Much like the Federal Deposit Insurance Corporation (FDIC) was created to help consumers when banks fail, the Securities Investor Protection Corporation (SIPC) was designed to aid them when brokerages run into trouble. The SIPC is the government organization that steps in when a brokerage fails and replaces the missing assets from customer accounts. However not every investor is protected by the SIPC.
For those investors doing business with brokerages covered by the SIPC, 99% of eligible investors got their investments back when their brokerages failed. That is from 1970 (the year the SIPC was created by Congress) and 2005, an estimated 624,000 investors got more than $585 million from the SIPC, assisting in the recovery of $14.1 billion in assets.
How the SIPC and FDIC Differ in Their Protection
When a brokerage firm is closed due to bankruptcy or other financial troubles, the SIPC works to replace the assets missing from consumer accounts. Without SIPC protection, investors may lose their securities permanently or find themselves tied up in years of legal battles.
However, the SIPC does not offer the blanket protection given by the FDIC in the case of banking. When a bank fails, the FDIC goes in and replaces the total cash value in customers accounts up to a certain dollar amount, protecting the money of the risk-adverse. Investors, however, assume a certain amount of risk (even seek it out) when they make an investment. What the SIPC seeks to do is replace any missing stocks and securities when a brokerage runs into trouble.
It does not replace the value, but instead replaces the missing items (stocks, for example). Therefore, the SIPC does not cover individuals who were sold worthless securities. Among other ineligible investments that receive no protection under the SIPC are the following:
* commodity futures contracts
* fixed annuity contracts
* investment contracts (for example, limited partnerships)
Similarly, certain individuals are not protected by the SIPC and these include:
* general partners, officers, or directors of the firm
* beneficial owners of 5% or more of any class of equity security of the firm (other than convertible preferred stocks)
* limited partners with participation of 5% or more in net assess or net profits of the firm
* anyone with the power to exercise a controlling influence of the management or policies of the firm
* brokers, dealers, or banks who are acting for themselves rather than their customers
Process the SIPC Follows
When a brokerage firm fails, the SIPC usually asks a federal court to appoint a trustee to liquidate the firm and protect its customers. Customers of a failed brokerage will receive all the securities (stocks, bonds, and cash) registered (or in the process of being registered) in their name. After this, any remaining customer assets are then divided on a pro rata basis with funds shared in proportion to claim size. If there are insufficient funds, the SIPC will pay up to a ceiling of $500,000 per customer, with no more than $100,000 in cash.
The trustee depends on the accuracy of the failed firm’s records. Often, if the records appear accurate, the trustee and SIPC will arrange to transfer accounts to another firm, at which point a customer can either stay or leave the new firm. Most customers can expect to receive their property within 1-3 months, if the records are found to be accurate within the firm.
Delays of several months can occur when records are determined to be inaccurate or if the troubled firm’s principals are involved in fraud. Claims on customers accounts are calculated as of the “filing date.”
Where customers fall through the cracks in this system is when a firm is not covered by the SIPC, leaving the customers at a loss to collect any assets. When selecting a brokerage firm, a customer should always be sure that the firm says “Member SIPC.” This can frequently be found on company advertising. If there is a question about a particular firm’s participation, investors can check the following website for a particular firms participation:
Brokerage customers should exercise caution. Some SIPC members have affiliates or related companies or people in their employ who are not SIPC members. These companies often have similar names, operate from the same offices, or use the same people as the SIPC company, but are not covered. Investors should be sure to receive written confirmation of each securities transaction on their accounts from an SIPC member, as well as each statement.
How Investors Can Protect Themselves
In addition to ensuring that their brokerage firm is covered by the SIPC, deposits made (by check or otherwise) should not be made payable to an account executive or registered representative or any other individual associated with the company.
Investors should also keep vigilant watch for periodic statements, which should appear on a regular basis. Failure to provide a statement is a warning flag of impending trouble at a brokerage firm. Investors should contact their local Commission office if, for any reason, they suspect their brokerage has stopped doing business.
To recover missing assets, the trustee assigned by the SIPC will depend on the brokerage’s in-house records. Investor customers must prove mistakes have been made in record keeping if they disagree. Therefore, it is essential to keep copies of trade information as well as the latest monthly or quarterly account report. If an investor discovers a mistake in a confirmation or statement, it is essential that an investor put this immediately in writing to the brokerage firm, and retain a copy.
If a brokerage firm is put into liquidation, the trustee will notify its customers, sending a claim form to be completed and instructions on how to complete the claim. There are two essential deadlines in this process:
* court deadline (30-90 days of notice; this date will appear in the information sent to customers)
* federal law deadline (If a claim is filed after the court date has passed, but no later than 6 months, a claim is subject to delayed process and only a limited payment.)
The federal deadline absolutely bans any and all claims beyond the 6 month period. Failure to comply means an investor will lose everything, so it is essential that customers adhere to these deadlines.
Even if investors are notified that their accounts have been liquidated and transferred to a new brokerage firm, investors should still file claims, thus preserving the right to correct any errors. Remember, if something is incorrect in the brokerage records, the investor must be able to prove via documentation (that he or she possesses) that there has been an error. Otherwise, the trustee will accept the failed firm’s records at face value.
With vigilance, investors can help protect themselves in the worst case scenario and help preserve at least some of their assets should their brokerage firm fail. The SIPC was created to help protect investors, but only by working within its rules, can investors be assured it will truly assist them in times of trouble.