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.
