Here's What Happens if Your Brokerage Firm Goes Belly Up

There are protections in place in the event of brokerage failure.

You're working with a brokerage firm, sailing along with your investments, and you receive word that the firm has gone belly up. Here, we'll outline what you can expect and how much protection you will have available.

Historical perspective

In the past, brokerage firms that have been unable to meet their financial obligations have dealt with it in one of two ways.

1. Find a buyer: For example, in 2008, when Bear Stearns crashed, it was purchased by J.P. Morgan.
2. Self-liquidate: As Drexel Burnham Lambert was forced to do in 1990, firms who don't find buyers must liquidate.

Will anyone step in?

Yes, if a firm self-liquidates, securities regulators like the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) step in. The agencies work with the failed firm to ensure that your accounts are protected, and your assets are transferred to a SIPC-protected brokerage firm.

What is SIPC?

The Security Investor Protection Corporation (SIPC) is a federally mandated, non-profit corporation created under the Securities Investor Protection Act (SIPA) of 1970. That act mandates that U.S.-registered brokerage firms be members of the SIPC. It's their membership fees that fund the organization.

While the SIPC is not a government agency, its purpose is to speed the recovery and return of missing customer assets during the liquidation of a failed investment firm.

How much money is protected?

SIPC protection is limited, covering the replacement of missing stocks and securities up to $500,000. This amount includes cash claims up to $250,000. SIPC only comes into play when a firm shuts down, and customer assets are missing.

Why the term "legal customer" matters

SIPC coverage of $500,000 applies to each legal customer. Let's say that you have three accounts at the failed firm. One is in your name only, another is a joint account with your spouse, and the third is an IRA account in your name.

Each of these separate accounts is considered a legal customer, meaning that each is eligible for the full $500,000 coverage.

What's not covered

There are some losses that SIPC does not cover, including:

• Drop in value due to ordinary market losses.
• Investments in currency, fixed annuities, hedge funds, commodity futures, or investment contracts that are not registered with the SEC.
• Accounts of the brokerage firm's directors, partners, officers, or anyone else involved with the firm's failure.

What you should do if your brokerage firm is liquidated

In the rare event that your brokerage firm goes bust, you'll receive a notification letter. Here are the steps you should take:

• Gather brokerage account records, statements, trade confirmations, canceled checks, and correspondence with the firm.
• Check account statements to ensure they are accurate and reflect all cash deposits sent to the firm. Make sure there are no transactions you did not authorize.
• Follow the instructions provided by SIPC in filling out necessary forms. Make sure to complete your claim by the date set forth by SIPC. Any claims filed late cannot be satisfied.
• Be aware that you may be unable to execute trades or transfer your accounts during the liquidation process.

Due to security measures, brokerage failures are exceedingly rare. However, if you're concerned, ask your brokerage firm if it carries additional insurance coverage beyond SIPC-provided limits.