiving the funds. And the
fact of the matter is that the kinds of funds, the kinds of
institutions the trustee himself has alleged could have known
and should have known about this fraud were the ones that are
receiving most of these funds, and the fact of the matter is
that over a thousand innocent victims are being sued.
Mr. Hurt. Okay. I hope I have time for one more question.
Again to Mr. Harbeck, a second fact that is stated in Mr.
Stein's testimony is the fact that in addition to saving SIPC
over a billion dollars by the trustee's own calculations, the
trustee and his associated consultants have similarly been
enriched by almost $1 billion, funds which could have gone
instead to the devastated and desperately needed, those who
desperately needed it. Is that true? Would you agree with that
as a fact? And, again, do you believe that is consistent with
the intent of Congress, and is that fair?
Mr. Harbeck. The billion dollars in administrative expenses
in the Madoff case went to compile the $9 billion fund that the
trustee has been able to recover.
Mr. Hurt. So you think that is fair?
Mr. Harbeck. I think that is an extraordinary return, yes,
sir.
Mr. Hurt. Mr. Stein?
Mr. Stein. That is kind of patently absurd on its face
because $7.2 billion or approximately was immediately recovered
by the Department of Justice. Early in the trustee's
proceedings, long before the number had reached $100 million,
another 2.2 was negotiated with another estate. So the amount
of money the trustee has actually utilized to effectively
recover funds has been an enormous amount. If you look at the
investment quality of the return on investment for the trustee
for the majority of that $1 billion in expenditures, a
relatively small amount of money has been recovered from the
large institutional investors.
Mr. Hurt. Okay. Thank you. My time has expired.
Chairman Garrett. Thank you.
The gentleman from Colorado.
Mr. Perlmutter. And I, again, want to thank the Chair and
the ranking member for tackling what is a very difficult and
unsatisfying problem because no matter how you push the
balloon, somebody gets hurt, because this is all a sham, and
everybody has been robbed from the beginning to the end. Now
the way I look at it is, there are three pots of money--we
talked about two. There really are three pots of money. And I
am sorry, ma'am, you are Ms. Kogutt? How do you say it?
Ms. Kogutt. ``Kogutt.''
Mr. Perlmutter. ``Kogutt,'' pardon me. There really are
three pots of money: You have the insurance fund, and how big
are we going to make that insurance fund so that we can cover
people who have been lost, and how many tiers down? Is it the
direct investor, is it the second direct, indirect investor,
third? Then, you have the recovery that goes on among the
people who have been defrauded.
So, Ms. Shean, you get, your husband gets in at the end of
Stanford, okay? You are helping the guys who got in earlier
into the fraud than your poor husband and you. You are in 18
months before they close it down, but there were people in 3
years, 4 years, 5 years; they are the ones getting interest
payments off of your money. So, that is the second.
Then, you are trying to figure out how do we resolve it so
that everybody is treated equally, the early guys get paid, but
the late guys don't get paid? They are hurt?
And then there is the third pot of money, which, Ms.
Kogutt, you reminded me of, is those people who got you into
the deal, okay? Whether it was the lawyers or the accountants
or the advisers or some other company, and then there are all
those lawsuits about--
Ms. Kogutt. Actually, there are no lawsuits.
Mr. Perlmutter. There certainly are in the Madoff side.
Ms. Kogutt. There should be.
Mr. Perlmutter. I don't know about on the Stanford side,
but there certainly are on the Madoff side.
Ms. Kogutt. There should be on the Stanford. There is a
litigation stay that has been in place since February 2009.
Mr. Perlmutter. Here is the question, and I appreciate the
ranking member and the chairman for tackling this. Do we try to
even it out? Is equity--everybody was robbed, so everybody is
going to be treated equally, or do the first people get to make
out better than the guys who put their money in at the end?
That is a policy question. For me, I think the equality,
everybody being treated equally is appropriate.
You then have the lawsuits against the advisers, and then
you have the question of how big should we have this insurance
fund? And will the broker-dealers or the taxpayers add to that
insurance fund? Because the losses from Madoff and the losses
from Stanford are so huge, they swamp the fund. It is just
gone. It is bankrupt because we haven't made it that big
because we hadn't seen those kinds of losses before. And in my
previous life as a lawyer, I represented victims of Ponzi
schemes. I represented trustees trying to collect money for the
victims of Ponzi schemes. These are horrible situations because
everybody is--and I want to use a crass term, but I am not
going to since I am on the microphone--robbed, and I don't know
that there is a good answer.
Ms. Shean, please?
Ms. Shean. One of the things that confuses me is that we
invested in Stanford Trust Company.
Mr. Perlmutter. It is all phony.
Ms. Shean. But Stanford was a member of SIPC.
Mr. Perlmutter. Absolutely, I agree.
Ms. Shean. As an investor, when I purchase an IRA
government-approved account, or I should say my husband did,
and my statements come from Baton Rouge, Louisiana; there is no
mention of Antigua. I have--
Mr. Perlmutter. I know, but it is snake oil. It is not
real. That is the problem. And when you told--when you brought
up that the SEC knew 12 years in advance, okay, that is
horrible. And I don't know how we want to try to compensate you
for that. That is terrible.
Ms. Shean. So since Stanford was a member of SIPC, what is
SIPC covering?
Mr. Perlmutter. There ought to be something from the
insurance fund available to you, and I don't know why you are
not getting some recovery, but there were so many people making
a claim against that fund, it is gone.
Ms. Shean. So they were accepting money from a brokerage
firm that was being run illegally?
Mr. Perlmutter. Correct.
Ms. Kogutt. Can I comment on that?
Mr. Perlmutter. Sure.
Ms. Kogutt. Part of the provisions of SIPA, 78eee(a)(1), if
the SEC or any self-regulatory organization is aware of facts
which lead it to believe that any broker or dealer subject to
its regulation is in or is approaching financial difficulty, it
shall immediately notify SIPC. However, in 1997, the SEC had an
item of interest in their very first exam--
Mr. Perlmutter. That is a troubling fact, and I am not sure
what the heck to do with that, because you don't have to have a
claim against the United States, I am not sure you could do it,
but I feel like you have a claim--
Ms. Kogutt. There have been lawsuits against the SEC. The
one that has moved forward the most is the one that has alleged
the SEC's violation of SIPA for this particular role because
the broker-dealer had a negative 1,400 percent loss year after
year, so they are at a negative operating loss, and it grew
every single year.
Mr. Perlmutter. And, look--
Ms. Kogutt. Why didn't SIPC know that?
Mr. Perlmutter. Your testimony is very compelling, but my
time has expired.
Chairman Garrett. The gentleman's time has expired.
Mr. Perlmutter. I appreciate you all coming here and
sharing with us. This is a tough deal, and I appreciate them
tackling it. I am not sure they have the right answer.
Chairman Garrett. I appreciate that the gentleman's time
has expired. I also appreciate the fact that the gentleman
indicated that Ms. Shean probably should receive something from
the SIPC fund.
I now recognize Mr. Hultgren.
Mr. Hultgren. Thank you, Mr. Chairman.
I, too, thank you all for being here today. I know this is
a very difficult thing.
I would like to focus my questions for on, Mr. Harbeck, if
that is all right, just for me to help understand a little bit
more of some of the challenges here. Focusing on the SIPC
Modernization Task Force report, I know one of the
recommendations is to eliminate the distinction between claims
for cash and claims for securities during the resolution of a
failed broker-dealer. First, I wondered if you can explain why
this distinction between cash and securities claims may have
existed before and, second, why SIPC feels the distinction is
no longer appropriate or necessary?
Mr. Harbeck. First of all, that is not SIPC's position; it
is the task force's position. And SIPC will be responding to
the task force on or before its next February board meeting.
What the original distinction tied the amount of cash directly
to the amount of cash available for the FDIC, and rose with
that dollar number. But in point of fact, sometimes cash gets
literally caught in the form of a check going to someone when
they didn't really want to leave cash with the brokerage firm,
it just happened to be caught as cash as the brokerage firm
failed. The task force looked at that and said it might be
appropriate to simply abolish the difference.
Mr. Hultgren. I wonder if you could explain how fictitious
securities are categorized in this process. And as you talk
about that, are claims for fictitious securities considered
cash claims or security claims? I understand there has been
some confusion over that in the courts, and I wonder what
SIPC's position is on that?
Mr. Harbeck. There is a split in the circuits on this. The
Sixth Circuit has taken the position that the only conceivable
way to measure cash legitimately deposited for the purpose of
purchasing a security which does not ever exist would be
protected as a claim for cash.
The Second Circuit has taken a different view, and
protected it as a claim for securities. But one important thing
with respect to any claim for securities is that SIPC, under no
circumstances and in no case, was ever intended to guarantee
the underlying value of a security. SIPC was designed to get
you your security back. If it went up, excellent. If it went
down, that is the way the marketplace works. Under no
circumstances, regardless of why a security moves up or down in
value, does SIPC protect the underlying value. It simply
returns the security to you.
Mr. Hultgren. I know another recommendation from the SIPC
Modernization Task Force report is to increase the maximum
level of protection from $1.3 million and index it to
inflation. If the distinction between cash and security claims
is eliminated, effectively eliminating any cash maximum, and
the level of protection is raised to $1.3 million, this means
that all cash up to $1.3 million would be SIPC-covered. That is
over 5 times the level of FDIC coverage. Is that desirable? And
how might that affect cash holdings in deposit accounts and
brokerage accounts?
Mr. Harbeck. I think there may be unintended consequences
to the task force's recommendation. And I am sure that the SIPC
board will be actively debating that and has begun that debate
already.
Mr. Hultgren. And that response will be in the next few
months?
Mr. Harbeck. It is my understanding that the board intends
to reply to the task force on or before its February board
meeting in 2014.
Mr. Hultgren. One last thing. Appreciating that one of the
fundamental principles guiding SIPC is to certainly protect
small investors, I wonder how raising the maximum coverage
level would affect small brokers. Surely you would think this
would raise broker-dealer assessments.
Mr. Harbeck. The fact of the matter is that what we will do
when we reach the target of $2.5 billion, which matches the
Federal line of credit that we have against the United States
Treasury, I am confident that the board will assess whether at
that particular point in time--our current assets are $1.9
billion--whether a target of $2.5 billion is appropriate or
whether it should be increased. I think we will take a hard
look at where we stand and where our obligations are and what
our legal obligations are as to whether the assessments should
be raised, lowered, or stay the same.
Mr. Hultgren. Thank you all. My time has almost expired.
I yield back. Mr. Chairman, thank you so much.
Chairman Garrett. Thank you. The gentleman yields back.
Mr. Carney is recognized.
Mr. Carney. Thank you, Mr. Chairman.
I would like to thank you and the ranking member for having
this hearing today, and particularly for your tenacity on
behalf of your constituents. Knowing how important our
constituents are, I have great sympathy and appreciation for
the work that you are doing. I appreciate in particular the
victims who have come here today.
For me, I think our role is at some level to establish what
the facts are and to try to come up with the best public
policy, not just for these two terrible cases, the Stanford
case and the Madoff swindle, but also going forward for
everything else. So I am going to try to I think address most
of my questions to Mr. Harbeck and Mr. Hammerman.
First, I want to have some more discussion about the
treatment of institutional investors versus retail investors.
Mr. Stein, I think, said that 80 percent of the institutional
investors were protected, and obviously, a lot of retail
investors were not getting assistance.
Mr. Harbeck, you mentioned the situation with pension
funds.
Mr. Stein seemed to take some exception to that.
What is it? Is that the full explanation, or what other
institutional investors might we be talking about here?
Mr. Harbeck. The statute makes no distinction between a
corporate investor, a large investor, or a small investor. The
measurement is how much and, in the Madoff case, how much net
did that investor put in.
Mr. Carney. So is it the case that the institutional
corporate investors put in more money than the retail
investors? Is that part of the explanation?
Mr. Harbeck. Whatever the net amount in was for any
individual, whether it is a corporation, a hedge fund, or
anything else.
Mr. Carney. So it would be your view that in fact SIPC is
not treating institutional investors any differently than
retail investors in terms of the methodology that you are
using.
Mr. Harbeck. The methodology is the same for all.
Mr. Carney. So should we look at that methodology if the
effect is to maybe, this is my word, favor institutional
investors over retail investors? Or is there something in the
methodology that gives preference to institutional investors?
Mr. Harbeck. It gives no preference to institutional
investors. It gives preference, on a pro rata basis, to a
larger contributor to the fund.
Mr. Carney. Which at some level is fair, right?
Mr. Harbeck. Especially when you consider that the
institutional investor, whether it is a hedge fund which has
partners, or whether it is a pension fund which has pension
participants, if that institutional investor is an innocent
institutional investor, it will get a proportional share.
One thing that I take strenuous exception to is the fact
that any institution that should have known about this or is
alleged to have known about this has not shared, nor will it.
Mr. Carney. Quickly, Mr. Stein, you are jumping out of your
chair to get a point in here. Please feel free. My time is
running out, but go ahead.
Mr. Stein. I get back to the words that Mr. Garrett stated
initially when he was referring to the opening comments that
President Nixon made. This legislation and the statute was
intended--its very purpose was to protect the small investor. I
don't know how many times that point has to be reiterated for
it to sink in to SIPC's conceptual thinking. But that is the
essential point. It is understood that professional investors
and institutions have the resources and the recourse to be able
to protect themselves and their investors.
Mr. Carney. Fair enough. So should the methodology then
slant towards the retail investor?
Mr. Stein. I think it is a legitimate question to pose
going forward. But I interpreting the law as it is written now,
I think first of all it is from a public policy point of view,
it is essentially we protect the smaller investor and the
middle-class investor, as it was intended in the law.
Mr. Carney. That makes a lot of sense to me. There is
something to be said for that. But does the kind of the
fundamental part of the bill going from a calculation of actual
net investment to last statement method, does that do that?
Mr. Stein. Actually, the bill that Congressman Garrett has
written gives the trustee the ability to determine what is in
the best interests when it comes to the recovery of customer
property, that second pool of money that Congressman Perlmutter
was referring to. So those moneys that are recovered--we are
talking about everybody getting their $500,000--the pool of
money that is recovered, the trustee now has the ability to
look to the SIPA legislation and say, what is the most
equitable way to distribute this money? Do we give most of it
to the small investor? Do we give most of it to the large
investor? How are we going to split it?
Mr. Carney. That seems to me to be a fundamental question.
My time has run out. I may have additional time at some
point. But I appreciate everybody coming in. Again, thank you
to the chairman and the ranking member for your tenacity on
this issue.
Chairman Garrett. Thank you. And we are going to stay for 5
more minutes and then go to vote, or 10 more minutes, to go a
second round, without objection.
So, Mr. Hammerman and Mr. Harbeck, you have heard the
testimony or the statements by Ms. Shean and Mr. Friedman as to
how Mr. Shean invested and how Mr. Friedman invested. Can you
tell the committee, and I guess all the American public who is
watching them as just regular investors going forward, can you
tell us what exactly did they do as regular investors that was
wrong in their process of making their investments?
Mr. Harbeck. Chairman Garrett, these victims did nothing
wrong, nor has anyone ever said that they did.
Chairman Garrett. Okay.
Mr. Hammerman, as far as the clients or the institutions in
your association, would you say on their behalf that either one
of them did something wrong as far as their selection?
Mr. Friedman told how he went out and knew about it,
actually went to the company and went through it, which is sort
of amazing. That, to me, is due diligence. Do you think they
did anything wrong?
Mr. Hammerman. Absolutely not, Mr. Chairman. These are
victims of terrible financial crimes.
Chairman Garrett. So if America is watching right now, and
they put themselves in the shoes of Ms. Shean and Mr. Friedman,
and that those two people did absolutely everything right, and
looking, they went in and they saw the SIPC logo there, Mr.
Harbeck, and they saw that there was a guarantee that SIPC
would protect them, and now America realizes there is no
protection, as you were saying before, both of you were saying
before, for fraud or these Ponzi schemes, what is the answer
then for other Americans?
Mr. Hammerman, should there be an addendum, or Mr. Harbeck,
should there be an addendum on the SIPC logo that when they go
into Mr. Hammerman's, any of the firms in his association,
should there be a bold statement saying that you are protected
by SIPC; however, if there is fraud by this firm or if there is
a Ponzi scheme by this firm, you will not be protected? I am
willing to do that. Are you?
Mr. Harbeck. Chairman Garrett, SIPC has given $800
million--
Chairman Garrett. Answer the question.
Mr. Harbeck. I am. $800 million to the victims of a Ponzi
scheme.
Chairman Garrett. But you are not to this one.
Mr. Harbeck. Yes, sir, $800 million.
Chairman Garrett. Not to Ms. Shean, you haven't. Not to Mr.
Friedman, you haven't.
Mr. Harbeck. No. We have not started a liquidation
proceeding for Stanford because the courts have upheld the
position that it is inappropriate to start such a case.
Chairman Garrett. Ms. Kogutt?
Ms. Kogutt. That is under appeal right now with the D.C.
Circuit Court.
Chairman Garrett. So, in the Madoff situation, then, are
you willing to say that if they had invested in Madoff, as
opposed to in Mr. Stanford's case, you are saying in this case,
you are willing now to have SIPC advances being made so that
they can be guaranteed that those payments will be made?
Mr. Harbeck. SIPC advanced $800 million to the victims of
the Madoff Ponzi scheme.
Chairman Garrett. In the case where they are in similar
situations, where they have withdrawn more than they have
invested in the fund?
Mr. Harbeck. If you wish to put an addendum saying SIPC
does not permit the payment of fraudulent, fictional profits,
we would be in agreement. Because the courts have
consistently--
Chairman Garrett. How about this situation, then? Say I put
$1,000 into one of Mr. Hammerman's firms or clients a few years
ago, and I have been taking out, like Mr. Friedman says, I took
out enough just to pay my taxes, I took out just to pay my
medical bills and so on. So after so many years, I have taken
out my $1,000. But my statement says I still have a thousand or
more, right? Under your understanding, how much would I get
from advances?
Mr. Harbeck. If the entire--if the entire scheme is a Ponzi
scheme--
Chairman Garrett. Right.
Mr. Harbeck. --then the answer is--
Chairman Garrett. Zero, right?
Mr. Harbeck. The answer is zero. And the reason the answer
is zero, sir, is because it would take money away from people
who did not get their own money.
Chairman Garrett. Wait. The time is mine. So what you are
advising to do, what I have to do and what they should do in
the future, everyone watching this should do in the future, is
when you go to a broker-dealer and you make an investment, you
should keep track every day that you take money out of that
broker-dealer--every day you take out money to make a tax
payment, every day you take your money out to make a payment
for your insurance or your health care--keep track so that you
say, as soon as I get to that limit, in my case my
hypothetical, I took out my $1,000 original investment, you are
telling me at that point my coverage with SIPC ended, so you
know what I would do as a prudent investor? I would close my
account with that dealer, and I would walk across the street to
another dealer, and at that point, it resets. Is that true that
it would reset when I walk across the street?
Mr. Harbeck. I think what you--
Chairman Garrett. Answer that question, please. Would it
reset?
Mr. Harbeck. I am trying to answer it, sir.
Chairman Garrett. Yes or no?
Mr. Harbeck. The answer to your question is that if you did
that, you would be protected. But it is not necessary. And it
is not necessary because--
Chairman Garrett. Tell me how else I would be protected for
that thousand dollars.
Mr. Harbeck. The answer is, in the history of SIPC--
Chairman Garrett. No, tell me how I should be protected.
Mr. Harbeck. You should be protected by the regulatory
system, you should be protected by the auditors of the firm.
Chairman Garrett. Okay. So you have been there for 38
years. You know you are not protected that way. So how am I
going to be protected?
Mr. Harbeck. I believe that one of the things that has come
out of the financial crisis is heightened review by the PCAOB
of auditors of--
Chairman Garrett. So, we don't need SIPC any more because
my protection is not from SIPC at that point; it is from the
SEC and the other agencies. Is that what you are telling me?
Mr. Harbeck. Certainly, that is the first line of defense
against fraud, yes.
Chairman Garrett. That is. But I thought SIPC was my second
line, my final line. You are telling me SIPC is not going to be
there for me.
I think that is one of the takeaways from today is that
first, you are willing to change the SIPC logo to say that
there is a caveat and that your members will now have a caveat
or statement, and that should be indicated to them on a regular
basis--I think that is significant that we are going to have to
do that. And second, your takeaway is that to be a prudent
investor, as Ms. Shean and Mr. Friedman should be going
forward, is that you should roll your money every so often from
one broker-dealer to another broker-dealer as soon as you have
come to that capstone, because my only reliance is on the
regulators, and we know how good regulators are, and we know,
you have just stated, that SIPC will not be there to protect
me. I think that is a significant takeaway from this hearing.
Ms. Kogutt?
Ms. Kogutt. That is assuming that the Ponzi scheme has gone
on long enough for all of the investors to have withdrawn
anything. In my case, we invested 9 months before the collapse
of the Stanford Ponzi scheme.
But I want to point out that SIPC's Web site right now says
that SIPC helps individuals whose money, stocks, and other
securities are stolen by a broker-dealer or put at risk when a
broker fails for other reasons.
But Mr. Harbeck has said SIPC doesn't cover fraud. How do
you steal a customer's funds without defrauding them? Isn't
that burglary? There has to be some level of fraud to steal
money.
Chairman Garrett. Yes. This issue is so frustrating on so
many levels.
Mr. Harbeck, you indicated you have been there for 37
years. Can you tell me, prior to this collapse, what was the
insurance rate that you charged the member firms during that
period of time?
Mr. Harbeck. It has varied dramatically over that 38-year
period.
Chairman Garrett. Okay. Just prior to the crisis in--
Mr. Harbeck. Just prior to the crisis, when we had $1.6
billion, we felt that was enough. And there was a token
assessment of $150 per firm.
Chairman Garrett. $150.
Ms. Kogutt. Stanford paid $1,750 for their protection for
their--
Chairman Garrett. So Goldman Sachs in New York, what were
they paying?
Mr. Harbeck. At the time, they were paying $150 a year.
Once we turned the assessment spigot back on, they paid tens of
millions of dollars.
Chairman Garrett. Right. Just coincidentally, I am in the
market right now to buy a used truck. It costs $1,500. So I
called up the insurance agent last night and said, how much
does it cost me to insure this truck that I bought for $1,500?
They said, it is going to cost you $1,000 a year to insure that
truck. If I have homeowners' insurance, it is going to cost me
about $1,000 on my house. If you go to a Sears and you go and
you buy a large TV or something like that, when you leave, they
try to sell you one of these insurance policies, which will
cost you $200 or $300. Goldman Sachs was paying $150 for
basically--for coverage. That doesn't seem irresponsible to
you?
Mr. Harbeck. I will refer to my written statement, where I
have gone through SIPC's financial condition, Chairman Garrett.
And we are currently in a stronger position than we were in
2008.
Chairman Garrett. Right. But you were not in a strong
enough position in 2008 not to have to make these draconian,
what appears to be draconian increases, sudden increases, which
I can understand completely when I meet with Mr. Hammerman,
some of your smaller members, and they are saying, hey, I
budgeted, or I planned, and this is my operating budget, my
budget for this much. And all of a sudden, wham, I am going to
be hit this much. I can understand that. If your guys--I am
sorry, if your members had known back in 1980, it was this
much; in 1990, it was this much; and in 2000, it is this much,
as a business owner, you could probably have planned for that
and made for appropriate adjustments in your operation, and I
can understand that completely. But to go from next to nothing,
less than it costs to buy insurance on a TV at Sears, to go to
what some of your members, Mr. Hammerman, are going to right
now, you can tell us, is this significant to them, the changes?
The increases that some of your members are going to have to--
Mr. Hammerman. It sounds like, from Mr. Harbeck's
testimony, that it is multiples of millions of dollars.
Chairman Garrett. Right. And I can understand that is
probably unconscionable to your members' situation, and that
they just can't adapt to it.
That is why, Mr. Harbeck, when you say you have been there
for years and you have seen this ramping up to this, and the
preparation wasn't made, it goes back to my opening questions.
What did they do wrong? Nothing. What did the regulators do
wrong? A lot. What did SIPC do wrong? Apparently not a
significant amount with regard to preparing the fund and being
in preparation for cases like this.
Ms. Shean?
Ms. Shean. Nothing.
Chairman Garrett. The committee will stand in recess. Mr.
Stein, do you--
Mr. Stein. Yes, Chairman Garrett, I just wanted to thank
you very much. I think you have hit a lot of the key points. I
think there are two things that I would just ask for
consideration here.
I think we are finally getting a chance to shine a light on
the culture of SIPC. I think it has been largely opaque for
probably the 38 years that Mr. Harbeck has been there. I think
the transparency is essential. I think we are getting to see
some of the warts, but I think we need to dig deeper. I think
we need to truly see whether SIPC is in fact even worthwhile.
Is bad insurance better than no insurance at all?
The second point, more of an overarching issue, is getting
back to what the concept was in setting up basic issues of
certainty for the banking industry and the financial services
industry, and that means that when people see a bank deposit
statement or a bank statement or an investment statement, there
has to be a certain level of certainty in order for those
markets to operate with the kind of confidence and trust that
allows this economy to prosper.
Once we start chipping away and nuancing at those very,
very fundamental assumptions, we are threatening great damage
to our financial and banking systems.
If we applied the same characteristics that Mr. Harbeck and
Mr. Hammerman have just been speaking about to the banking
industry, to bank statements, to bank depositors, imagine the
horrific result that would take place.
I have to encourage the committee to consider, again, in
all these decisions what the impacts are going to be to the
financial industry and the importance of creating certainty and
confidence in the markets, particularly now after what we have
gone through collectively in this country.
Chairman Garrett. Thank you.
Without objection, and it doesn't look like I am going to
have any objections, I am going to put into the record: a
statement from the Financial Services Institute; the GAO report
of 1992; and an email of May 21, 2009, from Mr. Harbeck
relative to the matters that we somewhat touched upon during
the course of this hearing.
We are in votes, and I know that the other Members will be
leaving town. So I want to take this opportunity to thank each
and every one of the witnesses who have come here today. I
appreciate your concern for this issue, and I very much
appreciate the testimony. We look forward to any input that any
of you have on suggestions as we move forward on this
legislation.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
And with that, this hearing is adjourned.
[Whereupon, at 11:24 a.m., the hearing was adjourned.]
A P P E N D I X
November 21, 2013
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