Bank customers have enjoyed the security and protection provided by the Federal Deposit Insurance Corporation (FDIC). Customers can rest easy knowing their savings deposits are backed by the full faith and credit of the U.S. government for up to $250,000 per account. However, those in search of higher returns who were willing to risk their money in the securities markets, for much of Wall Street history, had virtually no protection of any kind, even from losses due to broker/dealer bankruptcy.

Tutorial: Basic Financial Concepts

In 1970, Congress created a new agency known as the Securities Investor Protection Corporation (SIPC). This agency's only function is to cover the losses of investors incurred by the bankruptcy of their broker/dealer. Read on to learn about the difference between the FDIC and the SIPC, as well its rules of eligibility.

Not the FDIC

The FDIC insures account holder losses up to $250,000 regardless of the cause, whereas the SIPC will only reimburse investors in the event of broker/dealer insolvency. The SIPC does not cover any kind of loss incurred as a result of market activity, fraud, or any other cause of loss other than the bankruptcy of a broker/dealer. Regulatory agencies such as the Securities And Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) deal with issues related to fraud and other losses. (For more, see Is there a form of insurance for my investments?)

About the SIPC

The SIPC either acts as a trustee or works with the client to recover assets in the event a broker/dealer becomes insolvent. The SIPC will also oversee the recovery process and ensure that all customer claims are paid in a timely and orderly fashion, and all recovered securities are distributed on an equitable, pro-rata basis.

Who Is Eligible?

Most investors are eligible for reimbursement under SIPC guidelines. The exceptions are as follows:

  • A firm's general partner, officer or director
  • The beneficial owner of at least 5% of any class of a firm's equity security
  • A limited partner who owns or receives at least 5% of the firm's net assets or profits
  • Anyone who exercises a controlling influence over the firm's management
  • A broker/dealer or bank acting for itself rather than for its customers

How Much Is Reimbursed?

The SIPC will reimburse investors for up to $500,000, of which up to $250,000 can be cash. Any securities that are already registered in certificate form in the investor's name will be returned as well. Let's take a look at the following example:

Example – SIPC Coverage

An investor has $300,000 in cash and $150,000 in securities held in street name with a broker/dealer that becomes insolvent. He also deposits $450,000 worth of securities registered in his own name with the broker/dealer just before it declares bankruptcy.

The SIPC guidelines dictate that the investor will receive $250,000 of his cash and all of his securities that are held in street name, for a total of $400,000. Although the SIPC will reimburse for up to $500,000, the remaining $50,000 of cash will not be covered because it is over the $250,000 limit for cash. He will also get back all of his stock certificates, provided they are still registered in his name. 

Not all types of securities are eligible for SIPC reimbursement: Securities that the SIPC will not reimburse for include commodities futures, currency, limited partnerships (LP), and fixed and indexed annuity contracts, which are covered separately by insurance carriers. In addition, any security that is not registered with the SEC will not be eligible for reimbursement. (For details on keeping your investments safe, click here and also check out Weave Your Own Retirement Safety Net.)

Most investors who file a claim with the SIPC can expect to receive their money back in about 30 to 90 days. Delays beyond this time frame are due to inaccurate or incomplete records by the broker/dealer. In reality, less than 1% of all investors nationwide have ever lost any actual assets from insolvency when SIPC was involved. Between the pro-rata recovery distribution, the return of all registered securities certificates and the insurance coverage limits, there is little chance that an investor will suffer a net loss as a result of broker/dealer insolvency.

Private Insurance

In addition to protection by SIPC, many broker/dealers also provide their customers with additional coverage through a private carrier. This type of coverage is known as "excess SIPC" insurance and coverage limits for this protection are often high, such as $100 million per account. As with the SIPC, this coverage will only reimburse investors for losses due to broker/dealer insolvency. Coverage limits for this type of insurance will vary from firm to firm. (Find out how well your savings will be protected; read Bank Failure: Will Your Assets By Protected?)

The Bottom Line

When you choose a stockbroker or financial planner, be sure to ask whether their firm offers coverage through SIPC – most reputable firms do. Find out whether excess coverage is provided, as well as its terms and limits. Remember that while SIPC and excess SIPC coverage is good to have, it will only ever become relevant if the broker/dealer your planner uses becomes insolvent. Also look into whether it makes sense to have securities registered in your own name instead of in street name.

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