By Duff McDonald
September 22, 2010

The investment industry is still paying dearly for Bernie Madoff’s crimes, and if SIPC is to be believed, there may be no end in sight.

Last week, an editor sent me out on what I thought was a fool’s errand—a story that might engender sympathy for a Wall Streeter. The surprise answer: he was right.

The CEO of a relatively small broker-dealer had run into said editor and mentioned how angry he was at the fact that a fee he paid every year had suddenly risen from $150 to something more than six figures. You’d be pissed too, right? We were hooked.

A deeper dig, though, gave me pause. Our man was talking about the SIPC Fund — brought into being by the Securities Investor Protection Corporation created by Congress in 1970 to protect people from the likes of…Bernie Madoff. It was an industry-funded vehicle, and originally set at $75 million, meant to protect investors from broker-dealer failure and thereby engender confidence in our securities markets. (Those were the days. Today, that amount sounds a little Mike Myers as Dr. Evil. $75 million!) Much like FDIC insurance covers $250,000 of an individual’s bank account, SIPC covers $500,000 of an investor’s securities account, although only $100,000 in cash.

For years — from 1996 to 2007, remarkably — the fund, which the board had seen fit to build to $1 billion in the 1980s, hadn’t been depleted, and therefore required an annual contribution of a mere $150 from any and all broker-dealers. Then came Madoff and the failure of Lehman Brothers, and the fund was running on empty. (The details and mechanisms are complicated, but SIPC advanced more than $633 million to Madoff victims. Estimates for Lehman suggest SIPC will ultimately be on the hook for $1.6 billion.)

Congress originally gave SIPC the right to make an assessment of up to .125% of net operating revenues of every single broker dealer in any given year—that limit has since been raised to 0.25%. So that’s what they did in April 2009, for the first time in thirteen years. And this is where our friend got tagged. He was successful enough that his fee was now “hundreds of thousands” of dollars.

Short on answers

What this money manager wanted to know, and what he asked regulators, was whether this was a one-time assessment or whether he has just encountered a new line item that would measure six-figures annually from here on in. SIPC refused to answer, so we tried to get an answer for him. “How big is the fund going to be?” we asked SIPC in an email.

The following response came back from Stephen Harbeck, president and CEO of SIPC: “The goal [is] to have assets of $5 billion available, and since the previous SIPC Fund target of $1 billion was equal to the Treasury credit line, the same concept was simply carried forward with the higher dollar amounts.”

Just because I’m that type of guy, I asked for clarification. I wondered whether the assessments would then drop back down to $150 once the target was hit. Harbeck’s answer was noncommittal: “The assessments will continue until the SIPC Fund reaches its new, higher target of $2.5 billion. At that time SIPC will reassess the need for continued assessments.  The new target matches the newly increased Treasury line of credit.”

“Reassess the need for continued assessments?” Sounded like a non-answer to me. I asked once again. What did “reassess” mean?

“SIPC will review the adequacy of the Fund when the $2.5 billion target is reached, and then make a decision.”

It was time to get on the phone. Harbeck refused to apologize for the vagueness of his responses,  explaining to me that the appropriate size of the fund was a moving target and the constant question on the minds of board members. Once the $2.5 billion is raised, he said, it’s quite possible that a new study will conclude that SIPC should grow the fund even more, requiring it to continue with meaningful (i.e., not $150) assessments. “That’s the only thing I can say,” he said. “Once we get to $2.5 billion, that should focus attention on whether we need even more resources than that.”

Sure, this is a bailout fund, so it’s hard to conjure too much outrage on behalf of those funding it. But the goalposts do seem remarkably mobile.

Our friend is thus left to plan for the possibility of continued six-figure assessments until he is informed otherwise. He considers the imprecision of SIPC just another in an ever-lengthening list of government overreach. Apparently he’s got company; receivables for the fund at the end of 2009 stood at $211 million.

The political winds do not favor a sympathetic view of the financial services industry these days. But on this small point, we find we are in agreement with our friend. Of course, fraud is an uncertain thing. But a fund to protect against it need not be quite so uncertain itself.

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