What Happens If Your Broker Goes Bankrupt?

How to Protect Your Investments If Your Brokerage Goes out of Business

Businessman in abandoned office after he lost funding for the building.
•••

Image Source / Getty Images

If you have an account with a brokerage firm, you may wonder if your money is truly safe. After all, a brokerage firm can go bankrupt like any other business. What would happen to your stocks, bonds, mutual funds, and other securities? It's an alarming thought, but there are some protections in place that would help you.

Failures in Difficult Economic Times

Some of the most notable and long-standing financial institutions can fall by the wayside during economic difficulties.

Brokerage firms are just one of the financial institutions that can find themselves in trouble during major economic downturns. When this happens, firms that carry a great deal of financial clout may partner with other firms to remain competitive or even viable. Others may simply close and self-liquidate.

Consider the story of Bear Stearns, the global investment bank and brokerage firm that failed after the financial meltdown of 2008. Its involvement with the subprime mortgage crisis led to its collapse and subsequent purchase by JPMorgan Chase. Another example of a bank thought "too big to fail" was Lehman Brothers, which was the fourth-largest investment bank in the U.S. before its bankruptcy in 2008. It, too, was involved in the subprime mortgage crisis before its failure.

A Safety Net for Your Investments

One reassuring thought is that brokerage firms are under a watchful eye when it comes to investor funds. There are many regulations—not to mention regulatory agencies—that are intended to reduce the risk of brokerage failure.

For example, the U.S. Securities and Exchange Commission (SEC) has something called the Customer Protection Rule that says firms are required to segregate client assets from firm assets; accessing the money in client accounts would be committing fraud. Another SEC regulation, called the Net Capital Rule, says that firms must keep a minimum amount of liquid assets, depending on their size. 

FINRA, the financial industry regulatory authority, regularly monitors firms for compliance with these and other regulations.

The Securities Investor Protection Corp (SIPC) is another layer of protection for investors: This organization insures investments and oversees the liquidation of its member firms when they close, helping investors transfer their accounts and protecting their assets in the event of financial disaster.

How the SIPC Can Help

The SIPC protects clients' cash and securities, such as stocks and bonds that are held at troubled financial firms. The SIPC will protect up to $500,000 in cash and securities; of that, $250,000 may be in cash.

Many firms have their own supplemental insurance as well, which covers client assets in the event of financial failure.

What the SIPC Does Not Do

Though the SIPC covers securities like stocks and bonds, it doesn't cover everything. Commodity contracts, limited partnerships, hedge funds, and fixed annuities contracts are not eligible for SIPC protection.

The SIPC also does not cover your losses in the market, poor investment decisions, or missed investment opportunities. Those are still your responsibility, and they're just part of the risk of investing.

Finally, the SIPC is not a government agency, although it was created under a federal law. The SIPC does not work the same as the Federal Deposit Insurance Corporation (FDIC); it doesn't provide blanket coverage, but rather it will help you in the event your brokerage fails.

How to Protect Yourself

Your priority is to be diligent about your investment portfolio. No one is ever going to care about your financial health and security more than you do. Even if you have an ethical broker with whom you have a long-standing relationship, it's still your job to do your due diligence.

Therefore, you should check to make sure the firm you are dealing with is a member of SIPC. It only takes only a few minutes to verify this, so it's worth the effort.

Another simple way to protect yourself is to maintain organized records of your securities and your accounts. Keeping your paperwork in order will help you if the brokerage firm you are dealing with should go out of business. You might need those account statements to prove that you own what you say you own in the event of a brokerage firm failure. Remember, you may know and respect your broker, but he may be in the dark about the firm's financial health.

To get a picture of how the firm is doing, check out their company filings with the SEC. These records will show you important information about the firm's finances. You can also check with the firm itself to see whether it offers more insurance beyond what the SIPC will cover.

Alternatively, you can hold your assets directly through something such as the direct registration system, or you can set up a custody arrangement with a very strong bank trust department. Both of these options will safeguard you and your money against an unforeseen disaster.

Article Sources

  1. U.S. Securities and Exchange Commission. "SEC’s Oversight of Bear Stearns and Related Entities: The Consolidated Supervised Entity Program," Page 4. Accessed Feb. 4, 2020.

  2. FINRA. "If a Brokerage Firm Closes Its Doors." Accessed Feb. 4, 2020.

  3. SIPC.org. "Mission." Accessed Feb. 4, 2020.

  4. FINRA. "Investor Checklist." Accessed Feb. 4, 2020.