What Happens If Your Broker Fails? SIPC Brokerage Insurance Info

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.

Summary
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?

Comments

  1. With the number of people investing through brokerages for their retirement the 500k seems a little low. That makes me want to start diversifying across a few houses instead of sticking to one or two.

  2. > 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.

    This wasn’t entirely clear (and neither was the source). Most securities purchased, unless otherwise specified, are purchased in the “street name” (the name of the brokerage that holds the assets for the customers. By “in their name”, does it mean that the actual securities must be requested to be held in the investor’s name, or the street name of the brokerage?

    Likely this is just splitting hairs, but where insurance and contracts such as this are concerned, one can never be too careful.

  3. Thanks for the clear and precise synopsis. One question – would the SIPC cover extend to foreign customers of E*Trade?

  4. Thanks for this post! Strong work. One question:

    Anyone know why commodity futures are different than stock vis a vis SIPC insurance? Just idle curiosity, not planning in futures trading!

  5. As an Etrade account holder it seems as though I have the following choices:

    1.) Do nothing and hope that Etrade doesn’t fail (or if failure seems imminent, another broker buys them out.)

    2.)Sell all my holdings and move the money. This will have tax consequences in my taxable account and even worse tax consequences in my IRA.

    3.) Transfer the accounts to another broker. The problem with this is that this is not an instant transaction. Say I go to Fidelity and ask them to transfer. They send a request to Etrade, which Etrade processes in their own good time. If many people start to bail, I fear the processing time for Etrade will get slower and slower; if Etrade purposely “drags their feet”, it will even get worse. Probably months.

  6. We’re covered, but I worry about problems if I’m using the money NOW.

    If I’m paying for a home addition, for instance, I can’t afford to wait for Etrade to go through a bankruptcy. I don’t necessarily expect that to happen, but I’m taking action because I can’t afford to have my money tied up.

  7. Danny Tsang says:

    I’m in the same boat as Mark, I’ve got a pretty large chunk in the e-trade savings account, but I also have my IRA and my regular brokerage account with them. I’m hoping for the best but I’m wondering if I should sell off and move it.

    Any other e-trade users reading this? Please give us your thoughts. Thanks for the detailed post Jonathan.

  8. James Wilcox says:

    I don’t think Etrade is going under. With the ability to absorb $1 billion in write-downs, it’s pretty irresponsible of the analyst to talk about bankruptcy. After all, Etrade’s core business is as a trading platform. The banking/mortgage business isn’t a huge part but yes, they will have some losses short term. Long term I think the company is fine and Wall Street put their stock on sale yesterday.

  9. As I understand it (me no lawyer), being held in street name means it is held by the broker in an independent depository trust with the actual owner as beneficiary. So in the event of a “organized” failure it will be very easy to redistribute the shares. But all this talk about poor records and having to send in proof makes me kind of queasy.

  10. As for E-Trade, it looks like they had a big bounce back up today. Not quite back to normal, but I don’t think they’ll fail instantly either. All this subprime stuff is still unraveling, with gradual credit downgrades and everything.

    What happened to E-Trade does seem isolated though, they used all their bank money to take extra risk by buying mortgage-backed securities.

  11. I am an E*trade customer as well. I have a savings & brokerage account there and am not even thinking about moving it. The subprime mortgages they are writing off are being valued as zero. However, there is a value to them.

    Honestly, if people are bailing because of this questionable report from Citi, then you really need to get a spine.

  12. I hope they dont go under, I really like their ease of website. I just move some of my savings and checking money to other places but kept some of it, along with the CDs. Worst case senerio they will be bought.

  13. I too have money in E*Trade’s savings account as well as my bill money in a Money Market sweep account that I use to pay bills from (best Billpay setup I’ve used also BTW). No plans to move any of it and am happy to know that I’m secure one way or another. If anything, E*Trade will be an attractive buyout rather than bankrupcy in my opinion (FWIW!!).

  14. ETFC seems like a good example to refute EMT. Any thoughts?

  15. Actually, I don’t think it refutes efficient market theory at all. The theory states that prices react almost instantly to all available information – as more comes out the price adjusts accordingly. When the Citi report came out, people reacted. E-Trade refutes, people react. More data comes out, people react.

    I’m sure some people made money off the last few days, but just as many people lost money. Could they have known beforehand? Was there a reliable method to profit from the last two days without insider information? I don’t know of any.

  16. Remember when Countrywide went through this in August (I believe). People were lining up at the physical Countrywide Bank branches in California. Three months later Countrywide is still here. They do seem to have to offer very high rates to attract money though.
    Maybe Etrade will have to offer higher bank rates. So long as you are under the $100k FDIC limit you should be okay with their bank.

  17. I forgot to add that I am leaving my checking, savings, brokerage and two IRA’s at Etrade and have no intention of bailing.

    In the worst case, my bank accounts would be covered by FDIC and the brokerage would be taken over by another brokerage. I doubt, however, that the worst case will come to pass.

  18. RothNovice says:

    Jonathan,

    How does Bill Gates and all the other billionaires keep their money? (apart from stocks)

    Even if u have $10 million cash, that would amount to almost putting ur money in 100 banks to protect urself. (Married, 50 banks, but still 100 accounts).

    Why doesnt FDIC increase insurance limit to $200K because even now many average joe’s have >$100K

    What is the alternative?

  19. ParatrooperJJ says:

    SPIC insurance covers $500,000. They also have private insurance that covers up to $49,500,000. This gives each person up to $50,000,000 in coverage. This amount is pretty much standard across the brokerage industry.

  20. to answer the above poster,

    The alternative is buying gold and silver coins with your excess over 100k, each gold coin will cost you $800+ and each silver coin+, you will have enough room, and I bet you can afford a nice little safe also.

    Thats the only way to store your weath at its current vaule instead of losing in paper money.

  21. I’nm a E*Trade customer, and while I don’t think the situation is ideal, I’m not doing anything. I have less than 500k, so SIPC insurance should cover me if worse came to worse. I for one think this is bit overblown. E*trade’s banking business is only a part of the entire business, and financial instutions like E*trade should be able to absorb $1 billion write down. It’s a writedown, it’s not like they have to make a billion dollar payment immediately.

  22. wow. amazing that one analyst’s words could cause such a sell off and really dramatically impact a company.

    could someone please elaborate on “writedowns” and what exactly that entails?

  23. I moved my assets from E*TRADE to Fidelity yesterday (was thinking about Schwab). The process is electronic, and takes 5-7 days. This is my assets and I don’t need any delays in being able to trade, it’s ridiculous not to take action when you can.

  24. Etrade’s CEO has already indicated that it has enough cash reserves to handle the write-downs. He ruled out the possibility of bankruptcy, although he did caution that these things are always unpredictable.

    Etrade will be fine in my opinion. Then again, I have all of my money with Fidelity…
    -R

  25. Pinnacle of Cynical says:

    I was a happy Brownco customer absorbed against my wishes by E*Trade. This debacle finally inspired me to leave E*Trade, but I probably would have moved anyway because I’ve always been weary of the financial superstores. The lessons of the Glass-Steagall Act (repealed in 1999) will apparently need to be learned the hard way by a new generation of investors.

    The five million retail customer accounts at E*Trade are worth a fortune. TD Ameritrade would almost certainly try to acquire them; however, if AMTD and ETFC can’t agree to terms and ETFC fails, the story of MJK Clearing is something to consider in your decision to stay or go.

    According to the SIPC, Trustee James Stephenson was appointed in September 2001 to represent the interests of more than 175,000 customers of MJK Clearing. On 06/10/2004, the SIPC announced that the United States Bankruptcy Court for the District of Minnesota has approved the final distribution of payments to the remaining customers of MJK Clearing. No typos – approximately 3 years! I’m sure most customers didn’t wait that long, but some did. (http://www.sipc.org/media/release10jun04.cfm)

    E*Trade has almost 5 million retail accounts (27x times more than MJK). How long might it take for a bankruptcy trustee to sort that out? I’ll leave that as an exercise for the reader.

    Good luck.

  26. Let’s clear up something about E-trade and brokerages in general. They don’t make money from the trading fees. That’s minor noise. If all 5M customers made 5 trades a year, that’s 250M a year. Look at the financials — E-Trade’s expenses are 750M a year. Just the trading alone is a loss.

    Where brokerages make money is taking money sitting idle in sweep accounts (+ their bank offerings) and making loans against that money. E-trade has a portfolio of 40B in mortgage loans! E-Trade’s CEO says they could easily absorb a 1B writedown. Uh, that’s 2.5%. Totally over-optimistic. Citibank used 10% because that’s what’s happening in the subprime market now. (The numbers actually may be worse — but Citibank can’t use 20% because they they’d have to writedown another 15B themselves.) A 10% writedown would completely wipe out the 4B in equity E-Trade has.

  27. I’m a little confused on the SIPC insurance. They insure up to $500,000 per customer including a maximum of $100,000 cash. What if you have $100k in stocks but have $150k in cash. Is the $150k in cash covered or not?

  28. I wish someone had answered Dks’ question above. My entire IRA is in Money-Market funds with TD Ameritrade. I’m assuming Money Market Funds are what you all refer to as “cash.”

  29. Sometimes when people say cash, they mean money market funds. Sometimes they mean bank accounts.

    Bank accounts (or less commonly money market accounts w/ a bank) = FDIC insured cash (if bank is FDIC member), Money Market funds with a broker = SIPC.

  30. me haenggi says:

    We are trying to find out how much protection we have for our IRA. Is everything covered? Or is there a limit as there is for regular brokerage accounts? I am wondering if we should consider spliting up the account. Like people do with the insured bank accounts.

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