Another Wall Street Fleece

Aug 4, 2015 by

Dollar sign on Wall Street

On Wall Street, money rules.

Do you have brokerage accounts through which you’re investing for retirement or maybe your kids’ college tuition? You probably know that the FDIC does not insure brokerage accounts. But have you noticed that brokerages are “insured,” sort of, by the Securities Investor Protection Corporation, or SIPC. If that gives you a bit of a warm feeling, please allow me douse you with a financially healthy bucket of cold water.

What’s the SIPC?

From the “Mission” page of the SIPC’s website:

SIPC oversees the liquidation of member broker-dealers that close when the broker-dealer is bankrupt or in financial trouble, and customer assets are missing. In a liquidation under the Securities Investor Protection Act, SIPC and the court-appointed Trustee work to return customers’ securities and cash as quickly as possible. Within limits, SIPC expedites the return of missing customer property by protecting each customer up to $500,000 for securities and cash (including a $250,000 limit for cash only).

That sounds good, right? Gives me that nice warm feeling about my brokerage accounts with Charles Schwab.

But—big surprise—like everything controlled by Wall Street, the SIPC’s real beneficiary is Wall Street, not you and I, the little guy and gal.

Your Brokerage Firm Goes Bankrupt Because of Fraud

Let’s say after cumulative contributions of $25,000, you’ve withdrawn $40,000 over the last two years from a brokerage account—which had grown to $60,000 because you’re such a smart investor—leaving $20,000 in the account. Maybe you’re paying retirement expenses, according to plan, or footing college tuition for kids. You’ve done, and are doing, absolutely nothing illegal or unethical; you’re just following the strategy so assiduously marketed by Wall Street.

Then you get the bad news: your brokerage account is shutting down, and fraud is alleged.

(Think brokerage business fraud is rare? Ever hear of Bernie Madoff? At the time of this writing, six open cases, including Madoff’s, are listed on the SIPC’s website.)

Your gut tightens a bit, but then you remember: “not to worry, the SIPC will make us whole, right?” Wrong!

To the SIPC, You’re a Fraudster Too

Your bubble is burst by a letter from the SIPC-appointed trustee for the case informing you that you must repay $15,000 of the $40,000 you’ve withdrawn over the past two years from your accounts with the now bankrupt brokerage. Decline to pay, and you’ll be sued.

What?!? Yep, investors must repay withdrawals made during the two years prior to fraud-induced brokerage bankruptcy, up to the amount by which their cumulative withdrawals over the life of the account exceed contributions. In my example cumulative withdrawals were $15,000 more than contributions, so $15,000 must be paid to the trustee.

If you were over 70½, that you were legally required to make withdrawals would be neither here nor there.

And what if you’d contributed $60,000 to your account and your contributions had grown by another $60,000 over many years. Then, three years ago, you withdrew $60,000 (and paid tax on those withdrawals), so you’re back to a $60,000 account balance.

Guess how much of your $60,000 account balance the SIPC would restore after your crooked brokerage goes bankrupt? Zero, nada, $0, none. By the SIPC’s unique math, you have no net equity in your account because withdrawals have equaled or exceeded cumulative contributions.

Why Not Incentivize Wall Street to Police Itself?

In the case of a pure Ponzi scheme, I can sort of understand the logic of requiring investors to return withdrawals in excess of contributions. After all, those excess withdrawals would have been paid with other investors’ contributions, not returns earned by investing contributed cash. That’s the definition of a Ponzi scheme.

But surely not all frauds are wholly Ponzi schemes. If an investor’s contributions were invested and, at least in part, earned legitimate returns which were withdrawn, why should the investor be required to repay those returns?

Further, even in the case of a Ponzi scheme, wouldn’t Wall Streeters be incentivized to police its ‘members’ if Wall Street itself, not investors, had to foot the bill for the damage done by a Ponzi scheme? I have to believe that many on Wall Street knew or strongly suspected fraud at Madoff’s firm. Why didn’t anybody blow the whistle, long and loud? Wall Street’s answer, I suspect, would be: why should we?

What Should You Do?

Bipartisan legislation changing the rules has been stalled in Congress for years. H.R. 1982: Restoring Main Street Investor Protection and Confidence Act, would prevent Wall Street from fleecing innocent investors through the SIPC, but rates the bill’s chance of being enacted at 4%. Why? Could it be because Wall Street funnels Everest-sized mountains of cash to both political parties? Ya think? Why don’t you phone your representative’s or Senators’ office and ask?

In the meantime, I recommend you make your investments directly with a mutual fund company, not through a brokerage. Move your IRA account to, for example, Vanguard, rather than buy Vanguard mutual funds through a brokerage account.

Greed Can Be Good

Wall Street is driven by one force: greed. If investors closed brokerage accounts in droves citing the farce that comprises the SIPC as the reason, things would soon change. Until then, the less faith you place in brokerages, the better.

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