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2009-09-04 — bloomberg.com

In an exercise of fantastically-contorted logic, the SIPC has ruled that Stanford-issued CDs physically delivered to depositors are not covered by SIPC insurance, leaving many of Stanford's scam-ees high and dry, in contast to those Madoff swindled.

The decision turns on the distinction of taking delivery of the securities. By the SIPC's logic, if they are delivered, even if the notes were fraudulent, they are not "missing", therefore not insured.

While this might at first blush seem to be only a problem for Stanford's hapless investors, it seems to us that there are staggering general ramifications for the US securities market, including the entire stock and bond markets: the ruling means investors cannot take delivery, because then they are not covered by the SIPC insurance they are already paying for systemically. But if they don't take delivery, they have no assurance that their securities aren't being played with by financial companies -- either being lent out secretly, used as collateral against the bank's other liabilities, or are simply fraudulent "phantom" securities, possibly the result of naked short sales.

I can't see how this could possibly be good for instilling confidence in the US financial markets. Plus, we may be getting a peek behind the curtain of the real purpose of the system and its government patrons -- providing a protection for financial company gaming, with no concrete recourse on the part of the citizenry.

Under U.S. law, SIPC repays up to $500,000 in custodial losses to investors whose securities are missing from accounts at member firms, SIPC President Stephen Harbeck said in an interview. The protection doesn’t extend to investors who’ve got their certificates, even if the securities have been rendered worthless by fraudulent conduct, he said.

...

“The fact that they went down in value is of no consequence,” Harbeck said Aug. 26. “The investors have custody of those CDs.”

...

“With Madoff, the money was entrusted to him, and he just spent it,’’ Stephen Malouf, a Dallas lawyer who represents more than 600 Stanford investors, said in an interview. “There was an extra step at Stanford, the purchase of the CDs, which are still there. SIPC doesn’t cover securities that are purchased but then decline in value.”

...

Some investors’ lawyers complain SIPC is splitting hairs by limiting coverage to securities that are “missing” instead of rendered worthless by fraud.

“It’s a distinction without a difference,’’ Houston lawyer Michael Stanley said of SIPC’s interpretation.

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