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Protection for Investors' Brokerage Accounts

Covering your investment assets

Most brokerage accounts are protected by the Securities Investor Protection Corp (SIPC). Unlike the FDIC, which provides coverage for bank deposit accounts, the SIPC is not a governmental agency. Though created by Congress, it is a nonprofit corporation funded by its membership, which is comprised of broker-dealers registered with the Securities and Exchange Commission. (Any broker-dealer that is not an SIPC member must disclose that fact to customers.)

SIPC was created by Congress in 1970 to help return customer property, including both securities and cash in brokerage accounts, should a broker-dealer or clearing firm go bankrupt, become insolvent, or experience unauthorized trading in a customer's securities account. Many brokerages also carry additional private insurance to extend coverage beyond the SIPC limits. Should an SIPC member firm become insolvent, SIPC would either ask a court to appoint a trustee to supervise the transfer of customer securities to another member firm, or act as the trustee itself.

It's important to know the types of accounts and securities that qualify for this protection, as well as the maximum amounts that can be held in each account and still qualify for SIPC coverage. Otherwise, an investor's account might inadvertently have less coverage than expected. And though any excess amounts might be safe, any protection beyond the SIPC limits isn't necessarily assured. On the other hand, if money is distributed appropriately among various types of accounts, an investor may be able to qualify for greater protection at a single institution.

How much is covered?

SIPC covers a maximum of $500,000 per "separate customer," including up to $100,000 in cash, at a given brokerage house or clearing firm. Total coverage can be higher for multiple accounts at one institution, depending on how they're held. For example, a married couple could have two individual accounts with $500,000 of coverage each, plus a joint account that would bring their aggregated coverage for that firm to $1.5 million.

As long as accounts are held by what the SIPC considers "separate customers," each account qualifies for separate SIPC coverage. Categories of separate customers include:

  • Individual accounts: those held by someone in his or her own name, or by an agent for another individual
  • Joint accounts: those held jointly by two individuals with equal authority over the account
  • Accounts held by executors, administrators, and guardians: those held in the name of a decedent, an estate, or an executor or administrator, or guardian (for example, for an UTMA account)
  • Accounts held by a corporation, partnership or unincorporated association
  • Trust accounts: those held on behalf of a valid trust created by a written instrument (trust accounts are considered separately from those of an individual trustee)

Each of your retirement accounts at a given firm also is generally eligible for an additional $500,000 SIPC coverage (including up to $100,000 in cash) in the event that securities in your account are lost or stolen.

Many brokerage firms also carry private insurance to cover problems with amounts above those that qualify under SIPC guidelines.

What qualifies for SIPC protection?

It's important to remember that SIPC does not protect against market risk or price fluctuations; if shares drop in value before a trustee is appointed, that loss of value is not covered by SIPC. The value of securities is determined as of the date upon which a trustee is appointed. In general, SIPC covers notes, stocks, bonds, mutual funds, and other shares in investment companies. It does not cover investments that are not registered with the SEC, such as certain investment contracts, unregistered limited partnerships, fixed annuity contracts, currency, gold, silver, commodity futures contracts, or commodities options.

Tip: SIPC protection applies only if a brokerage firm fails or experiences a theft of assets. It does not cover losses that result from fraudulent investments.

SEC protections

The Securities and Exchange Commission (SEC) also has provisions that can help protect investor assets. For example, the SEC requires brokerage and clearing firms to segregate money and securities in customer accounts from their own proprietary assets and funds. This can help protect customers from being harmed by a firm's own trading activity. Also, firms are required to maintain a certain level of capital reserves that would enable the firm to return customers' securities and cash in the event of a financial failure. The SEC specifies that customer claims are senior to other claims on a firm's assets.

Should the SIPC fund be deemed insufficient to meet investor claims--something that has never happened since the organization was created--SIPC has the authority to tap a line of credit set up with a consortium of banks. And if necessary, the SEC also is authorized to lend SIPC up to $1 billion, which the SEC would borrow from the U.S. Treasury.

How securities are returned to customers

In the event a firm is liquidated, any securities that are registered in a customer's name or in the process of being so registered (as opposed to being held in "street name," the most common form in which securities are held today) are returned to customers first. Assets held in street name make up what's known as the "fund of customer property." That fund is divided on a pro rata basis, with the assets shared in proportion to the size of claims. Only if securities are still missing after the pro rata distribution would SIPC coverage be applied to make up the difference, up to the statutory coverage limit. In the event of a liquidation, individual customers must file a claim with the designated trustee to ensure that their assets are recovered. Claim forms are available at www.sipc.org, where you also can check on the status of a liquidation proceeding.

Example(s): In the process of liquidating ABC Company, the trustee discovers that 97% of the pool of customer assets is intact, but 3% cannot be accounted for. Each customer would receive 97% of the property in his or her account, and SIPC would then make up the remaining 3% up to the applicable coverage limits.

Help protect your assets

  • Know whether or not your brokerage accounts are at SIPC member firms, and consider the coverage limitations for each account and for aggregated amounts.
  • Review and check all documentation, including trade confirmations and account statements, to ensure accuracy.
  • Make payments to the firm rather than to an individual, and send them to the appropriate business address.
  • Ensure that all records, such as addresses and beneficiary forms, are up to date and accurate. If dealing with a trustee for a failed firm, make sure the trustee has your correct, current address.
This article was provided by Forefield and distributed by Lawrence Sprung.

@MitlinFinancial