Could your broker face a financial collapse? That’s highly unlikely. Multiple regulatory safeguards help ensure brokerage firms remain financially solid and investor assets stay safe.
Still, “unlikely” is not the same as “impossible.” So the question naturally arises: What would happen if your broker faced financial distress and possible failure? That’s when the Securities Investor Protection Corporation (SIPC) would step in.
Unlike the Federal Deposit Insurance Corporation (FDIC), which insures U.S. bank deposits, the SIPC isn’t a government agency or a regulator. Instead, it is a “non-profit membership organization” created by the brokerage industry following the enactment of the Securities Investor Protection Act of 1970. Today, any broker registered with the Securities and Exchange Commission must be an SIPC member.
What SIPC does
The primary role of the Securities Investor Protection Corporation is to protect investors “against the loss of cash and securities…held at a financially troubled SIPC-member brokerage firm,” according to the organization’s website.
SIPC coverage does not protect the value of one’s investments. It doesn’t bail out investors who’ve followed bad advice or restore losses from market declines. Instead, SIPC guards the “custody function” of brokerage firms. In other words, if your investment assets were missing because of a brokerage failure or fraud, SPIC would act to restore those assets.
How much protection?
Before discussing protection limits, let’s clarify what SIPC guidelines mean by “cash and securities.” In this instance, “cash” refers solely to uninvested money held in a brokerage account, such as proceeds from the sale of stock or bonds, or money transferred to your brokerage account that hasn’t yet been invested.
Although investors typically consider money-market funds (MMFs) to be a “cash” holding, SIPC treats MMFs as “securities,” along with stocks, bonds, traditional mutual funds, ETFs, brokered CDs, and several other types of investments.
That’s important because while SIPC coverage for uninvested cash is limited to $250,000, its combined limit for cash and securities is $500,000. For example, an investor with $300,000 in uninvested cash would not be fully covered. However, an investor who held $300,000 in money-market funds — and up to $200,000 in additional securities — would be covered.
SIPC’s coverage limit of $500,000 was set in 1980, and is no doubt inadequate today. On average, investors between the ages of 55 and 74 have more than $500,000 in retirement account holdings, according to Federal Reserve data.
That said, an investor with multiple types of accounts actually has more than $500,000 in SIPC coverage because each type of account is considered separately.
A Roth IRA and a traditional IRA, for example, would each qualify — providing an investor with each type of account total coverage of $1 million ($500,000 per account). Likewise, a joint account held by a husband and wife has a $500,000 coverage limit that is separate from the coverage provided for an individual account held by one of the spouses. Trust accounts and guardianship accounts also qualify separately.
“Excess coverage”
Since investors with significant holdings might consider SIPC coverage insufficient and be tempted to spread their investments among multiple brokerage firms, many brokers carry “excess of SIPC” coverage from various insurers.
For example, Fidelity Investments has $1 billion in additional coverage through Lloyd’s of London and other insurance companies. There is no per-customer dollar limit on coverage of securities, and uninvested cash is covered up to $1.9 million. “This is the maximum excess of SIPC protection currently available in the brokerage industry,” according to Fidelity (PDF).
Schwab also offers extra coverage. “Schwab’s Excess SIPC program has a $600 million aggregate,” says the Schwab website. “This helps ensure claims will be covered in the event of a brokerage firm failure and funds covered by SIPC protections are exhausted.”
E-Trade also offers “excess of SIPC” coverage “with an aggregate limit of $600 million.” Firstrade and Vanguard provide additional protection, too.
(Even though all these firms carry robust levels of excess coverage, remember that brokerages hold hundreds of billions of dollars — in some cases, even multiple trillions of dollars — in customer accounts. Therefore, even the highest levels of excess coverage would be insufficient in the face of a catastrophic failure in which investor assets went missing.)
SIPC in action
Suppose the Securities Investor Protection Corporation learns that a brokerage firm is in financial trouble. It first would act as a “matchmaker” rather than an insurer. SIPC would seek out a healthy firm willing to take on the failing broker’s clients, in a manner somewhat similar to the FDIC finding a strong bank to assume the customer accounts of a failed bank.
The matchmaker scenario occurred during the 2008 Global Financial Crisis when the financial services firm Lehman Brothers collapsed. Accounts at Lehman’s brokerage unit were largely unaffected and SIPC quickly facilitated the transfer of those accounts to London-based Barclays.
Brokerage failures involving missing investor assets are different. In 2011, when commodities broker MF Global failed, investigators discovered the company had illegally tapped into customer funds to shore up its weakening financial position. In this case, SIPC initiated court proceedings that enabled clients to recover misused money (from MF Global’s parent company and subsidiaries).
A high level of protection
In summary, your account is guarded first by regulations that require your brokerage firm to segregate its internal financial operations from investor holdings. Next, your holdings are protected by SIPC coverage and other SIPC functions, including the “matchmaker” role that likely would move your account intact to a healthy firm if your brokerage ran into financial difficulty. Finally, client assets are covered by brokerage-purchased supplemental insurance running into the hundreds of millions of dollars.
So, is your brokerage account safe? Yes, in all but the most dire financial circumstances. Theoretically, it is possible for each of the protections and backstops described above to prove insufficient. The risk, however, is extremely remote.
