More On Legal & Compliancefrom The Advisor's Professional Library
- Registration Requirements for Investment Advisor Representatives (IARs) When individuals launch an advisory firm, they must avoid marketing themselves or the firm as investment advisors before they are properly approved and registered. Otherwise, they are subject to severe penalties.
- Client Communication and Miscommunication RIA policies and procedures must specify what type of communications should be retained. The safest course of action is for RIAs to retain all communicationsto clients, from clients, and about client accounts. To comply with fiduciary obligations, communications must be thorough and not mislead.
Economist Laurence Kotlikoff is calling on all Americans to close their brokerage accounts immediately because of the risk of a total wipeout — a risk he says stems from a massive Wall Street insurance scam perpetrated by the Securities Investor Protection Corp. (SIPC).
“SIPC, a brokerage ‘insurance’ arm of Wall Street, has been and remains today engaged in insurance fraud,” Kotlikoff told ThinkAdvisor in a telephone interview. “SIPC claims to insure brokerage accounts. Nothing could be farther from the truth. What it's really doing is placing all brokerage account holders at extreme risk.”
The Boston University professor, who has long been outspoken on a wide range of public policy questions, was careful to add that investors in mutual funds are likely to be safe if their fund companies place assets in the care of third-party custodians who are responsible for the safety of customer funds and do nothing but custody assets.
But the arrangement is very different in the case of brokerage accounts, nearly all of which notify their customers — fraudulently in Kotlikoff’s view — that accounts are insured up to $500,000.
The economist offers as his Exhibit A of the fraudulent nature of this insurance the fact that Wall Street firms, including such giants as Goldman Sachs with nearly a trillion dollars in assets, were, until the Madoff scandal, paying premiums totaling a mere $150 a year to SIPC. (Today SIPC members pay .0025 of net revenue from eligible products.)
“How can there be any insurance protection for brokerage accounts if they don’t have any money [to pay claims]?” Kotlikoff asks.
Congress created SIPC in 1970 legislation to protect investors in the event of a brokerage failure and thereby increase their confidence, but the Wall Street firms who make up its membership prefer to hold onto their cash rather than reserve funds sufficient to pay large claims to investors.
But the real crime, says Kotlikoff, is a process by which Wall Street firms criminalize innocent brokerage account holders by essentially making them pay for any criminal misconduct — not once, but twice.
“If your broker, or the broker at the next desk, engages in fraud that shuts down the firm,” Kotlikoff explains, you’ve not only lost your hard-earned assets, but SIPC will put its army of paid-by-the-hour lawyers to recover other customer losses from you.
By declaring the fraud a Ponzi scheme, the organization can claw back any funds from account holders who withdrew money from their accounts in the past two years (or six, under some circumstances), under the theory that the account holders knew something was amiss and reacted by withdrawing their wealth.
Adding further insult to injury, countervailing evidence that the account holder had no knowledge, and may have even added funds to the account during the same period of time, is not considered.
And worse, Kotlikoff says that innocent account holders are legally obligated to withdraw funds from retirement accounts on reaching age 70 ½.
Kotlikoff illustrates the problem thusly: Say a 40-something investor—you—put $200,000 into a SIPC-insured retirement account decades ago, which grows to $2 million. Also suppose you withdraw $1 million in your late 60s and early 70s and spend the money to help defray your parents’ nursing home costs, live off the funds, give to charity, or help pay grandchildren’s college costs.
Then your New York-based brokerage firm goes bust because of fraud within the firm. Not only have you lost your remaining $1 million in life savings, but SIPC will regard you as a “net winner” (you put in just $200,000 and took out $1 million based on decades of what you thought were legitimate market gains) and will sic its lawyers on you to claw back every penny you withdrew over the prior 6 years (i.e., $1 million, but limited to the $800,000 difference between your past withdrawals and contributions over the entire life of your account).
The significance of being a net winner, Kotlikoff says, is that SIPC rules will then make you ineligible to recover $500,000 of the supposed insurance on the account but will rather go after you to make whole those customers who are net losers.
Rather than the firms insuring accounts, SIPC will protect its members from having to pay out losses and will hire expensive lawyers with an incentive and the legal cover (thanks to an economically ignorant 2nd Circuit decision, he says) to go after winning accounts, under the theory that the case was a Ponzi scheme and some accounts benefited.
“But there’s no clear economic definition of a Ponzi scheme,” says Kotlikoff, who cites reports that such schemes are uncovered on average every four days, thus making it easy to call any broker-dealer fraud a Ponzi scheme that will thus protect SIPC members from having to pay.
“They’ll sue for gross withdrawals, not net — in other words, it makes no difference to them at the time you were supposedly fleeing with your money you were adding to the account,” he says.
“If you had $2 million in the account and took out $1 million — and spent it on kids, retirement and all the rest — SIPC says 'you’re a net winner and therefore do not qualify for $500,000 insurance protection; therefore we owe you nothing. You just lost a million and now we’re going to come after you for $800,000.'
“There is no inflation adjustment in any of these calculations — another travesty,” the economist adds.
The model for this arrangement is the recovery of funds in the Madoff investment scandal, says Kotlikoff, who discloses that scandal victims include both his family and friends — such as his Boston University colleague Elie Wiesel.
“[Madoff victims trustee] Irving Picard has essentially sued some victims to pay other victims and has collected millions and millions of dollars in legal fees,” Kotlikoff says.
In contrast, Kotlikoff adds, “JPMorgan was banker to Madoff for decades, was engaged in money laundering for decades, and has paid nothingto those being sued by SIPC.”
So while Wall Street is protecting itself, the Boston University professor calls it “risky for anyone to hold a brokerage account” until such time as Congress passes, and President Barack Obama signs, legislation that would strengthen SIPC investor accountability.
“Thanks to SIPC's precedent-setting, atrocious mistreatment of Madoff victims, none of us can safely invest in a U.S. brokerage account. If the brokerage account goes under because of fraud, SIPC can a) declare the fraud a Ponzi Scheme, b) renege on its obligation to cover up to $500,000 of your loses and c) sue you for every dollar you withdrew over the last 6 years,” Kotlikoff says.
The economist strongly backs legislation introduced last November by Reps. Scott Garrett, R-N.J., and Carolyn Maloney, D-N.Y.,the Restoring Main Street Investor Proectection and Confidence Act of 2013.
In a release announcing the bill, Maloney described the intent of the legislation this way:
“Markets run as much on confidence as capital, and this bill will restore investors’ confidence in the markets by modernizing the Securities Investor Protection Corp., and by protecting innocent victims of Ponzi schemes and other frauds from further clawbacks by the very government agency that is charged with protecting them.”
An inquiry to Garrett’s office by ThinkAdvisor found the bill, which was referred to the House Committee on Financial Services on Nov. 14, to be languishing, with no action taken since initial hearings held in subcommittee on Nov. 21.
Kotlikoff has taken to the Web to spread his campaign against brokerage accounts and SIPC, writing in both Forbes and PBS Newshour’s Making Sen$e about the matter.
His PBS article triggered a tete-a-tete with SIPC president and CEO Stephen Harbeck, who defends his organization’s record in recovering investor losses and sharply criticizes the proposed legislation as supposed redress that would have the effect of “legitimizing Ponzi schemes.” Kotlikoff countered that Harbeck was “shamelessly trying to deceive the public.”
Related on ThinkAdvisor: