Difference between broker and dealer trading my sorrows

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October in Fund Discussions. Vanguard has been after me to make this transition for months. They list a number of good reasons why I should. It won't cost me anything. Does anyone know of negative consequences for doing so?

Using a Vanguard brokerage might present a minor problem when doing Roth conversions. In contrast, if an IRA is directly with the fund, then you can do a precise dollar conversion. Check whether Vanguard can do this from a brokerage account. If you were able to write checks directly from your fund some bond funds may have had this feature , you'll lose that with the brokerage. The brokerage can offer check writing, but not directly from the funds in the brokerage.

If you're converting a taxable account, you'll get multiple s for the split year. Okay, that's a really small downside. But consolidating s is the only upside I see to the conversion. This would be state specific; I live in WA State. You might take your question to: October edited October IMHO, only a fool would convert to brokerage. The brokerage account offers SIPC protection. The regular account does not. Although this is probably no issue given it's Vanguard I'd rather have the protection than not.

This advantage outweighed any disadvantages in my case so I made the switch years ago when first presented with the option.

Spoke to VG rep. He indicated that basically if you plan to hold only VG mutual funds, it is not really worth your while. For that reason, I did not convert my accounts over. At first, the directed dividend "problem" looked like a show stopper because I currently use VMMXX as my settlement fund for distributions. Exactly how do they define a "trade"? Vanguard might actually pay you some incentive to move assets from other firms.

Dividend reinvestment might not count as a "trade" at Vanguard; it doesn't at Fidelity. On Oct 27 msf asked: You own a number of Vanguard mutual funds, in a retirement account which is held in the form of a VG regular [non-brokerage] account. Many of the funds pay regular or semi-regular distributions. You take your RMD monthly. Interest rates are unattractively low. Then you could - for example - direct all of your distributions from all of your other funds to a single -for want of a better term- 'distribution fund'.

This might be the Vanguard Wellesley fund or the new Global Wellesley fund. The 'distribution fund' might have been pre-seeded or funded with some money in addition to the distributions that it automatically collects. You could then take all of your monthly RMD distributions from the single 'distribution fund' e.

When you check your RMD at the beginning of each year, you could look at the balance of the 'distribution fund', and fudging a little for expected distributions and appreciation or depreciation - make sure that you have enough in the 'distribution fund' to cover the upcoming year's RMD requirements. Can't do this with a brokerage account. While one may hold ETFs in addition to VG Mutual Funds prior to retirement and time to take RMD's, once one starts taking RMDs, can liquidate all ETFs in retirement accounts, transfer to more-or-less equivalent Vanguard funds held in regular non-brokerage retirement accounts and take advantage of the wonders of directed dividends.

One can also - from time to time - "buy low" or reinforce an existing position, by directing all of the dividends from all of the other mutual funds to the fund that is "low" or which you want to gradually build a position. As I understand it, you're prefunding the Wellesley account to ensure that it has enough to cover the year's RMDs after also including the expected dividends from other funds in the IRA. You're having Vanguard automatically make your with RMD withdrawals monthly.

That is certainly functional. But by having the fund distributions directed out of the funds and into the Wellesley account, you're throwing your asset allocation out of whack.

The higher yielding funds are getting depleted more quickly, the others less quickly. Rebalancing appears to take on more importance with this strategy. In this sense, it seems you're trading ease in one area for a bit more complexity in another. If it works for you, fine, that's why you're better off investing directly in the funds. In working through the mechanics of what you're doing, I discovered a related downside to the Vanguard brokerage.

In essence, directing dividends is equivalent to: One could achieve a similar effect to what you're doing by reinvesting dividends and periodically using automatic exchanges from the other IRA funds into Wellesley. In fact, that might even work a little better, because you could control the timing and amounts shifted, rather than being subject to the randomness of dividends.

It turns out that automatic exchanges are available for funds but not within a Vanguard brokerage: Not available for brokerage accounts. As you say, it works for me. And yes, I rebalance yearly. Since brokerage does not allow either directed dividends or -as you noted- the automatic exchange between funds that you mentioned in above post , I consider brokerage to be inferior to the 'standard' account and would never convert. The role of misconduct in failures, however, suggests that industry stability requires the elimination of misconduct, not merely the allocation of its costs to the firm.

The persistence of misconduct indicates that the existing vicarious liability regime is not providing firms sufficient incentive to deter misconduct.

Moreover, there is evidence that the vicarious liability regime, as administered by the industry-dominated arbitration system, does not adequately protect customers. The nature of the broker-dealer business makes insider fraud and theft especially easy. Broker-dealers, like other financial intermediaries, conduct "transactions that are 1 numerous, 2 in highly liquid form, 3 easily forgeable, and 4 involve large amounts of money which 5 often cross jurisdictional boundaries.

In fact, misconduct is the leading cause of the insolvencies administered by SIPC. SIPC officials have estimated that over half of the broker-dealer failures it had administered as of were due to some type of fraudulent conduct. The significance of misconduct as a cause of failures is underscored by the fact that SIPC liquidations often involve introducing firms that handled customer property without legal authority to do so.

Introducing firms have retail relationships with customers, but may not hold cash and securities for customer accounts. Nonetheless, twenty-six of the thirty-nine firms SIPC liquidated from to , or sixty-seven percent, were introducing firms. A study by the General Accounting Office found "shortcomings in the detection and discipline of unscrupulous [broker-dealer firms]. Although originally designed for broker registration purposes, the CRD is the only centralized source of information about broker-dealer disciplinary proceedings and terminations.

It was designed to provide information about individual brokers and not as a tool to monitor regulatory compliance. Second, the CRD is incomplete in that it does not include information on informal disciplinary actions. Rather, CRD personnel had to research and compile data from public records.

The public does not have direct access to the CRD. While it may be tempting to suggest reallocation of substantial regulatory and disciplinary powers from the SEC and SROs to SIPC, such a drastic change is unrealistic on both the political and logistical levels. As argued below, however, SIPA as currently formulated does not contribute to the prevention of misconduct.

Quite to the contrary, it may indirectly discourage attempts at prevention. Mismanagement and misconduct are perennial problems that reached crisis proportions in the late s and remain problems today. In addition, two more recent developments affect the risk of brokerage firm failure: The increased riskiness of broker-dealer firms stems from the shift in the source of broker-dealer revenue.

Prior to the mids, broker-dealers received a significant proportion of revenue in the form of commissions. Following the abolition of fixed commission rates in , commission rates began to decline.

As late as , commissions still made up approximately thirty-four percent of broker-dealer revenues. In analyzing the losses suffered by a set of NYSE member firms in the October stock market crash, the SEC identified proprietary trading in equity securities as the most important factor. Broker-dealer businesses were traditionally conducted as partnerships. Today, however, like banks, they are usually incorporated and owned through holding company structures of increasing complexity.

Affiliates may engage in more diverse financial and non-financial activities such as corporate finance, merchant banking, insurance, and even real estate and energy. Experience teaches that the financial weakness of affiliates has the potential to drag down SIPC member firms.

Moreover, corporate parents have no legal obligation to assist ailing subsidiaries. SIPC appoints a trustee to oversee the liquidation [] which is transferred to the jurisdiction of the bankruptcy court. Although it is often said that the SIPC fund will satisfy "customer claims," this does not mean that the fund guarantees reimbursement of all losses suffered by an investor who had an account with the failed firm.

Rather, the fund applies only to satisfy a certain type of investor claim—namely, claims for the net contents of accounts with the debtor. These claims, properly referred to as "customer claims for net equity," include claims for securities held in accounts and for cash deposited for the purpose of securities trading. To the extent that the fund of customer property may be insufficient to satisfy all customer claims for net equity, the SIPC fund will cover the shortfall.

Investors who were, in the lay sense, customers of the failed firm often suffer losses that will not be paid out of the SIPC fund. Investors who had accounts with the debtor may have claims that do not qualify as customer net equity claims. To the extent that the general estate may be inadequate to satisfy these claims, the SIPC fund provides no "insurance. SIPC has no "watchdog" powers over its members. Nor may it conduct examinations of its members. The SEC retains authority and discretion to investigate violations of the federal securities laws and to pass regulations regulating the actions of broker-dealers.

The SEC delegates much of that power and responsibility over broker-dealers to the self-regulatory organizations. Indeed, SIPA specifically grants the SROs immunity from any liability for failing "in good faith" to report the financial difficulty of a member. SEC regulations assign the statutory duty to a number of different officials at various levels.

With respect to the means of promoting investor confidence, the legislative history indicates that Congress initially considered the SIPC fund less important than industry reform. According to the House Report on the bill, "It is clear that the protections to investors provided by the proposed SIPC fund are really only an interim step.

The long-range solution to these problems confronting the industry today is going to be found in the ultimate raising of the financial responsibility of the brokerage community. In reality, however, the statute itself did little to pursue the "long-range solution. Congress merely directed the SEC to promulgate rules regarding financial responsibility and SIPC and SROs to collect information; it did not give any substantive guidance as to these tasks.

Congress delegated the task of addressing financial responsibility in two ways. Second, it assigned financial information-gathering tasks to SROs. Despite Congressional rhetoric and the real need for reform, neither the SIPA nor any of its many amendments has ever included a single substantive regulation of broker-dealer financial responsibility, other than prohibiting the violation of such rules as the SEC sees fit to promulgate.

Rather than providing the [SEC] with a clear mandate, the legislators had granted the agency authority to study the controversy or issue its own rules.

The political processes that produced the jerry-built statute were allowed to continue. Broker-dealer financial responsibility rules are justified primarily on the "liquidity principle"—that each broker-dealer should maintain adequate liquid assets to self-liquidate, if necessary, and thereby satisfy all current liabilities, particularly customer claims. They do not directly prevent firms from becoming insolvent, nor are they intended to do so.

While the tradition of regulation in this area is long, Congress and the SEC have not implemented very demanding capital rules, and have left much of the responsibility for enforcing the rules to the industry itself.

Section 15 c 3 of the Exchange Act, adopted in , gave the SEC authority to promulgate regulations governing the financial responsibility of over-the-counter broker-dealers. The rule requires firms "to maintain specified levels of net liquid assets as a ratio or percentage of aggregate indebtedness if on the basic method or customer related receivables if on the alternative. SIPA amended section 15 c 3 to authorize the SEC to promulgate rules "with respect to the financial responsibility and related practices of brokers and dealers.

Under the CPR, a broker-dealer must have physical possession or control of fully paid and excess margin [] securities carried for customer accounts. The broker must also make a weekly deposit of cash in the net amount owed to all customers.

Like the statutory provision it is promulgated under, the CPR is a compromise between customer protection and broker-dealer flexibility.

A broker may maintain control of a certain type of security in bulk for all customers with a claim to that type of security.

In addition, a broker need not actually possess the securities. In , the SEC acknowledged that 15c "by itself, is not an adequate financial responsibility test.

Some brokers that are poorly capitalized apparently defy the rule when they encounter financial difficulties. It is precisely at such junctures, of course, that compliance with the rule is necessary for the protection of customers. Although the net capital rule and the CPR are based on the "liquidity principle," they are not always sufficient in practice to protect customers when a broker-dealer becomes insolvent.

Problems of compliance and enforcement aside, capital may be insufficient to satisfy customers even if an insolvent broker had been in compliance with the rules.

The industry rapidly finds new financial devices to meet capital requirements, and the law must struggle to keep up and determine how to treat these new devices for net capital purposes. As noted above, SIPA also contains provisions regarding financial reporting. However, it does not authorize SIPC to inspect or examine any of its members. Nor does it authorize SIPC to require self-reporting by its members. Investor Protection or Industry Protection?

SIPA was drafted and passed rapidly as an immediate response to a perceived threat to the securities industry. While Don and Wang are correct in the limited sense that SIPA does not rescue individual failing firms, this section will argue in detail that the statutory scheme subsidizes the securities industry. It is often said that a SIPA liquidation is "essentially. While a SIPA liquidation sometimes superficially resembles a bankruptcy in that the statute incorporates Chapter 7 as a gap-filling provision, the policy concerns behind a SIPA liquidation differ fundamentally from those that motivate bankruptcy law.

Indeed, the Bankruptcy Code still contains its own provisions for the liquidation of stockbrokers, and SIPA is invoked only when it is determined that the need for customer protection renders the Code approach inappropriate. There is vigorous debate as to the goals that bankruptcy law should serve.

One commentator has divided the debaters into two camps: Efficiency-minded commentators argue that bankruptcy law is primarily "a collectivized debt-collection device. It is concerned primarily with the health of the securities industry. Under SIPA, a question central to bankruptcy—whether liquidation or reorganization would yield the greatest value for creditors [] —is not even a topic of discussion.

Professor Cheryl Block defines a "bailout" as "a form of government assistance or intervention specifically designed or intended to assist enterprises facing financial distress and to prevent enterprise failure.

Federal "insurance" programs like SIPC or FDIC deposit insurance [] may have customers as their direct beneficiaries, but the member enterprise receives assistance in that it is relieved of its obligation to the investor or depositor.

Investor confidence and "prospective bailout": Even without rescuing firms in distress, however, federal "insurance" programs serve a more subtle form of industry assistance that Professor Block refers to as a "prospective bailout.

The failure of any firm, and the mere potential for losses due to firm failure can erode public confidence in broker-dealer firms generally. The SIPA scheme was enacted to promote investor confidence in each broker-dealer firm and in the broker-dealer industry as a whole on the theory that this would help to prevent individual and firm-wide failure. The bailout effect extends to SROs as well. The stock exchanges and NASDAQ compete for investor dollars not only with each other, [] but also with other forms of investment.

Investor confidence in the members of an exchange translates into investor confidence in the exchange. Moreover, to the extent that firm insolvencies can be attributed to self-regulatory failure, a customer protection fund that absorbs customer losses due to failures also insulates SROs from negative repercussions, such as political pressure for external regulation. Despite the massive failure of self-regulation by the securities industry demonstrated by the back office crisis, Congress did not even consider reforming the existing self-regulatory structure.

Instead, SIPA was designed to fit within it—indeed, to protect it by promoting public confidence in it. SIPC was constituted as a nongovernmental private corporation "to maintain consistency with the self-regulatory character of the securities industry under the overall supervision and oversight of the SEC. Orthodox economic theory holds that the stock markets play an important role in efficient economic resource allocation.

Therefore, the theory goes, securities regulation should minimize transaction costs so as not to interfere with trading. It has been suggested, however, that the current regulatory structure goes too far and rather than merely removing impediments to trading, actively encourages trading as if it were an end in itself. It goes so far as to deliberately obscure market signals that might correctly alert the investor not to trade, or at least not to trade with a given broker.

Such a policy is akin to resuscitating the canary rather than leaving the coal mine. Loss of public confidence, translated into lost business, can be good for industry health in the long run by spurring the securities industry to improve its reliability. SIPA may act as a type of subsidy to firms that systematically engage in or allow their individual brokers to engage in risky or unethical behavior, since SIPC insurance can encourage investor confidence in firms that do not merit it.

An investor may be led to invest with a firm with which she would not have invested absent SIPC protection—a firm that eventually becomes insolvent. Firms that would otherwise have to pay for their riskiness or instability by discounting their fees, or simply by attracting fewer customers, are relieved of that burden by the availability of SIPC insurance.

Such losses may include those due to broker fraud and inability to access the contents of a frozen account. Thus, while SIPA qualifies as a bailout because of its intent to use investor confidence to protect broker-dealers from failure, the reasoning behind this intent is questionable.

First, as noted above, lost investor confidence is not, and has not been, a significant cause of broker-dealer failure. Second, engendering investor "overconfidence" prevents market discipline from encouraging firms and SROs to attack the real causes of failures.

Thus it likely does little to prevent failures and may even indirectly contribute to failures. Protection from the "domino effects": The failure of one aggravates the problem and reduces the financial soundness of all other firms to which it is indebted. Brokers worry, too, that failure of one big house could trigger a series of collapses in a sort of domino effect.

Collapse of house A could freeze stock and cash it owed house B—and that could tie up just enough capital to prevent house B from bailing out of its own difficulties. A still worse nightmare: Brokers fear that the collapse of several houses, or even only one big one, could set off waves of panic selling by customers of other houses—even the strong ones.

The second type of "nightmare" described above is merely a dramatic manifestation of the loss of investor confidence. Such hypothetical panics would be similar to the contagious "bank runs" witnessed during the Great Depression. It has been argued, however, that the likelihood of bank runs causing macroeconomic ripple effects is very low.

SIPC rules promulgated under SIPA [] require the trustee to complete executory securities contracts, though only where a customer of the other party not the debtor has an interest. Because "customer" is a term of art in the statute, it is little more than a tautology to state that "SIPC protects customers.

This is demonstrated by the ways in which customer protection provisions favor securities investments over cash. A customer must take the attendant higher risks of investing to enjoy SIPC protection for either cash or securities. The SIPA amendments went even further in favoring securities over cash. SIPA attempts to satisfy customer net equity claims with securities as much as possible, even to the extent of using the proceeds of customer property or SIPC advances to purchase them for the customer, regardless of their value.

If the fund of customer property did not contain sufficient X Corp. While any investor bears the risk of volatility, the risk to which a SIPA customer claimant is exposed is far greater than the normal market risk. During the pendency of customer claims processing, customer accounts are effectively frozen, often for months and, for contested claims, even years and despite the possibility of a decline in the price of his securities normal investor risk , the customer has no power to sell.

Furthermore, where the debtor was a primary market maker in an issue, the collapse of the debtor can decimate securities value overnight. The SIPC fund provides the most dependable firms and the least stable firms alike with uniform protection, at the same negligible cost. They do so by paying the same flat premiums as the risky firms. They pay an additional, subtler subsidy when, despite SIPC protection, the collapse of one firm has some adverse effect on investor confidence in the entire industry.

This system appears to be self-financed by the industry, in that risks created by the industry are shifted among members of the industry. Thus it may be argued that even if SIPA assists the securities industry, it is not a publicly funded "bailout" because it only involves risk-spreading within the industry. This section contends, however, that the costs of failures are not borne entirely by the SIPC fund or ultimately by the securities industry. The direct costs of SIPC protection—the assessments that make up the fund, are spread out among broker-dealers and, by extension, their customers.

Similarly, the putative benefits of SIPC protection—customer protection leading to improved investor confidence and increased investment—are shared by broker-dealers and their customers. However, within the class of customers and within the class of broker-dealers, the costs of liquidation are not distributed in a fair or efficient way. Furthermore, certain costs of SIPC protection, most notably administrative expenses, are placed on parties who do not gain from SIPC protection, a situation which is neither fair nor efficient with respect to reducing the likelihood of failure.

The SIPA scheme shifts many costs outside the industry and thus the system is partly financed by taxes on other parties. Although the SIPC "insurance fund" is nominally financed by its members rather than by taxpayers, it receives some indirect subsidies from taxpayer money. However, it did not address the question of whether the billion dollar fund would be sufficient to handle such failures. In , each of the five largest broker-dealers had over one million customer accounts, while the largest SIPC liquidations thus far have involved approximately sixty thousand accounts.

It is unclear whether the private insurance market could provide satisfactory investor insurance, particularly at a low cost comparable to that of SIPC assessments. Such policies, however, are not comparable to SIPC. Finally, excess SIPC coverage is not always available when necessary. When Drexel Burnham Lambert, Inc. The lack of any objective pricing mechanism for SIPC protection suggests the possibility of an allocative inefficiency problem. A great deal of scholarship has been devoted to questions regarding the efficiency of capital market pricing and the resultant effect on allocative efficiency.

However, the scholarship tends to consider only the relationship between underlying value however calculated and market price. It tends to downplay, if not ignore, the relationship between the value and the full cost to the investor—which includes the transaction costs involved in participating in the market.

If SIPC insurance is indeed underpriced, the cost of investing in securities is also underpriced. Thus, SIPA may act as a subsidy to the securities industry as well as to securities issuers by causing investors to overinvest in the securities market.

SIPA further subsidizes the costs of broker failure in the way it allocates the often immense costs of administering a liquidation. Larger liquidations require the retention of a professional trustee, attorneys, consultants, and accountants, as well as an administrative staff. Because the professionals must be experienced in complex issues of the securities business and securities law, they are often very high profile and prestigious, and therefore very expensive.

As in a Chapter 7 liquidation under the Bankruptcy Code, claims for administrative expenses in a SIPA proceeding have highest priority on the general estate. Furthermore, it is the depletion of net capital—the primary component of the general estate—that often necessitates a SIPA liquidation in the first place. As a result, not only is the cost of administration of general creditor claims a relatively small portion of the total administrative expenses of a SIPA liquidation, but general creditors are also unlikely to recover much, if at all, on their claims.

A SIPC Special Task Force report noted in that administrative expenses "frequently" exhaust the general estates of debtors and preclude recovery by general creditors. Under the equitable principle of cost allocation, general creditors would bear little, if any, of the administrative costs. Prior to , allocation of administrative expenses in SIPA cases followed the equitable principle.

The trustee divided the burden of expenses between the general estate and customer property [] according to which creditors benefited from the administrative tasks. SIPA concentrates almost exclusively on the satisfaction of members of the customer class, in the belief that their satisfaction and not that of general creditors is crucial to the continued health of the industry. Thus, most of the business of a liquidation has great importance to the industry and its customers, and very little to do with the interests of general creditors.

Although general creditors shoulder the administrative costs in bankruptcy, the comparison to SIPA is inapposite. In effect, a SIPA liquidation is the liquidation of two separate estates—the fund of customer property and the general estate. Nonetheless, the cost of administering the fund of customer property is charged to the general estate, not to the fund of customer property or its guarantor, the industry-financed SIPC fund.

This safeguard is for the benefit of industry stability and for the investor who is the counterparty to the transaction. Nonetheless, payments made to complete open contracts are charged to the general estate as administrative expenses. In effect, SIPA obliges general creditors to pay the costs of administering the fund of customer property and the SIPC fund, despite the fact that general creditors recover nothing from either fund.

This is an inequitable and inefficient result in that the costs of failure should be placed on the parties most able to avoid those failures. But in the SIPA context, unlike in a liquidation under the Bankruptcy Code, privileging one class of creditor customers does not have to be done at the expense of another class of creditor general creditors.

Rather, the burden can be placed on the intended beneficiaries of the SIPA scheme—the members of the broker-dealer industry—by allocating the costs to the SIPC fund. It may be argued that the current structure assumes that general creditors are best able to judge the creditworthiness of a securities firm, and that they can impose market discipline on broker risk taking.

Broker-dealer financial reporting requirements are notoriously complex, and there is no private cause of action under those requirements. As a result, it is hard to believe that general creditors, who may include landlords, equipment vendors, and nonprofessional employees, are the market actors best able to evaluate and avoid the risks of broker failure.

The same may be true for general creditors, who may not realize at the time of contracting that their likelihood of recovery under the SIPA scheme is significantly less than that under bankruptcy law. It is also important to keep in mind that the distinction between "general creditors" and "customers" is in many cases an arbitrary one. This may seem equitable when the SIPA scheme is viewed as a debt-collection device; however, it seems much less fair and much less efficient when SIPA is viewed as a bailout of the broker-dealer industry.

The SIPA scheme places costs on customers as well as on general creditors and the economy generally. This practice is fair and efficient, in that it is evenly distributed among the beneficiaries of SIPC protection. In any case, it is minimal, given the nominal size of SIPC assessments.

However, SIPA may cause customers to pay more significant and economically unjustified costs in addition to the direct costs passed on by the firms. In the event of firm failure, those investors may bear more of the costs of failure than they had anticipated. While the hypothetical "rational investor" should be aware of the limits of SIPC protection, in reality it is unreasonable to expect the typical individual investor to appreciate the complexities of the statutory scheme.

However, there is currently no legal requirement for its distribution. SIPC must rely on broker-dealers to distribute the brochures to their customers. In addition, the regulatory enforcement branch of the NASD has observed a tendency for brokers, whether intentionally or not, to misinform customers as to the nature and extent of SIPC coverage. SIPC gives investor confidence the same quantum of encouragement with respect to each member firm.

SIPC insures customers of all brokers in the same way and charges each broker the same annual assessment. SIPC lacks the power to channel investor confidence toward the soundest houses and away from riskier ones because it gives investors no information at all in this regard. It also lacks the power to give firms any incentive to become less risky. The statute requires SIPC to "insure" the customers of all registered broker-dealers.

SIPC must therefore protect and encourage investors in all American brokerage firms as long as the SEC believes they are qualified to do business, regardless of whether SIPC believes them to be a good "insurance risk. The fact that a person or institution is insured often indicates that the insurer has examined the insured party and deemed it an acceptable risk.

SIPC insurance entails no such endorsement, though investors may believe that. Even where investors understand fully the limits of SIPC coverage, SIPC membership gives the investor no information about the relative soundness of the firm, as nearly every firm in the country is a member. If we allowed many of the marginal broker-dealers to display an FDIC [sic] emblem all over their place of activity similar to that displayed by Merrill Lynch or Bache, would we not be lulling the public into a false sense of security—a feeling that their investment would be guaranteed by the Federal Government?

I think the question raised is whether or not the public would feel that the guarantee is broader than it is. In other words, that it would guarantee against investment losses as opposed to the kinds of losses it would actually cover. We have no authority to pass on the merits of a public offering of securities.

The Congress very wisely determined that the Commission should simply see that the investor is sufficiently informed so that he can make an intelligent decision and did not give the Commission power to judge the merits of the investment at all.

It is amazing how many members of the public, who see anything with SEC on it, think it is guaranteed by the Government. Another cost of administering a liquidation is the resolution of disputed claims. This issue has been the subject of a great deal of SIPA litigation.

The unlikelihood of recovery on a general creditor claim makes it all the more imperative for each creditor to seek a judicial determination that its claim qualifies as a "customer claim. SIPC and the trustee it appoints may have wrested control of the debtor firm away from an unwilling management on the suspicion that the management was corrupt or incompetent. Like placing administrative costs on general creditors, the distribution of these costs is neither fair nor efficient.

Customers, perhaps even more than noncustomer general creditors, often lack the necessary information to avoid costs by avoiding brokers likely to become insolvent. While the SIPA scheme is intended for the benefit of customers, taxing them through the costs of resolving disputed claims assigns the burden of liquidation costs in the form of a random tax on those who happen to have disputed claims.

Yet customers whose claims become the subject of dispute bear this cost disproportionately. Customers should be encouraged to pursue action against malfeasant brokers. Customer actions can supplement the monitoring capacities of the SEC and SROs, which are insufficient by themselves to detect all such signs. SIPA was apparently intended in part as a failure prevention device since it seeks to promote investor confidence and requires the completion of open contractual commitments.

But neither lost confidence nor incomplete transactions has been shown to be a significant cause of broker-dealer failure. Furthermore, both these "preventive" concepts are purely reactive.