The brokerage industry may have to pony up as much as $1 billion to replenish the Securities Investor Protection Corp. fund, should SIPC's liquidation of Bernard L. Madoff Investment Securities LLC of New York deplete its reserves.
The issue of assessments is certain to be discussed when SIPC's board meets later this week or early next week, said Stephen Harbeck, president of the Washington-based non-profit organization, which is funded by member broker-dealers.
"I am certain that the board will be reviewing that process," he said, referring to firm assessments.
Since assessments are based on a complicated formula, Mr. Harbeck said that until the board meets he could not estimate how much they would have to be raised to replenish the SIPC fund.
But providing some measure of relief to investors caught in the $50 billion Ponzi scheme alleged to have been perpetrated by the Madoff firm will be costly. SIPC has mailed letters to about 8,000 former Madoff clients inviting them to apply for aid from SIPC. Should all those requests result in maximum claims, which is unlikely, the SIPC fund could be tapped for $4 billion, assuming each customer receives the SIPC limit of $500,000 for losses from missing securities.
It seems evident that Madoff-related claims will exceed the $322.5 million total of SIPC advances from 1971 to 2007.
SIPC currently has about $1.6 billion in its fund, and can draw on a $1 billion line of credit from the Department of the Treasury, as well as a $1 billion line of credit with an international consortium of banks.
Because its fund seemed adequate until the recent market decline and the Madoff scandal, SIPC has assessed brokerage firms a nominal $150 a year since 1996. In 1995, it charged member brokerage firms 0.095% of their net operating revenue.
[More: SIPC raises assessment fees on brokerage firms]
"In a pre-Madoff world, when we thought only small guys were crooked, you could look at SIPC's reserves and say it should be enough," said Rep. Brad Sherman, D-Calif., a member of the House Financial Services Committee who questioned Mr. Harbeck about the adequacy of SIPC's reserves at a hearing on the Madoff case Jan. 5.
"But what Madoff has done is show us that big guys can be crooks and crooks can be big guys," Mr. Sherman said. "I don't think anybody would believe that SIPC is adequately capitalized now, even with the $1 billion line of credit from the public sector."
Mr. Sherman predicted that SIPC would have trouble getting its private lines of credit renewed in coming months.
"Madoff itself will cost SIPC at least two-thirds of its net worth. You have Bernie, plus you have a much-heightened sense that there may be another Bernie out there," he said.
Because no one is certain what precisely is in the accounts of Madoff's customers, investors may discover that their claims produce very little.
"People think they have stocks in their account," said Seth Lipner, a plaintiff's attorney and member of Deutsch & Lipner in Garden City, N.Y., and a law professor at City University of New York. "The first thing that SIPC is going to do is erase all the stocks, because there are no stocks," said Mr. Lipner, a founder of the Public Interest Arbitration Bar Association, based in Norman, Okla., who has litigated unsuccessfully against SIPC in prior brokerage-firm bankruptcy cases in attempts to get SIPC to reimburse his clients.
"That leaves you with a claim for cash," which SIPC reimburses at a rate of only $100,000 per account, said Mr. Lipner, who added he had been contacted by "dozens of people" who invested with Madoff and lost money.
Even at the $100,000 level, claims by 8,000 Madoff customers could cost SIPC $800 million.
SIPC does insure against theft, however, and many Madoff clients obviously consider themselves the victims of a theft.
Mr. Lipner and other plaintiff's attorneys have faulted SIPC in the past for interpreting claims too narrowly to be helpful to investors. Timothy Dennin, an attorney in Northport, N.Y., forced SIPC to make payments to his clients after he sued over claims involving the former Stratton Oakmont Inc. brokerage firm of Lake Success, N.Y., which was shut down in the late 1990s for defrauding customers in "pump and dump" schemes.
SIPC initially took the position that the losses were not covered under its charter because the brokerage firm did not actually steal the money, but rather made unauthorized trades, Mr. Dennin said.
"We got an order from the bankruptcy court in Manhattan that accepted our arguments," he said. After that, "they covered the claims."
E-mail Sara Hansard at shansard@investmentnews.com.
