How Safe Is Your Broker?

It's not a good day to be an E*Trade (NYSE: ETFC) investor. The shares shed more than half their value this morning after a Citigroup analyst issued a bearish warning on the company. With writedowns on E*Trade's mortgage portfolio mounting, the analyst feels there is a 15% chance that the company will have to file for bankruptcy to get out of its mess.

Sure, a 15% chance of filing for bankruptcy reorganization translates into an 85% chance that it won't go into Chapter 11, but the b-word can make investors do some crazy things. It doesn't matter that the glass is 85% full when the rest of it can fill a shot glass with its airy poison.

So we know why E*Trade investors are smarting today. What about E*Trade brokerage account clients? After all, despite the devalued loans, E*Trade remains a popular discount broker and online bank, thanks to its low trading commissions and chunky banking product yields.

Last month's quarterly report found total accounts climbing by 6%, with client assets soaring 18% higher. All three of the major discounters -- E*Trade, TD AMERITRADE (Nasdaq: AMTD), and Charles Schwab (Nasdaq: SCHW) -- came through with respectable gains in their retail brokerage divisions last month.

Even the smaller Web-savvy trade enablers like optionsXpress (Nasdaq: OXPS), TradeStation (Nasdaq: TRAD), and Investools (Nasdaq: SWIM) are making the most of recent market volatility to keep business growing.

Will the very whiff of a potential bankruptcy be enough to derail the sector? Two months ago, an identity theft hack into TD AMERITRADE's system had some wondering if their identities were safe. TD AMERITRADE rose above it, but an E*Trade bankruptcy conjures scarier images of portfolios being sucked dry in bankruptcy court.

Thankfully, it doesn't work that way. Bank deposits at E*Trade are FDIC-backed up to $100,000, while securities are protected up to $500,000 through SIPC. If you have more than that sitting in any brokerage account, you may want to consider splitting that among different brokerages, though the vast majority of discount brokerage clients will be covered by the SIPC and FDIC protection.

So it's perfectly understandable for E*Trade shareholders to be concerned. Today's stock price hit is a brutal paper loss. There are only so many hits an asset-backed loan portfolio can take. However, the 4.7 million retail accounts being watched over by E*Trade are also being watched by a few higher authorities.