what happens when a broker fails: sipc coverage

In short

A friend of mine once asked me what happens to her savings if her brokerage simply closes its doors. I told her I did not know, and I was a little ashamed of that. So I went and learned it, and here is what I found. If you hold stocks, bonds, or cash at a brokerage, a group called SIPC may step in when that firm fails. SIPC stands for the Securities Investor Protection Corporation, and it was created by Congress. It returns your shares and cash, up to a limit set by law, and that limit is the current figure, which the official source publishes each year per customer, per kind of account. It does not cover losses from the market going down. Check that your firm is a SIPC member on sipc.org, and keep your statements.

The whole of it

What it is

You have probably wondered whether your money is safe sitting at a brokerage. It is a fair worry, and a sensible one.

SIPC is a nonprofit corporation that Congress created under the Securities Investor Protection Act of 1970. Nearly every brokerage that deals with the public must be a member. Its job is narrow, and I think it helps to say so plainly. It steps in when a member firm fails and customer assets are missing. It does not guard you against a bad investment. It does not guard you against a falling market. It does not guard you against a poor decision you made yourself.

Think of it this way. A bank fails, and the FDIC protects your deposits. A brokerage fails, and SIPC works to give back the stocks and cash the firm was holding for you. These are two different agencies with two different jobs. Mixing them up is easy, and a lot of good people do it.

One more point deserves a word. SIPC is not an agency of the government, and it is not the same as insurance against loss. It is a backstop for one kind of trouble, which is the firm itself going under or its assets going missing.

How it works

A friend of mine once found out his firm was in trouble, and his first question was a good one. What happens next? Here is the path, as SIPC describes it on its own site.

When a member firm fails, SIPC can ask a federal court to start a liquidation. That is a court supervised process for winding the firm down. A trustee is appointed to run it. The trustee's first task is to find out what each customer is owed, using the firm's books and the customer's own records.

Whenever possible, the trustee moves customer accounts to another brokerage. Then customers can reach their holdings again. If that cannot be done, the trustee returns the securities and cash directly. Customers get back what the firm held for them, up to the legal limits.

There are two limits worth knowing. The protection covers a total amount per customer, and inside that total sits a smaller cap for cash. The official figures change by law, so the numbers appear in the next section. The protection is also counted per customer in each separate capacity. An individual account and a joint account are separate capacities, for example, and each gets its own limit. SIPC explains how this works in its publication on what SIPC protects.

It is slow work. A trustee must sort through records, and some cases take months. Patience is part of it. Your shares are still yours during that time.

The numbers, and where to find yours

If you are holding an account right now, you may want a number to hold on to. Here are the figures.

The total protection limit is the current figure, which the official source publishes each year per customer, per capacity. The cash limit inside that total is the current figure, which the official source publishes each year. Both are set by law, and the site fills in the verified figure with its source and date.

To find your own situation, start with your latest statement. It lists what you hold and the cash balance. Add up your securities at their market value on the day the firm fails. That day is the one that counts, not the day you bought. Then compare the total to the limit for each account type you own.

Next, confirm that your firm is a member. SIPC keeps a searchable list of members on sipc.org. Do this today, before any trouble comes. It takes two minutes.

Last, keep your own records. Trade confirmations and monthly statements are your proof. If a trustee ever asks what you were owed, those papers answer the question.

A worked example

Let me tell you about a woman I will call Marlene. She is a retired teacher who keeps one individual brokerage account. On the day her firm fails, her statement shows $180,000 in stocks and bonds and $15,000 in cash. Her total is $180,000 plus $15,000, which is $195,000.

To make the arithmetic easy, pick a story total cap of $500,000 and a story cash cap of $250,000. Those two figures are made up for this tale. They are not the current limits. The real limits are the ones the site shows in the section above. Marlene's total of $195,000 sits well under $500,000. Her cash of $15,000 sits well under $250,000. So everything she is owed falls inside the protection.

Now picture her neighbor, Walter. He has an individual account holding $620,000 in securities. On the failure date, SIPC works from that day's value. Using the same story limit, $620,000 minus $500,000 leaves $120,000 above the cap. That $120,000 is not covered by SIPC. Walter may still recover some of it from the firm's remaining assets, but SIPC does not promise it.

Here is the part people miss. Say Walter also has a joint account with his wife worth $400,000. That is a separate capacity. It gets its own $500,000 limit in this story. His $400,000 there is fully inside the line. One person can hold protected accounts in more than one capacity.

Where it goes wrong

I have watched good people trip over this, and I do not say it to scare anyone. I say it because a little knowledge now saves a lot of grief later.

The first mistake is believing SIPC covers losses from the market. It does not. If a stock falls by half, no one pays you back. SIPC only works when a firm fails and assets are missing.

The second mistake is thinking every financial company is a member. Some firms, and some products, sit outside SIPC. A few examples are commodity futures accounts and certain investment contracts. SIPC lists these exclusions on its site. Do not assume. Check.

The third mistake is mixing up SIPC with the FDIC. Cash in a bank account is protected by the FDIC. Cash in a brokerage account is protected by SIPC, if the firm is a member. Each has its own limit, its own rules, and its own paperwork.

The fourth mistake is waiting. After a firm fails, a trustee sets a deadline for filing a claim. Miss that date and your claim can be hurt. The trustee must send notice, and the customer has to respond in time.

The fifth is a quiet one. Some people think a very large account is fully safe because the firm is famous. A big name does not raise the limit. The cap is the same for a small firm and a giant one.

None of this means you did something wrong by trusting your brokerage. It means a clear look at the facts makes you steadier.

Questions to answer before you leave this page

Do you know whether your brokerage is a SIPC member, and have you looked it up on sipc.org rather than taking anyone's word for it? Have you added up what you hold in each account and compared it to the limit for that kind of account? Do you keep your monthly statements and trade confirmations somewhere you can reach them, even if the firm's website is down? Do you understand that SIPC does not cover a drop in the market, only a failed firm with missing assets? Do you hold accounts in more than one capacity, such as individual and joint, and do you know each gets its own limit? Would you know where to look for the claim deadline if a trustee ever sent you a notice? And have you set aside ten quiet minutes this week to check all of this, so that worry has less room to grow?