Is Your Brokerage Account Safe?

Please can you clarify what SIPC does? I called my brokerage firm to ask about the safety of my investment account, which is not covered by FDIC. They told me not to worry because my securities and cash are covered by SIPC. What does SIPC do if my brokerage firm goes under?

The Securities Investor Protection Corp. (SIPC) helps protect account holders if a brokerage firm goes bust. It's an important safety net that can help you worry less about the stability of your brokerage firm. But there are some key differences between how SIPC and the Federal Deposit Insurance Corp. provide protection, and remember that while SIPC can come to the rescue in cases of bankruptcy or fraud, it does not protect you against market losses.

Congress created SIPC in 1970, and nearly all brokerage firms registered with the Securities and Exchange Commission must be members. It covers stocks, bonds and other assets held at a brokerage firm that gets into financial trouble (the FDIC, on the other hand, covers bank deposits).

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Investors, however, have another layer of protection from bankrupt brokerages even before SIPC needs to step in because the SEC has strict rules about segregating the firm's money from the customers' investments. Even if a broker goes under, the investors' money should still remain intact.

"Even if a firm is in very serious trouble, it can either merge with another brokerage firm or sell part of its business," says Stephen Harbeck, president and chief executive of SIPC. "We only get involved when a firm used up its capital and has misappropriated customers' securities." SIPC did not need to get involved, for example, when Bear Stearns was acquired by JPMorgan Chase in March.

If a brokerage firm fails, SIPC first tries to transfer the investors' securities to another firm. If that doesn't work, then it attempts to rebuild the investors' portfolios, even buying new stocks or bonds to make up for any missing shares. To the extent possible, "We give you exactly what was in your account, and if we have to buy it, we will," Harbeck says. If the investments aren't available, SIPC will give you cash based on their value when the brokerage failed.

SIPC first returns your share of the broker's remaining assets, then uses its own funds (up to $500,000 per account, including a $100,000 limit on cash) to buy the same number of shares that you originally owned. That $500,000 limit only applies to the maximum amount SIPC will spend on its own to make up for any missing securities; not the total amount of money you can get back. If many of the customers' assets remain intact at the brokerage firm, then you can get back a lot more than that SIPC limit -- which is a key difference between how SIPC protects brokerage customers and how FDIC covers bank deposits.

In the rare case when an investor's losses exceed SIPC's limits, the difference usually is covered by brokers' supplemental insurance -- often provided by Lloyds of London or a new firm called CAPCO, the Customer Asset Protection Company, which provides excess SIPC coverage to 15 major brokerage firms, such as Goldman Sachs, Morgan Stanley, Raymond James and Wachovia Securities.

It's been extremely unusual for investors to max out their SIPC coverage, though. In the history of SIPC, only 349 people have not received the full value of their accounts from their prorated share of the firm's assets plus SIPC coverage, says Harbeck, who explains that most of those cases happened before 1978, when the maximum SIPC could advance was $50,000, rather than today's $500,000 limit. "With the current limits of protection and the tightening of the regulations protecting customer assets from being used as part of the broker firm's business, it's quite rare," he says.

Even though your assets should be protected if your brokerage goes bust, you may lose access to your money for a while. If SIPC takes over, it tends to take from one week to two or three months to get control of your account, or longer if the brokerage firm kept shoddy paperwork or was involved in fraud. SIPC does not protect against market losses while your account is in limbo.

For more information about how SIPC works, and to make sure your brokerage firm is a member, see the SIPC Web site.

For more information about how the FDIC works, see Is My Bank Safe? Also see the Deposit Insurance section of the FDIC Web site.