03/18/2010 05:12 am ET Updated May 25, 2011

SIPC, The Grinch That Grotesquely Stole Christmas

You have probably seen the Television ad. A young girl is given a bicycle set in a white painted rectangle that's, say, 8 by 4 feet. Delighted the young girl happily sits on the bicycle and starts to ride. Barely getting started she is stopped at the white line. "That's as far as you can ride" scolds an austere gentleman who we are given to understand is a banker. Stunned the young girl gazes at him, befuddled and sad. "Didn't you read the fine print?" he sternly asks, "It says you can only ride the bicycle in a predetermined space." Welcome to the world of the Securities Investor Protection Corporation (SIPC). Protection?

The Madoff calamity touched thousands of individuals and families, many of whom lost what amounted to their life savings. Many had gone to bed one night last December ensured that their financial future was secure only to wake up the next day to find their lives devastated and their savings worthless. Many were now without even the means to pay their monthly bills and many, given their ages, had no hope of ever finding a job again.

Confronted with disaster, all the Madoff account holders believed that with the SIPC seal prominently displayed on their brokerage statements -- the seal of an organization created by an act of Congress -- would protect them at least up to the $500,000 SIPC was authorized to pay out. Whether they were generally aware or not, SIPC, in its literature, such as its information brochure, brayed about its insurance coverage; "SIPC replaces missing stocks and other securities...", while the Financial Industry Regulatory Agency, Inc (FINRA) would point out in its literature; "SIPC's coverage also includes protection against unauthorized trading in customers securities accounts". With input like this even a highly sophisticated investor would have found comfort with the SIPC seal that appeared on their Madoff brokerage statement.

And yet, perversely and after the fact, SIPC sniffed out a legal loophole that imperiled probably the most vulnerable, longest standing and probably the oldest of the Madoff victims. They adopted a bizarre method of determining claims, namely the 'cash in cash out method' which repays customers the money they invested minus the cash they withdrew from their account, and thereby seeks where possible, to squelch their maximum $500,000 obligation. It makes as much sense as if the the Federal Deposit Insurance Corporation (FDIC) would deny paying out the bank statement balance of an interest bearing account of one of its failed banks because the customer withdrew more funds from his account than he deposited into the account over the years the account was active.

Instead of finding a solution that would uphold their moral and legal obligation and return credence to SIPC and what was once thought to be bankable government guarantees, it was with brazen callousness that SIPC's deputy solicitor would dismiss the last hope of thousands of claimants: "The claims of the Madoff investors cannot be valued based on the balance shown on their account statements". Possibly that would be true in some measure in bankruptcy court, but SIPC was specifically created to deal with the issues of failure and fraud, with a $500,000 account limit, and if that was the amount lost by the customer then that was the amount SIPC was expected to make good. All sums above that figure would be between the account holder and the bankruptcy court.

Testimony before the House Financial Services Committee on December 9th bore out the terrible straits of the victims and the callousness of SIPC . "The money I invested with Madoff represented 30 years of my life savings," Jeannene Langford from San Rafael, California told the committee, "this was my retirement, a down payment for a house, investment for the business I was starting and it was money for my daughter's education. I do not have thirty years to earn this money again."

According to some, SIPC's hard line is conditioned in part by a perception that it is grossly underfunded, having access to only limited funds and an inherent caution that paying out troublesome claims may not leave enough funding for future claimants. In testimony before December 9, 2009 before the U.S. House of Representatives, Subcommittee on Capital Markets, Insurance, Government Sponsored Enterprises, Committee on Financial Services, Stephen P. Harbeck, President and C.E.O. of SIPC, testified that the balance of the SIPC fund was $1,188,000,000 (note: less than 10% of the Goldman Sachs 2009 bonus pool exceeding $20 billion). He also advised that SIPC "may borrow $1 billion line of credit from the United States Treasury." He then went on to proclaim proudly, "In its nearly forty year history, SIPC has never drawn upon the credit line". In doing so Mr. Harbeck clearly revealed he is not the man for the job. Instead of doing his utmost to calm the turbulent waters caused by the greatest economic crisis since the Great Depression, at a time of massive claims occasioned by the Madoff, Lehman, Stanford bankruptcies and myriad others, he is busy pinching pennies.

And where is our Treasury, so eager to bail out or make whole the likes of Citigroup, AIG, Morgan Stanley, Goldman Sachs and on, with billions upon billions of cash loans, infusions and guarantees of otherwise toxic loans and derivatives? And what would the prospects have been if, as a condition of the billions going to the banking and Wall Street crowd, they would have been persuaded or coerced to use some of their bumper profits to come, to significantly increase their fees to SIPC so it could substantially increase its lines of credit and conduct itself in a way that would be of real assistance to those victims of financial mismanagement and fraud, and to regain for itself the respect and confidence of the nation's stockholders? In the meantime Mr. Harbeck better watch out, that little girl may indeed be riding off on that bicycle.