July 20, 2010
Dodd-Frank Forum: Bernard Madoff as the Big Idea
Posted by Christine Hurt

Renee compares the Dodd-Frank reforms to Sarbanes-Oxley and wonders what the cohesive theory is behind Dodd-Frank.  Sarbanes-Oxley had Enron and Arthur Andersen as villains, and accounting fraud as the bad act.  Some things to remember:  First, SOX was passed quickly, very soon after the fall of Enron, WorldCom, and Arthur Andersen.  Enron fell in late 2001; WorldCom in June 2002.  SOX was passed in July 2002, unanimously by the Senate and with only 3 "nea" votes in the House.  There was very little horse-trading there, and not much time for lobbying by industry.  This quickness has two sides -- on the one hand, the reforms were meaningful and substantial.  On the other hand, they may have been knee-jerk reactions to the perceived causes with little time for study.  Dodd-Frank, however, comes now almost two years after the beginning of the crisis.  Even if a year ago, the financial reform bill started out with big-picture themes (End Too Big To Fail, Curb Systemic Risk, Punish the Casino-Makers) and clear villains (AIG, Lehman, Goldman, Madoff), after months of lobbying and deal-making, not much of a theme remains (remember the now-defunct Bank Tax?)  But the one villain we can all agree on is Bernard Madoff, and he is very much alive in this financial reform.

First, "Improvements to the Management of the Securities and Exchange Commission" beginning in Section 961 sets out to make sure that no one ever drops the ball on a Madoff again.  The only problem is how to actually do that.  How do you make sure that no one is ever blinded to a charismatic industry player and ignores an unpleasant whistleblower who seems like a money-grubbing competitor?  Well, we make the SEC write a lot of reports, do a once-over study, hire a lot of examiners, and set up an employee hotline.  We also study the "revolving door" to identify when investigators might be going easy on examinees so that they can line up employment later.  An earlier version of the House bill had contained a Section 7306, which required the SEC to report to Congress on "implementation of post-Madoff reforms," but I think the passage of time took care of that requirement.  Then, Section 991 appropriates certain amounts to the SEC, and I'll just assume those are budgetary increases so that the SEC can't play the pauper when frauds go through the cracks.

Second, Section 922 provides for a reward system for whistleblowers, in addition to additional protections, closing up some gaps in federal whistleblower protections.  Whistleblowers must provide original information to officials regarding violations that end in a successful enforcement action by the SEC.  A qualifying whistleblower, who may be anonymous and act through counsel, would then receive between 10 and 30% of any fine or disgorgement over $1 million, at the SEC's discretion.  Though commenters see the most action with this section in FCPA enforcement, where fines are high and liability is strict, this is basically designed so the employees of the next Madoff will have an incentive to give information earlier.  (They seem perfectly incentivized to tell everything they know once an indictment is assured.)  In addition, the existence of this provision puts pressure on the SEC to develop information early and to listen to the Harry Markopoloses of the world.

Finally, SIPC.  I have blogged about some of the SIPC issues litigated in the Madoff liquidation here ("net equity") and here ("net winner" and "direct customer").  Because Bernard L. Madoff Investment Securities was a member of SIPC, direct customers who lost assets as a result of the financial firm's "failure" were eligible for advances from SIPC of up to $500,000 to reimburse them pending liquidation.  If the firm's assets aren't sufficient to satisfy all claims, then the advance may be the only recovery.  Madoff victims testified to Congress about many of the shortcomings of SIPC, including the $500k cap, the definition of direct customer, and the definition of net equity.  Dodd-Frank has two sections devoted to SIPC (the Securities Investor Protection Corp.) and SIPA (the Act), but they don't cover these points.  Section 929H increases the limit of the cash advance limit.  If you invested cash with a fraudster or a firm that then went defunct before converting your cash to a security, then you were entitled to an advance of up to $100,000.  That is now $250,000, indexed for inflation at SIPC's discretion.  No mention of the $500,000 limit on net equity after your cash has been converted.  Perhaps left for another day.  No mention of direct customer or net equity definitions.  Section 929V codifies the temporary increase SIPC had already instituted to reform the embarassingly low annual fee for SIPC members ($150 a year) to .02% of gross revenues.

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