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When brokers go bust
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July 10, 1998: 12:33 p.m. ET
SIPC, the stock market's answer to the FDIC, protects you -- sometimes
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NEW YORK (CNNfn) -- James Pipoly admits he was suckered once by the cold-calling broker with "a real exciting tone in his voice."
The 47-year-old novice investor said he felt duped again when that same broker suddenly went belly-up, without the slightest heads up.
It was as if, in one fell swoop, someone had snatched away his pride -- and his $70,000-plus portfolio.
"And the worst part," he added, recalling his stunned reaction at the time, "is that there isn't a damn thing you can do about it."
Except there was. And the Securities Investors Protection Corp. (SIPC) did it.
The what?
Pipoly, a Youngstown, Ohio, businessman, wondered the same thing on the day in November 1997 when a bankruptcy trustee appointed by the SIPC phoned him out of the blue with the sobering news that a bankruptcy court had declared his onetime broker legally insolvent.
Striking a solicitous note, the caller told Pipoly not to fret, the SIPC had a salvage crew at the ready. All he needed to do was fill out a claim form for his wayward stock. And wait. And hope.
"I was kind of surprised, because when I talked to my attorney, he said, 'You'll have to pay $8,000 to $10,000 (in legal fees to get the shares back),'" Pipoly said. "I never knew anything like this was available out there."
Neither do most jilted investors.
Yet the SIPC, a federally chartered non-governmental and non-profit agency, has been out there since 1971, helping customers left in the lurch by bankrupt brokers to get their cash and securities back.
Born of the 1970 Securities Investors Protection Act, the industry-sponsored SIPC functions much like the Federal Deposit Insurance Corp. (FDIC), except it bails out stockholders instead of banks.
The SIPC covers customers for a maximum of up to $500,000 each, including $100,000 in cash held in accounts for the purpose of buying securities.
The agency owes its existence to a grim Wall Street reality -- securities occasionally outlast the brokers entrusted with their safekeeping. Hence, when brokers go bust, they run the risk of bequeathing a sizable stack of blue chips to oblivion.
Unless reclaimed, these orphaned securities exist only as electronic blips, gathering virtual dust in some computer database, or, more quaintly, as dog-eared paper documents languishing in some forgotten vault.
Even an aboveboard broker can go under. Reasons for bankruptcy can range from a failure to meet standard requirements for net capital to book-entry problems or a simple computer glitch.
(Frequently Asked Questions about the SIPC)
But the SIPC isn't Santa Claus.
The corporation's protections cover customers only against losses caused by the financial failure of a broker, or by proven, unauthorized transactions.
The agency doesn't pay for claims involving fraudulent broker activities, such as trading in scam stocks, artificially inflating the value of a stock, or account "churning" (where a broker buys or sells stock without authorization, simply to get a commission).
Nor does the SIPC cover losses due to a rise or fall in a security's value.
Yet if a broker literally steals away with a customer's stock, the SIPC might buy back the pilfered shares for customers on the open market, so long as the owner can produce a record of purchase.
To prove a claim, applicants must furnish a tangible record of a stock purchase, typically a periodic statement or confirmation slip from their defunct broker.
In cases of unauthorized stock sales, a written objection from the customer to the broker may often suffice as evidence of wrongdoing on the broker's part.
Cleaning up
The SIPC does not regulate brokerages, the Securities and Exchange Commission and the National Association of Securities Dealers do.
Rather, the SIPC merely picks up the pieces when a brokerage fails, sort of like what the FDIC does when a U.S. bank fails.
Ideally, the SIPC and a court-appointed bankruptcy trustee try to find a buyer for the failed brokerage.
If successful, the SIPC transfers dormant investor accounts from the liquidated firm to the new owner, or to another firm of the customer's choosing.
More commonly, the SIPC must dip into its coffers to buy back stocks that the agency could not physically recover, or to pay for money missing from so-called "cash" accounts (money-market accounts containing funds customers planned to use for securities purchases).
Timetables for SIPC reimbursement vary widely, but most customers whose claims pass a three-stage review process see some money within one to three months of filing.
Over the decades, those payouts have added up. As of Dec. 31, 1996 -- the latest date with complete figures available -- the SIPC had paid out nearly $260 million in connection with 268 protection proceedings since the agency's inception.
Could SIPC handle a market crash?
What keeps the SIPC from going bust?
The answer -- obligatory annual dues of $150 from virtually every U.S. brokerage house.
The SIPC also has the authority to borrow $1.13 billion from the U.S. Treasury, a privilege it has never had to use.
As a last resort, the corporation can also tap a billion-dollar-plus credit line in a consortium of commercial banks.
In theory, a savings-and-loan-style rash of brokerage collapses could strain these vast resources. But that has yet to happen.
Even the market crash of 1987 left the SIPC relatively unscathed.
"We had what I am told is as large a crash (in 1987) as anything since 1929," said Steven Harbeck, the SIPC's general counsel. "Yet then, only one brokerage firm failed. It cost SIPC $100,000."
Which is not to say the SIPC is impervious to tumult.
Bankruptcy lawyers familiar with the corporation bemoan the legal dithering and bureaucratic snags that can delay claim resolutions.
Harried SIPC officials retort they do their best, given a barebones staff of 29, the tangle of thorny issues found in many claims, and the agency's limited mandate.
Stratton Oakmont's missing millions
The notorious case of Stratton Oakmont Inc. offers a window into current investor-protection law's shortcomings.
In December 1996, the NASD expelled the Long Island, N.Y., brokerage from the securities industry, citing a litany of alleged regulatory abuses involving small-time, thinly capitalized stocks.
When investigators went trawling for the firm's assets, they came up with only $100,000 in readily recoverable property.
By contrast, Stratton Oakmont's former customers have flooded the SIPC with more than 3,368 claims collectively involving up to $50 million in allegedly missing assets.
The SIPC denied many claims because the agency determined those losses stemmed from fraud.
That debacle prompted the NASD, for the first time, to form a task force to explore ways of better protecting investors in such cases.
Salvation
But for Pipoly, the sudden appearance of the SIPC claim form in his mail box offered a second stab at financial salvation.
Today, Pipoly is in the final stage of the SIPC review process, and is hopeful he'll recover most of his initial investment. But he says the whole experience has soured him on investing.
These days, Pipoly has a one-word answer for pushy brokers who phone him at home: "I tell them, 'Nope!'"
-- by staff writer Douglas Herbert
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