Money Matters: Gauging the safety of your brokerage account

 David Peartree, The Daily Record Newswire

A recurring question in the aftermath of the 2008 financial crisis has been, “is my brokerage account safe?” The answers, with further explanation to follow, are “yes,” “eventually” and “probably.” In other words, it depends.

The bankruptcy filing by Lehman Brothers in September 2008 marked the point at which the financial crisis truly intensified and grabbed the attention of the public. At the time, Lehman Brothers was the fourth largest U.S. investment bank and its holdings included a substantial brokerage operation.

Most accounts of retail investors were taken over by Barclays and were just fine, but another four years passed before the liquidation process finished returning an estimated $15 billion to a variety of other brokerage customers. All customers of the Lehman Brothers brokerage were eventually made whole by the bankruptcy trustee and without the need for SIPC coverage to satisfy any claims.

That’s reassuring, sort of, but in the years following the Lehman collapse the Madoff scandal and the implosion of MF Global, the commodities trading firm run by former New Jersey governor and U.S. Sen. Jon Corzine have kept this issue alive.

Brokerage customers can count on several basic protections. First, brokerage firms are required to segregate customer assets from their own assets and the assets of other customers. Second, brokerage accounts held with a SIPC member are protected up to statutory limits. Third, some brokerages will supplement SIPC coverage by securing additional insurance at Lloyd’s of London or elsewhere.

Most investors have at least heard of SIPC, the Securities Investor Protection Corporation. “Member SIPC” is a standard disclosure and is the usual reassurance that is dusted off when financial markets get shaky and clients begin to ask questions about their accounts. Let’s parse SIPC’s own description of what it does.

“The statute that created SIPC provides that customers of a failed brokerage firm receive all non-negotiable securities — such as stocks or bonds — that are already registered in their names or in the process of being registered. At the same time, funds from the SIPC reserve are available to satisfy the remaining claims for customer cash and/or securities held in custody with the broker for up to a maximum of $500,000 per customer. This figure includes a maximum of $250,000 on claims for cash.”

In other words, one of the first steps in the event of a failed brokerage is that any securities registered in a customer’s name are returned to the customer. While that sounds reassuring, the reality is that in most cases securities are not registered in the customer’s name, they are held in “street name.” This applies to most mutual funds, ETFs and stocks.

Street name registration means that securities are actually registered in the name of the brokerage firm or its clearing agent even though the brokerage customer owns them. In a sense, the legal and beneficial ownership are split. This is done to allow for the easy transfer of securities, without which the markets could not operate efficiently.

Securities registered in street name are distributed among the brokerage customers based on their claims of ownership. If there are insufficient funds to satisfy all claims, then SIPC protection kicks in.

The track record of SIPC is quite good. SIPC estimates that since 1970 at least 99 percent of investors who were eligible for protection have been made whole in the case of failed brokerage firms. Still, the fact that over 770,000 investors and $120 billion of recovered assets have been through the process tells you that this is not simply a hypothetical concern. Brokerage failures do occur.

Even in those cases where investors are made whole, the process can take months, in some cases years, and being made “whole” can be debated when an investor is precluded from using the security, selling it, or pursuing other opportunities.

Investors can take several additional steps to protect themselves.

First, investors should understand with whom they are dealing and whether that party is a SIPC member. It may not be obvious that there is more than one entity operating behind the scenes in a brokerage relationship. Some brokerage firms handle all clearing functions internally, others work through an affiliated or related company, while others delegate clearing functions to an independent company.

“Clearing” refers to the performance of back office functions such as handling account deposits, executing trades and processing confirmations. Investors should confirm and not simply assume that each such entity is a SIPC member. Account deposits, in particular, should only be directed to a SIPC member.

Second, investors should understand whether they opened a “cash” account or a “margin” account. In a cash account the investor must pay for a trade in cash on the settlement date. A margin account is one in which the investor is able to borrow against the account to fund a transaction. Most investors only need a cash account, but margin accounts are sometimes opened inadvertently or without the investor fully appreciating the risks.

Most margin account agreements allow the brokerage firm to borrow securities from a customer’s account and loan them out (a process known as “rehypothecation”) for their own gain. If the brokerage firm fails, the customer may be in no better position than an unsecured creditor who must contend with other creditors for the recovery of those assets.

Third, read your account agreement and related materials. It’s all there, in the fine print.

Most brokerage accounts are very safe and the risk of losing money due to the financial failure of a brokerage firm is low. But investors should understand when their actions or inattentiveness might introduce greater risk.


David Peartree, JD, CFP® is the principal of Worth Considering, Inc., a registered investment advisor offering fee-only investment and financial advice to individuals and families. Offices are located at 160 Linden Oaks, Rochester, NY 14625; email