U.S. agency insuring stock accounts will cover thefts but why not fraud?

Staying Ahead

August 30, 1999|By Jane Bryant Quinn | Jane Bryant Quinn,Washington Post Writers Group

WHEN you open a stockbrokerage account, you're safeguarded by the Securities Investor Protection Corp. (SIPC). But what, exactly, are you covered for? Not as much as you think.

Investors are bringing lawsuits to challenge what they say is SIPC's stingy view of its duties. SIPC says it's doing what the law directs.

But SIPC's view of the law has been expanded before, both by courtroom decisions and pressure from the Securities and Exchange Commission. Maybe that could happen again.

On paper, SIPC's covenant appears straightforward. You're covered if your brokerage house fails and your cash or securities can't be found. Maybe your broker misappropriated your assets. Maybe its records don't mention all the stocks you own.

Either way, you're guaranteed most or all of your assets back.

SIPC covers you for up to $500,000 ($100,000 of which can be cash). The money comes from an industry-supported fund that currently tops $1.16 billion. Customer losses that exceed $500,000 might be paid from the assets, or private insurance policy, of the failed firm.

But what constitutes misappropriation? What proof do you need? And how should SIPC value the securities you lost?

You're not covered for losses you suffer if your stocks drop in price. Nor does SIPC cover fraud, but it covers theft. In some circumstances, you might also collect for losses due to unauthorized trading in your account.

Say, for example, that you're dealing with a dishonest firm that buys tiny stocks for pennies a share and then artificially raises the price. The broker purchases some of the stock for your account, without your consent.

Eventually, the brokerage firm's insiders sell and the stock keels over, leaving investors holding the bag. SIPC used to call that fraud and refuse to pay. But the SEC persuaded the commission to change its mind.

But even though these losses are now covered, it's almost impossible to collect, complains Indianapolis attorney Mark Maddox, president of the Public Investors Arbitration Bar Association.

Maddox is pursuing about 350 cases of unauthorized trading at the notorious penny-stock firm Stratton Oakmont that failed two years ago.

Investors have to be able to prove that the purchase was unauthorized. The proof SIPC wants, according to general counsel Stephen Harbeck: a copy of a letter that you sent to your broker within 10 days of getting confirmation of the trade.

That 10-day limit isn't in the SIPC law. It's in your brokerage agreement, and the fine print on the back of your confirmation statement.

How many people know that? And even if you complained in time, why would you write? "Unless you're a lawyer or highly sophisticated investor, you'd pick up the phone and call," Maddox says.

In the Stratton Oakmont case, SIPC accepted written complaints that went to the broker one to three months after the trade, Harbeck says. So SIPC can take whatever proof it wants.

It won't take your word. After all, memory can fail. But it seems harsh not to take your handwritten notes, taken during a protracted struggle by phone.

If you did complain to your broker by phone, you might have been talked into holding the stock. Says Harbeck, "that ratifies the trade." Says Maddox, "No, it doesn't" -- not if the broker told you lies about the stock.

Even if SIPC does accepts your claim, it doesn't necessarily make you financially whole.

Say, for example, you own Penny-Stock A. Your broker sells it for $10,000 and buys Penny-Stock B without telling you. You object, but the broker ignores you. The firm fails. All the stocks that it was manipulating collapse.

SIPC might agree to cancel the transaction. But it merely returns your shares in Penny-Stock A, which now might be worth only $100 or less.

Says Harbeck, "Our job is to replace the securities that were in the account on the day the firm failed." Says Maddox, "Investors should get back the value of the stock on the day the unauthorized transaction occurred." In this example, that would be $10,000.

Investors have yet another beef. When a firm is manipulating the prices of penny stocks, it might not accept your order to sell. You can't get out until after the stock folds.

Maddox thinks that's just another form of theft. But SIPC won't cover that loss, and so far the courts have agreed. This issue, too, is on appeal. Whether the law allows you any more protection is up to the higher courts to say.

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