In case you haven’t heard, E-Trade got punked by Citi yesterday and its market value dropped by more than half in one day, ending at $3.59 per share. As recently as June, it was trading at $25. Shareholders are screaming class-action, but what if you’re just a regular brokerage account holder worried about bankruptcy? What happens when a broker-dealer fails?
First of all, your money at E-Trade Bank is covered by the FDIC. See here for a discussion of what happens if your bank fails. Your holdings at E*Trade Brokarege are covered by the Securities Investor Protection Corporation (SIPC). I have a feeling a lot of visited the SIPC website today… I did, and here’s what I found:
What’s Covered By SIPC, And What’s Not
The cash and securities ? such as stocks and bonds ? held by a customer at a financially troubled brokerage firm are protected by SIPC. Among the investments that are NOT protected by SIPC are commodity futures contracts and currency, as well investment contracts (such as limited partnerships) and fixed annuity contracts that are not registered with the U.S. Securities and Exchange Commission under the Securities Act of 1933.
Basically, if you had 5 shares of IBM, you’ll still end up with 5 shares of IBM regardless of its actual value.
How Much Coverage Do We Get?
Customers of a failed brokerage firm get back all securities (such as stocks and bonds) that already are registered in their name or are in the process of being registered. After this first step, the firm?s remaining customer assets are then divided on a pro rata basis with funds shared in proportion to the size of claims. If sufficient funds are not available in the firm?s customer accounts to satisfy claims within these limits, the reserve funds of SIPC are used to supplement the distribution, up to a ceiling of $500,000 per customer, including a maximum of $100,000 for cash claims. Additional funds may be available to satisfy the remainder of customer claims after the cost of liquidating the brokerage firm is taken into account.
What Happens After A Failure
- Best case scenario: Your shares are quickly transferred to another broker-dealer, and you can resume selling or buying as needed.
- Worst case scenario: Your brokerage firm has poor records, is put into liquidation, and the court-appointed trustee will notify you and send a claim form and instructions. You send it in, and you could wait months to receive your stock certificates back.
How quickly will I get my investments back?
Most customers can expect to receive their property in one to three months. When the records of the brokerage firm are accurate, deliveries of some securities and cash to customers may begin shortly after the trustee receives the completed claim forms from customers, or even earlier if the trustee can transfer customer accounts to another broker-dealer. Delays of several months usually arise when the failed brokerage firm?s records are not accurate. It also is not uncommon for delays to take place when the troubled brokerage firm or its principals were involved in fraud.
Good Precautions To Take
Given that you probably have no idea whether accurate records would exist or not, we should be prepared and keep good records of all your transactions and keep statements. If you have them online, I’d run backups or print them out regularly. Here is an example of a claim form from a smaller failed broker-dealer from 2001. It really does ask you to confirm all your holdings and even trade dates. More info:
Do I have to prove what the broker owes me? How does that work?
Yes, usually that is done by describing in your claim form the cash and securities that are owed to you. The court-appointed trustee will compare what you claim against the books and records of the brokerage firm. Frequently, your entire account can be transferred to another brokerage firm for your benefit before you have even filed a claim. However, there are sometimes instances of mistakes in brokerage firm records. In rare cases, these mistakes show transactions made without your authority. You should keep copies of trade confirmations. You should keep copies of your latest monthly or quarterly statement of account from your brokerage firm. A trustee may ask you to supply copies of these documents.
SIPC coverage definitely isn’t as nice as FDIC insurance. Not only do I have to prove what the broker owes me and submit claim form, but it may take 1 to 3 months to get my stock certificates back. In the meantime, I won’t be able to sell them (bad if you’re not a buy-and-hold’er). While it’s nice to know that I am covered, reading all this doesn’t make me want to stick with a brokerage company that is still entangled with unknown liabilities from subprime debt.
Many brokerages also offer additional coverage above SIPC levels, but that doesn’t really concern me as much as the documentation hassles and long delays. Here is another good brochure on SIPC and “Excess SIPC” coverage.
Why pay $12.99 a trade at E-Trade when you can get free stock trades?
By Jonathan Ping | Investing | 11/13/07, 3:09am