The safety of brokerage accounts is front and center for the first time since 2008, thanks to the bankruptcy of MF Global. News stories indicate that about $1.6 billion of customer funds disappeared from MF Global accounts. Customers are denied access to all or part of their account balances and many won’t be made whole. The bankruptcy trustee recently reported it found what happened to most of the cash but still hasn’t located many customer assets that were used as collateral by the firm.
Can this happen to your brokerage account?
Brokers are supposed to segregate their clients’ accounts and assets. But MF Global was a commodity broker, not a securities broker. MF Global was regulated by the CFTC, not the SEC, and was subject to different rules than securities brokers. MF Global was allowed to pledge customer assets for loans the firm used to purchase assets for its own accounts. The purchases were supposed to be limited to safe assets, but European government debts were considered safe assets under the rules at the time. They no longer are.
Another shortcoming of using MF Global or another commodity broker is that the firm isn’t insured by the Securities Investor Protection Corporation (SIPC). Securities brokers are required to pay fees to the SIPC in return for insuring up to $500,000 per accounts.
To maximize safety of your brokerage account, be sure you are using a securities broker regulated by the SEC and required to insure accounts with SIPC. Avoid commodity brokers. Even then, the SIPC coverage and key SEC restrictions might not apply to investors who use futures, options, or leverage (debt). For those situations, your protection is complicated. You’ll have to read the brokerage agreement closely or ask the broker.
When an account is insured by SIPC and a broker fails, SIPC first attempts to return all stocks, bonds, and options to the customers for whose accounts they were purchased. The trustee put in charge of overseeing the broker’s assets is given cash from SIPC to buy these covered assets from the broker and give them to the customers. Then, the broker’s cash, futures, currencies, commodities and other noncovered assets are divided pro rata among customers who bought those assets for their accounts.
Beyond that, SIPC covers losses up to $500,000 per customer with a $100,000 ceiling for cash. Many brokers purchase from private insurers coverage above these limits.
Money markets funds are considered securities, not cash. Exchange-traded funds are securities, regardless of their underlying assets. Securities that were registered in a customer’s name by the broker are returned to the customer regardless of any coverage limits.
There can be delays in the recovery. Assets and customer accounts are frozen until the trustee and SIPC can sort things out and are ready to return assets to customers. The process takes anywhere from weeks to years, depending on the condition of the broker’s and the customers’ records.
To maximize protection, consider holding no more than $500,000 at one broker and avoiding assets not covered by the SIPC. You can check with a broker for any coverage in excess of SIPC levels. Other goods steps are to check a broker’s rating from credit rating firms, and its capitalization and market cap. Review of the extent of a broker’s business for potential bombs such as the amount of trading it does for its own account. A broker that is just a broker is likely to be safer than a broker with aspirations to be an investment bank, such as MF Global.
Another concern is the firm that does trading for the broker, known as a clearing firm. This firm might be holding many of the securities in its name, and its failure would delay a customer’s access to the assets.
More information about the insurance and recovery process is available at www.sipc.org, including a brochure on brokerage firm liquidations.
We discussed the safety of other types of financial accounts and assets in the November 2011 issue, and that discussion is available on the members’ web site.
RW March 2012
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