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a trustee under chapter X of the Bankruptcy Act, and provision is made for the applicability of chapter X of the Bankruptcy Act and certain provisions (other than section 60e) of chapters I to VII of the Bankruptcy Act. The proceeding not only disposes of claims of customers, but also the claims of general creditors.

As noted, although it made some important changes, SIPA substantially tracks the provisions of section 60e of the Bankruptcy Act. Thus, customers are entitled to the return of their specifically identifiable property, as defined in the Act * and the Commission's Rule 15c3-3(j). SIPA continues the concept of a “single and separate fund” available for the satisfaction of the “net equity” claims of customers who are regarded as a single and separate class of creditors entitled to share ratably in such fund." The total subject matter of section 60e of the Bankruptcy Act is covered in section 6(c) (2) of SIPA," and the former section is specifically made inapplicable thereby limiting its utility to failed firms whose judicial liquidations, for one reason or another, are not effected under SIPA.

One of the broad purposes of SIPA was "to insulate the economy from the disruption which can follow the failure of major financial institutions." 31 Thus, Congress sought not only to protect customers of the debtor, but also to provide a measure of indirect protection to customers of other brokers and dealers doing business with the debtor. This was done via section 6(d) "and the Commission's Rule S6d-1 thereunder authorizing the trustee to complete certain open contractual commitments between the debtor and other brokers and dealers.

Customers file claims with the trustee who determines their validity. This is a claims program on an expedited basis. If a customer has a valid claim for securities, the trustee delivers those securities to the extent they are available after making any necessary or permissible allocation among customers claiming the same securities. 32 A cash payment from the single and separate fund is made in lieu of missing securities based on "filing date" values. Of course, claims for cash are payable in cash.

As a supplement to the assets in the trustee's hands, SIPA requires SIPC to advance funds to the trustee for the purpose of satisfying customers' net equity claims. However, SIPC may not advance more than $50,000 per customer, of which not more than $20,000 may be for that portion of a customer's claim which is for cash, as distinct from securities. Not only is there a limitation upon the amounts available from SIPC, but it is also provided that SIPC funds are not available to satisfy claims of certain customers. Thus SIPA prohibits the use of SIPC's funds for certain principals of the debtor as well as claims of other brokers and dealers or banks not involving transactions for their customers. 35 SIPC must also advance funds to complete certain open contractual commitments between the debtor and other broker/dealers, and may also do so for certain administrative expenses of the proceeding. 38

As the foregoing demonstrates. SIPC does not simply pay claims as would an insurer. Moreover, its advances of funds are recouped from the debtor's assets to the fullest extent possible. SIPC is subrogated to the rights and priorities of customers under SIPA to the extent of its advances. *7 Those rights are not only against the single and separate fund, but also against the debtor's general estate 3. In addition, funds advanced by SIPC for administrative expenses are recouped from both the general estate and the single and separate fund, to the extent assets are available. Such expenses enjoy priority under sections 64a (1) and (2) of the Bankruptcy Act." and section 61c) (2) (B) of SIPA.

Before I comment specifically on the bills before this Subcommittee, I think it is appropriate to put the matters we are discussing into more concrete form in terms of numbers and dollars. From the enactment of SJPA at the end of 1970 to date 118 of the approximately 6,500 broker/dealers which have been SIPC members have been placed into liquidation under SIPA. As of December 31, 1975 SIPC has made net advances to trustees totaling over $51.000.000. In addition to these advances, significant amounts of securities and cash have been dis

27 Sections 6 (b) and (c)(1):$$ 78fff (b) and (c)(1). 24 Sections 6(a)(1)(A) and (c) (2) (C):$$ 78fff (a) (1) (A) and (c) (2) (C). 29 Section 6 (C) (2) (B) ; & 78fff(c) (2) (B). 30 $ 78fff (c) (2). al Senate report at 4 ; see also llouse report at 1. 32 $ 7Sfff (d). 33 Sections 610) (2) (B)-(d), 6(e) and 6(g); $$ 78fff(c)(2)(B)-(D), fff(e) and fff (5). 34 Section 6(f); $78fff (f). 37 Sections 6 (f) (1) (C) and (D): $ $ 78fff(f) (1) (C) and (D). 36 Section 6(f) (2); $ 78fff(f) (2). 37 Section 6(f) (1): $ 7Sfff (f) (1). 39 Section 6 (c) (2) (B): $ 78fff(c) (2) (B). 39 11 U.S.C. $$ 104a (1) and (2).

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tributed to customers from assets which were held by the debtors or acquired for them by the trustees. We estimate that through 1975 securities and cash having a combined value of approximately $209,000,000, exclusive of SIPC advances, have been distributed to approximately 102,000 customers in the course of liquidation proceedings under SIPA. It is interesting to note the spread of those liquidations over the years of SIPC's operation : 1971—24; 1972–40; 1973–30; 1974–15; 1975–8; 1976 (3 months)-1.

The existence of SIPA and the declining number of liquidations under it do not lessen the need for provisions in the Bankruptcy Act dealing with stockbroker liquidations. As I have mentioned, SIPA does not cover all broker/dealers and I am therefore pleased to note that the bills being considered by the Subcommittee do not attempt to eliminate the provisions of section 60e, but rather try to conform those provisions to SIPA. The fact is that there is still a role for such provisions in the Bankruptcy Act. Since only broker/dealers registered with the Commission or members of an exchange are members of SIPC, there are many broker/dealers who are not members of SIPA. For example, there are intrastate broker/dealers who, not being registered with the Commission, are not members of SIPC. In addition, as pointed out earlier, there are broker/dealers who are excluded from SIPC memb hip by reason of the exclusions set forth in SIPA.

There is, of course, much merit in making the provisions of the Bankruptcy Act dealing with stockbrokers' liquidations as similar as is feasible to the provisions of SIPA. As I previously noted, SIPA does track very closely the provisions of section 60e. Certain changes reflected in H.R. 31 and H.R. 32 will bring the two statutes even closer together. As the Bankruptcy Commission noted :

"The Special Study of the Securities Markets by the Securities and Exchange Commission, published in 1963, described certain defects in section 60e of the Bankruptcy Act which the study group believed should be remedied at an appropriate time. These included proposals that securities in bulk segregation systems be considered to be “specifically identifiable for the purpose of the distribution rule, that the term 'stockholder' include dealers as well as brokers, and that the term 'customers' include persons depositing cash for the purchase of securities." 41

These proposed changes were in fact made in SIPA, and they should be included in any revision of the Bankruptcy Act. I am pleased to note that most of these changes are contained in both bills before this Subcommittee, with the possible exception of the one dealing with definition of the term "stockbroker”. This definition, in section 5-301 (7) of both bills, may require some further clarification to include dealers as well as brokers.

Aside from these changes which are clearly desirable, H.R. 31 and H.R. 32 would make further changes in section 60e to conform it to SIPA as it now exists. Obviously, many differences between section 60e and SIPA must continue to exist by reason of the availability of SIPC's funds to pay or otherwise satisfy customers' claims. Of the changes made by the bills, I would raise questions as to the advisability of some.

For example, since SIPA intends limited protection up to a maximum of 50,000, it is necessary to provide in the statute that “... accounts held by a customer in separate capacities shall be deemed to be accounts of separate customers ..."

." ** Since there are no comparable dollar limitations in non-SIPA liquidations, the nearly identical provision set out in section 5–301 (4) of both bills seems unnecessary and you may wish to delete it. Whether accounts held by a customer in separate capacities are deemed to be accounts of separate customers or of the same customer, that customer can still get no more than his pro rata share of whatever property is available in the single and separate fund.

A similar observation may be made concerning the requirement in both bills that:

As far as practicable, the trustee shall deliver in payment of claims of customers for their net equities based on securities held on the date of bankruptcy in their accounts (after giving effect to open contractual commitments completed as hereinafter provided) securities of the same class and series of an issuer ratably up to the respective amounts which were so held in such accounts." 43

40 Section 3(a)(2): $ 78ccc(a) (2).

41 Report of the Commission on the Bankruptcy Laws of the United States. H.R. Doc. No. 93-137, part I. 93d Cong., 1 st sess. 220 (1973).

12 Section 6(c) (2) (A) (1v): $ 78fff(c) (2) (A)(iv).

43 Section 5-304 of H.R. 32'; section 5-305 of H.R. 31. For purposes of such delivery, both bills require that securities in the single and separate fund be valued as of the close of business on the date of bankruptcy.

The distribution of such securities in kind is feasible where SIPC funds are available to pay customers cash in lieu of missing securities. But where such funds are not available, as will be the case in a liquidation under the Bankruptcy Act, in most cases it will be difficult, if not impossible, for the trustee to distribute securities in kind. This is so because all customers are entitled to share pro rata in all property in the single and separate fund, whether or not the securities which happen to be in that fund are the securities to which they have a claim. The result is that at least some, and perhaps all, of the securities in the single and separate fund must be reduced to cash to allow for the proper proration. If you do not wish to eliminate this provision, the legislative history should at least reflect its limited use and applicability.

Problems may be created by the provisions in the bills dealing with the completion of open contractual commitments." Completion of such commitments is provided for in SIPA principally "to minimize the disruption caused by a failure of a broker/dealer, precluding the 'domino effect of such failure." ^ Under SIPA the completion may be accomplished with the use of funds advanced by SIPC. How such a provision would work in the context of a liquidation proceeding which does not have the benefit of the availability of funds from a source other than the debtor's estate is questionable and may deserve further thought. It should be noted that, should the Subcommittee delete this provision, conforming changes would be required in other sections as well.

Finally, there is one area in which I believe an additional amendment to section 60e dealing specifically with SIPA would be useful. Under SIPA, the Commission and the self-regulatory organizations (that is, the exchanges and the National Associations of Securities Dealers, Inc.) are charged with the duty of notifying SIPC when it appears that a member of SIPC is in or is approaching financial difficulty."

SIPC has no investigatory powers of its own. While the Commission and the self-regulatory organizations have been doing an excellent job in carrying out their responsibilities under SIPA. an additional source of information about brokers in financial difficulty might prove useful. Therefore, I would suggest that the Bankruptcy Act be amended to require notice to SIPC of the filing by or against a stockbroker of a petition under the Bankruptcy Act. This seems particularly appropriate in light of the provisions in SIPA to the effect that SIPC may initiate a liquidation proceeding notwithstanding the pendency of any bankruptcy proceeding against the broker/dealer and that upon the filing of SIPC's complaint the Court must stay any pending bankruptcy proceeding."

In conclusion I would like to comment briefly on pending amendments to SIPA. The Report of the Commission on the Bankruptcy Laws of the l'nited States issued in July, 1973 correctly noted that at that time changes in SIPA should await more experience with the statute. We now have, however, five years of experience with the statute spanning the liquidations of 118 broker/ dealers. Hugh F. Owens, shortly after his confirmation as Chairman of SIPC in Vorember, 1973, appoi a Special Task Force to review the statutory framework of SIPC and make recommendations for improvement. The Special Task Force issued its report in July, 1974 to SIPC's Board of Directors, and legislation based on those recommendations was transmitted to the Congress by SIPC in December, 1974.

Those recommendations are contained in H.R. S064 and S. 1231, which are presently pending before Congress. Hearings on H.R. 8064 were held by the Subcommittee on Consumer Protection and Finance of the House Committee on Interstate and Foreign Commerce on October 20–22, 1975. These proposed amendments are designed specifically to carry out the particular purposes of SIPA and of course have that object in mind. They would, however, change the liquidation procedures of SIPA in many respects. For example, they would usually require a trustee to satisfy claims for securities with securities rather than with cash in lieu thereof. This would be done even when it was necessary for the trustee to purchase missing securities in the open market. In addition, the amendments would alter the present concepts of specifically identifiable property and single and separate fund with the objective of a fairer treatment of all customers in a liquidation where additional monies are being provided from the SIPC fund. The amendments would also provide SIPC with more flexible procedures for liquidating broker/dealers taking into account the differences in the size of the businesses to be liquidated. Most of these proposed amendments could not reasonably be adapted to an ordinary bankruptcy proceeding for a stockbroker, and accordingly most of them should not affect your deliberations on H.R. 31 and H.R. 32. However, it may be useful to keep aware of the development of those pending amendments to SIPA as you proceed with your work on H.R. 31 and H.R. 32.

44 Section 15-308 of H.R. 32: section 5-309 of H.R. 31, 4ü House report at 9. 46 Section 5 (a) (1): $ 7Seepla (1). ** Sections 5(a) (3) (B) and 5(b)(2) :$$ 78eee(a) (3) (B) and 7Seee (b)(2).

Thank you for giving us the opportunity of expressing our views. I shall be pleased to respond to any question you may have.

TESTIMONY OF THEODORE H. FOCHT, GENERAL COUNSEL,

SECURITIES INVESTOR PROTECTION CORPORATION, ACCOMPANIED BY WILFRED CARON, ASSOCIATE GENERAL COUNSEL

Mr. Focht. Thank you very much, Mr. Chairman. It is a pleasure for us to appear before you this morning and present the views of the Securities Investor Protection Corp., on H.R. 31 and H.R. 32, which make significant amendments to the Bankruptcy Act.

Since I understand that my prepared statement will be included in the record, I will just summarize briefly what is discussed in the statement.

I think before we get into our comments on H.R. 31 and and H.R. 32, it may be helpful to outline briefly for you the origin and development of SIPC. As some of you may recall, SIPC had its origin in the difficult years of 1969 and 1970, when the paper crunch in the securities industry brought on by an unexpectedly high trading rolume was followed by the most severe decline in stock prices since the Great Depression. Hundreds of broker-dealers encountered financial difficulties at that time, and many were merged, acquired by other firms, or simply went out of business.

Public confidence in the securities markets was shaken and the congressional response was the passage of the Securities Investor Protection Act which was signed into law on December 30, 1970.

This act created SIPC. SIPC is not an insurance company. It was conceived as a private nonprofit, industry-funded membership corporation, which would work within the existing regulatory and selfregulatory structure in the securities industry. Most broker-dealers which are registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934 are required to be members of SIPC, and accordingly pay assessments to the SIPC fund.

It is important to note, however, that some broker-dealers who are registered with the SEC are, by the terms of the 1970 act, excluded from membership in SIPC; these are basically firms which are dealing exclusively in the sale of variable annuities, the sale of mutual funds, or the rendering of investment advice to mutual funds and insurance company separate accounts.

SIPC's authority to commence the liquidation proceeding for the protection of the customers of one of SIPC's members is important and an integral aspect of our program. SIPC, however, does not itself liquidate any of its members; it merely is authorized to commence a liquidation proceeding in an appropriate Federal district court. Essentially, the liquidation proceeding is a custom-made bankruptcy proceeding, similar to the usual stockholder bankruptcy conducted in accordance with section 60e of the Bankruptcy Act.

The committee is familiar, I am sure, with the priorities which are given to customers in a proceeding under section 60e of the Bankruptey Act. Basically, customers in a 60e proceeding have the right to have returned to them their specifically identifiable property, and then they share on a priority basis in the single and separate fund.

Now, the 1970 act, in creating SIPC, basically used the same concepts for a SIPC proceeding, and therefore in a SIPC liquidation, customers, too, are entitled to the return of their specifically identifiable property as that is defined in the SIPC act, and they are entitled to share on a priority basis in the single and separate funds.

The most important difference, I suppose, between a SIPC liquidation and a 60e liquidation is that, as a supplement to the assets in the trustee's hands, SIPA provides that SIPC shall make available funds to the trustee for the purpose of satisfying customers who have net equity claims. However, SIPC may not advance more than $50,000 per customer account, of which not more than $20,000 may be for a customer's claim for cash, as distinct from a customer's claim for securities. Not only is there this limitation on the amounts of money that may be advanced by SIPC, but it is also provided that SIPC funds are not available to satisfy the claims of certain customers; thus, the SIPC act prohibits the use of SIPC funds for certain principals of the debtor, as well as claims of broker-dealers or banks, which do not involve transactions for their customers.

Before I comment on H.R. 31 and H.R. 32, perhaps it would be useful for the subcommittee if I reviewed briefly SIPC's experience to date. SIPC has iust passed its fifth anniversary, and in those 5 years of operations, we have become involved in the liquidation of 118 of the approximately 6,500 broker-dealers who have been SIPC members in this period of time.

As of December 31, 1975, SIPC had made net advances to trustees totaling a little over $51 million. In addition to these advances to trustees, significant amounts of securities and cash have been distributed to customers from assets which were held by the debtor, or which were acquired for them by the trustees. We estimate that through 1975, this property had a combined value of approximately $209 million.

These funds and this property have been distributed to approximately 102,000 customers in the course of these 118 liquidation proceedings. It is also important to note, I think, the spread of these liquidation proceedings. In 1971, the first year of SIPC's operation, we commenced the liquidation of 24 broker-dealers; in 1972, 40; in 1973, 30; in 1974, 15; in 1975, 8; and so far this year, 1. We are,

of course, very pleased with the decline in liquidation proceedings.

Now, to turn to the bills before you, as I mentioned earlier, SIPC does not cover all broker-dealers, and I am therefore pleased to note that the bills being considered by the subcommittee this morning do not attempt to eliminate the provisions of section 60e, but rather try to conform those to SIPA. The fact is that there is still an important role for such provisions in the Bankruptcy Act, since only broker-dealers registered with the Commission are members of SIPC; there are many broker-dealers who are not members of SIPC.

For example, there are intrastate brokers who are not registered with the Commission and who are not members of SIPC. In addition,

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