By Kathy Kristof

If you own U.S. stocks, you should know that the Securities Investor Protection Corporation (SIPC) is considering revamping its rules in the wake of the two biggest quakes ever to hit the brokerage industry -- the massive Lehman Brothers collapse and Bernard L. Madoff's record-setting Ponzi scheme.

SIPC is the brokerage-industry equivalent of the Federal Deposit Insurance Corporation, with some major differences. SIPC will cover a stock investor for up to $500,000 in securities and cash (there's a $100,000 cap on the cash part) in case his or her brokerage goes bust.

If your brokerage was lying to you, as was the case with Madoff, and fabricated your investment portfolio, SIPC may pay you considerably less than you think you're due. SIPC has decided to pay Madoff investors only the money paid in, minus any received from the sham brokerage.

In fact, Madoff investors who got back more in gains than the total funds they paid in have been told they have to pay the net gain back.

Some investors are crying foul. They say the brokerage industry, which funds the SIPC, should have done a better job policing itself.

The SIPC, which has been operating under rules written in the 1970s, is accepting comments from securities professionals and the public on how it should evolve in today's dicey securities environment. Both SIPC advocates and detractors maintain that the revamp is long overdue.

"It's time to look at whether retail investors ought to be treated differently than sophisticated investors such as pensions and hedge funds," said Stephen P. Harbeck, president of the SIPC. "It's time to look at the levels of protection and the adequacy of our funding."

Securities lawyers say it may also be time to consider whether the agency needs a mandate on how to cover various types of securities fraud. Chicago securities lawyer Andrew Stoltmann, for instance, maintains that the SIPC provides "phantom protection."

"Getting money from SIPC, even in meritorious cases, is extraordinarily difficult," Stoltmann said. "They have been very cheap in paying out claims to injured investors. I think there is a major need to revamp SIPC to provide real protection."

Harbeck says the SIPC has provided 100 percent coverage to all but 351 investors from its inception through 2009. (Madoff claims are still being litigated.) But Stoltmann counters that the numbers don't include thousands of people who have lost money to malfeasance by brokers but whom the SIPC won't protect. And the insurance fund's definition of "full coverage" is also debatable.

Consider two Ponzi schemes -- the $60-billion Madoff con and the $8-billion scheme allegedly orchestrated by R. Allen Stanford of Texas. The SIPC is providing insurance payments to Madoff investors but is not promising anything to those allegedly taken by Stanford. Why?

"The investors in Stanford Financial Group are holding the certificates of deposit in a bank in Antigua in their hands," Harbeck said. "We do not protect fraudulent projections of value. We ensure that investors receive the securities that they bought, and they have them."

Investors in the Madoff scheme, on the other hand, were told that they were buying listed stocks and bonds. The fact that their brokerage statements were falsified didn't negate the SIPC coverage, Harbeck said.

"Customers got statements saying that they had a portfolio of securities. They had reason to believe that was true, so we replaced it to $500,000," Harbeck said. "The methodology we used was the most customer-friendly methodology that the law permits us to use."

Still, even Madoff investors are not thrilled with the SIPC coverage they're getting.

Why? They want the SIPC to provide payment based on their last brokerage statements. Instead, the SIPC has promised to return their principal -- that's the money they put in, minus any withdrawals they'd made -- but no investment return.

That formula has reduced SIPC claims from the $64 billion that Madoff investors thought they owned to just $20 billion that the SIPC considers to be the insured loss, Harbeck said.

Another shocker to Madoff investors is that the SIPC wants any investor who took out more than he or she paid in to return the net gains. Harbeck says the "net winners" in the Madoff scheme were essentially taking capital from the net losers. If everyone ends up at the starting point, Harbeck will consider it a 100 percent recovery. But the Madoff investors, many of whom are suing the SIPC for higher recoveries, don't agree. They want to be covered for the profit they thought was theirs.

By the same token, providing insurance coverage for falsified profits presents a troubling situation. If the SIPC insured 100 percent of a con artist's stated profits, which are based on unrealistically lofty returns, why wouldn't all investors invest with crooks -- as long as they were SIPC-insured -- to guarantee themselves a windfall?

Another issue that has advocates as the SIPC considers changes: an increase to the $500,000 limit, which was set in 1978, to adjust for inflation. And Stoltmann wants reformers to figure out how to deal with the fact that the SIPC does not cover arbitration awards left unpaid by bankrupt brokers. Shouldn't those awards be given the same insurance coverage as a cash account, given that they were usually connected to securities losses the broker caused?

Any investor who has a strong feeling about how securities insurance should be revamped can learn more at www.sipcmodernization.org, where an online forum will be held Tuesday at 5 p.m. PST.

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Spend 'Til the End: The Revolutionary Guide to Raising Your Living Standard--Today and When You Retire

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Personal Finance - SIPC Considers Revamping Rules

© Kathy Kristof