Is Your Broker Bankrupt?

Those poor E*Trade (Nasdaq: ETFC  ) investors. Their shares dropped nearly 60% in one day because of an analyst's suggestion that the brokerage firm's subprime mortgage exposure may lead to a run on accounts.

Account holders weren't all that pleased either. Suddenly, the question on the tongues of many investors was: What happens to me if E*Trade goes bankrupt? According to optionsXpress (Nasdaq: OXPS  ) and TradeKing, their phones have been ringing with E*Trade customers looking to transfer their accounts.

Sure, moving your accounts from a teetering broker to a seemingly more financially sound one is one way to go. It might be worth it if it helps you sleep at night -- even if it costs you a few dollars in fees to do so. But before you decide to trade one broker for another, do a little research.

  • Make sure your broker is a member of the Financial Industry Regulatory Authority, which requires members to carry SIPC insurance. The U.S. Securities Investor Protection Corp. is a federally chartered private corporation that protects investors from their brokers going bankrupt, just like the FDIC protects your bank deposits.
  • Maintain good records. Make sure you're receiving timely statements from your broker and that they're accurate. While the SIPC covers you for $100,000 in cash and $500,000 total, you need to prove to the SIPC what you're owed. They'll compare what you submit with what's in the broker's books. And, no, you can't get around the $500,000 limit by opening multiple accounts unless the accounts are in "separate capacities" (e.g., opening up an account in your name, a trust account, or a joint account). So says the Interactive Brokers (Nasdaq: IBKR  ) website.
  • If you're nervous about having all your money tied up with one brokerage, spread your money across multiple brokerages while staying under the $500,000 limit on each account.
  • Find out if your broker carries insurance above and beyond the SIPC insurance. E*Trade, for example, claims additional protection of up to $150 million on its website.
  • Don't panic. In the four decades since SIPC's founding, it has "advanced $505 million in order to make possible the recovery of $15.7 billion in assets for an estimated 626,000 investors."

So, althought you will get your stocks and money back -- eventually -- according to the SIPC website, it can take anywhere from one to three months for investors to be made whole. Delays of several months have occurred when the brokerage firm's records are not accurate. Delays are also not uncommon when the firm or its principals have engaged in fraud.

No one has accused E*Trade of doing anything illegal here. Rather, it's been feeding at the same trough of subprime mortgage dog food that's ensnared any number of companies like Countrywide Financial (NYSE: CFC  ) , Wachovia (NYSE: WB  ) , and Citibank (NYSE: C  ) . Like others that have needed a cash infusion to settle rattled nerves, observers think E*Trade might need a similar deposit or succumb to a buyout from the likes of TDAmeritrade (Nasdaq: AMTD  ) .

It seems doubtful at this point that E*Trade will actually go bankrupt. Some white knight, whether with cash or a buyout offer, will undoubtedly save the day. Heck, even the stock has rebounded, bouncing more than 50% from its absolute nadir Monday. Still, that doesn't mean investors shouldn't review their broker's position and allow themselves a good night's sleep.

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