Why is SIPC covering Madoff investors?

Some broker-dealer executives who are now paying increased fees to the Securities Investor Protection Corp. are wondering why it is paying out on claims of investors victimized by Bernie Madoff.

Those higher SIPC bills that brokerage firms are paying are the result of $231 million in payouts to Madoff victims that have been approved by the SIPC.

And yet, in the wake of the Madoff scandal, officials of the Financial Industry Regulatory Authority Inc. of New York and Washington have claimed that Finra, which regulates broker-dealers, had no authority over Madoff’s investment advisory business, where the fraud occurred.

What’s more, no securities ever were purchased for Madoff customers.

That has led industry observers to question why SIPC is covering Madoff’s clients, since SIPC covers only broker-dealers.

Under the statute that created the SIPC, a customer is defined as anyone who has deposited cash with a broker-dealer for the purpose of purchasing securities.

“There were no transactions and no securities, but [Mr. Madoff] told people he did [place trades], and took their money on that premise,” said Stephen Harbeck, president and chief executive of the Washington-based SIPC.

“As long as customers deposit money for that [SIPC-]protected purpose, they’re covered,” he said.

“The fact that [Madoff was] registered as an investment adviser is simply irrelevant.”

Industry lawyers, meanwhile, have disputed the claim that Finra had no jurisdiction over Madoff’s money management business.

Prior to 2006, when Madoff first registered as an advisory firm, his broker-dealer — Bernard L. Madoff Investment Securities LLC of New York — had to be using the “solely incidental exemption” from the Investment Advisers Act, said John Coffee, a professor at Columbia Law School in New York, during Congressional hearings on the Madoff affair last January.

After 2006, Mr. Madoff’s advisory firm was using his broker-dealer as a qualified custodian, Mr. Coffee testified, which put it “fully within [Finra’s] jurisdiction.”