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How Safe Are Investors From Fallout?

Wall Street Journal

One of the largest financial scams to hit Wall Street has investors wondering if they’ll ever get their money back.

Bernard L. Madoff, a former chairman of the Nasdaq Stock Market, is accused of running a “giant Ponzi scheme” that is estimated to have defrauded investors of as much as $50 billion. While the details of the alleged scheme are still murky, some investors may recover at least part of their losses through an entity that insures brokerage accounts.

The following examines some of the questions the investors might have.

Is my account covered?

That depends. If you have a brokerage account with Mr. Madoff’s securities firm, then you may have some protections under the Securities Investor Protection Corp., the industry-funded nonprofit membership corporation that steps in when a brokerage firm fails. If your accounts are with Mr. Madoff’s investment-advisory business, then you’re probably out of luck since those accounts won’t qualify for SIPC coverage.

What does SIPC cover?

SIPC covers losses that are related to theft and proven unauthorized trading. Incidents of fraud, churning or manipulation of stock prices don’t qualify. Ordinary market losses, and some holdings, such as currencies, hedge funds and limited partnerships not registered with the SEC, also don’t qualify for SIPC coverage. If the firm doesn’t have the funds and securities to repay any customer obligations in a bankruptcy, then SIPC will step in to cover losses up to $500,000 per account, including $100,000 for claims for cash.

Would SIPC coverage apply to “Ponzi schemes”?

It’s likely, say securities attorneys. “If it’s a true Ponzi scheme — that is, if you take my money without my permission and give it to a prior investor as a profit — then I would certainly categorize it as a theft,” which should be covered under SIPC, says Robert Uhl, a securities attorney in Beverly Hills, Calif.

Does SIPC have enough money to cover all of the potential claims?

It may not if it has to cover losses as high as $50 billion. As of Dec. 31, 2007, the SIPC Fund had about $1.5 billion to cover potential claims. While the Securities and Exchange Commission can make another $1 billion in loans to them, it would probably have to go back to Congress for more money, says Steven Caruso, a partner at Maddox Hargett & Caruso PC, a New York law firm. “We’d be looking at another bailout, only this time it would be SIPC and not the auto industry,” he says.

Should I hire a lawyer?

Probably not. Even if you hire a lawyer and sue Mr. Madoff, it’s very likely there won’t be any significant money left — either in his business or personal assets. “Proving liability in true Ponzi schemes is the easy part of lawsuits,” says Mr. Uhl. “But who’s going to write the check at the end of the day?”

What are other options?

Wait to file a claim with the SEC. When the SEC collects whatever assets are left, it will eventually make some pro-rata distribution of those assets to investors. At some point, it will start notifying investors and requesting that they file claim forms documenting the amount of their investment, any returns on the investment and the dates of the investments. Typically, after several years, investors may get some fraction of what they’ve invested.