On seekingalpha.com's comments board, I've written that Madoff's investors ought to get their original investment back from the SIPC, but nothing more. My assumption was that the SIPC is funded exclusively by member banks and brokerages, i.e.
not the taxpayer. I was wrong.
Most writers praised my earlier
article, but a few detractors kept focusing on the SIPC coverage. I got curious about the SIPC and did a little bit of research. Guess what? At the end of the day, the SIPC is funded by American taxpayers. In fact, Congress changed the law in June 2009, increasing the SIPC's borrowing limits and enabling the government to print money to give to the SIPC. No wonder the pro-Madoff-investor camp kept focusing on the SIPC--as long as the SIPC received taxpayer-backed funding, Madoff's investors would get paid. I naively thought that only private sector financial institutions were contributing to the SIPC fund. Again, I was wrong.
Much of what you will read below is technical. I did not spend more than half an hour researching the law, but I was able to ascertain a lot of information. It is shocking to me that the
NY Times or some other major newspaper did not blow the cover off this scheme in early June 2009, when Congress changed the law. For example, I cannot find anything online about what interest rate the Secretary of the Treasury is charging SIPC members. That number is key. If the interest rate is reasonably high, American taxpayers may make money. But if it's low, then American taxpayers have basically given Madoff's investors free money. With interest rates already low, a below-market-interest loan is tantamount to American taxpayers acting as financial guarantors for Madoff's risky investment schemes and the investors who voluntarily chose a risky investment.
First, let's cast aside the idea that Madoff's investors are going to be destitute. From the
WSJ (Jay Miller, 07/02/09):
A total of $2.97 billion in claims has been allowed, including $2.74 billion that exceed the statutory limit of protection.$231 million has been set aside for claims from victims of the Ponzi scheme, with another $2.74 billion authorized for potential recoveries.
Yes, Madoff's investors will divvy up almost $3
billion. If anyone starts talking about how Madoff's investors were poor widows, give them a three word response--three billion dollars--and a link to this article.
Now let's discuss the
SIPC. The SIPC is basically a government-backed institution similar to the FDIC. Like Fannie Mae and Freddie Mac, the SIPC is not technically a government entity, but operates in a murky zone that's not quite "private entity" and not quite "government agency." (For the lawyers out there, the SIPC is codified in Title 15 USC Sections 78aaa. The
SIPC fund is codified in Title 15 USC 78ddd.)
Below is a good summary of the SIPC, from
SEC v. GUARANTY BOND AND SECURITIES CORP, 496 F.2d 145 (1974):
The Securities Investor Protection Act was enacted in response to the need to protect the customers of securities brokers and dealers which might fail, thereby jeopardizing the cash and securities that customers had left on deposit with the firm. S.I.P.A. accordingly created the Securities Investor Protection Corporation as a 'non-profit corporation,' not designed to 'be an agency or establishment of the United States Government,' but rather to be 'a membership corporation,' consistent with the self-regulatory nature of the securities industry. 15 U.S.C. 78ccc(a). The S.I.P.C.'s role is primarily one of consultation and cooperation with the self-regulatory organizations which remain subject to the federal securities laws and the rules of the S.E.C. By mandating membership in the S.I.P.C. for certain members of the securities industry and by granting the S.I.P.C. general assessment authority over the members in order to establish an S.I.P.C. fund, Congress accomplished its intention that the cost of providing protection to customers under S.I.P.C. was to be borne by the securities industry itself.But look at footnote 3:
S.I.P.C.'s first responsibility under the Act was to establish a fund which would consist of all amounts received by S.I.P.C. and from which all expenditures would be paid. 15 U.S.C. Sec. 78ddd(c). It the fund should become insufficient for the purposes of the Act, the S.E.C. is authorized, if necessary for the protection of the customers of brokers and dealers and for the maintenance of confidence in the United States securities markets, to issue notes under certain conditions to the Secretary of the Treasury in an amount up to one billion dollars, which then may be lent to S.I.P.C. 15 U.S.C. 78ddd(g). [emphasis added]Now take a look at
this bill, H. R. 2798, passed in June 2009:
(b) Increasing SIPC line of credit with the Department of Treasury.'Section 4(h) of the Securities Investor Protection Act (15 U.S.C. 78ddd(h)) is amended by
striking out ?$1,000,000,000? and inserting ?the lesser of $2,500,000,000 or the target amount of the SIPC Fund specified in the bylaws of SIPC?.
Congress just more than doubled the one billion dollars limit to make sure Madoff's investors would be paid. But that's not all. Congress even increased the amount of money that Madoff's investors could get directly paid, from $250,000 to a whopping $850,000:
(d) Eligibility for direct payment procedure.'Section 10(a)(4) of the Securities Investor Protection Act (15 U.S.C. 78fff?4(a)(4)) is
amended by striking out ?$250,000? and inserting ?$850,000?.
Now, who funds all this protection? Well, that's where it gets confusing. A federal
court's website states:
The fund is supported by assessments upon its members. If the fund should become inadequate, the SIPA authorizes borrowing against the U.S. Treasury. An analogy could be made to the role of the Federal Deposit Insurance Corporation in the banking industry.Now look at 15 USC §78ddd(g) and (h):
In the event that the fund is or may reasonably appear to be insufficient for the purposes of this chapter, the Commission is authorized to make loans to SIPC...The Secretary of the Treasury may reduce the interest rate if he determines such reduction to be in the national interest.See those words? Secretary of the Treasury? That means the Treasury, which manages government revenue--otherwise known as taxes. Have you figured it out yet? Yup, it's the taxpayers who are paying off Madoff's investors, because the SIPC didn't have enough money in the till to make the investors whole. Congress just printed money to save Madoff's investors.
I really, really want to know what the interest rate is on these taxpayer-backed loans. (Where's the
NY Times when you need them?) What's really funny/tragic is that the SIPC's members include banks, which are already receiving billions of dollars of taxpayer money. Our government has printed money--to be paid by our children and their children--to give to banks, the SIPC, and Madoff's investors. You might argue it's not a giveaway, it's a loan, but I?m not budging until I see the interest rate charged.
I can't believe I didn't see this before. I?m not a securities attorney, so I hadn't looked at the specific code sections to see how SIPC was funded. (Where are all the articles from securities and tax lawyers? Perhaps they?re too busy making money for Madoff's investors to do anything for the public interest.)
The way I see it, the American taxpayer has gotten screwed (again), and the rich seem to have a direct line to Congressional lawmakers. No wonder
China unofficially wants a modified reserve currency?our government keeps printing money without rhyme or reason. America's financial credibility is eroding. This will end badly unless fiscal discipline makes a comeback.
