Even though it might seem like the end of the world when your broker goes broke, it’s not. Well, it might be the end of your broker’s world, but it’s not the end of your world. In virtually all cases, your assets — and your wallet — will come out unharmed.
SIPC to the rescue
The U.S. Securities Investor Protection Corporation (SIPC) will be your best friend if your broker goes under. It’s pretty much the FDIC (Federal Deposit Insurance Corporation) of brokerage accounts — it insures shareholders just like the FDIC insures bank deposits.
In the unlikely event of a brokerage failure, the SIPC and a court-appointed trustee will work together to restore securities and cash to all customers. Sometimes, they’ll just arrange to have all of the accounts transferred to another brokerage firm. When this isn’t possible, they may initiate a liquidation.
If they go with Plan B, the trustee and the trustee’s staff will close the brokerage firm, ask all customers to file claims on what assets they were holding, and then compare the claims to company records in order to determine payment. All securities that were owned by specific customers (“customer name securities”) will be handed back. All other securities (“street name securities”) will be sold and redistributed to customers in proportion to the size of their claims.
If there aren’t sufficient funds in the firm’s customer accounts, the SIPC will provide some cushioning (up to $500,000 per customer, including a maximum of $250,000 in cash). Many brokers also purchase additional private insurance to cover losses beyond that — sometimes up to millions of dollars.
Of course, there’s no guarantee that you’ll be totally reimbursed if your broker goes bankrupt, but your chances are pretty good — the SIPC has a track record of compensating (in full) 99% of eligible investors.
What types of investments are protected?
The SIPC protects customers’ cash and just about all types of securities. The only items that aren’t covered are investments in commodity futures, currencies, hedge funds, fixed annuities, and investment contracts (such as limited partnerships) that aren’t registered with the Securities Exchange Commission.
But remember … the SIPC only covers missing assets. This means that you won’t be bailed out if the value of your securities falls, or if your broker has been ripping you off over the years. (Check out this page for more details.)
Is my brokerage firm covered?
The large majority of brokerage firms are registered with the SIPC – only a select few special-product firms, like those that sell only mutual funds or variable annuities, aren’t members. So chances are, you’re covered. (But you can visit the SIPC’s List of Members just to be sure!)
That being said, keep in mind that not all SIPC-insured brokerage firms are created equal. So if you’re shopping around for a broker, don’t just use the close-your-eyes-and-point approach to make your decision. One size doesn’t fit all, so it’s important to do your research.