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Suppose there is a brokerage (not like Madoff case), where investors buy ordinary stocks/ETFs (qqq, brk-b orcl or any stock traded on NASDAQ/NYSE, not pink sheet or unlisted) at a time (and never sell), and after many years it is discovered that the securities were never purchased by the brokerage company and the brokerage was simply making the entries in the statements.

In Is SIPC a scam or does it protect investors from fraud? it was stated that "the SIPC ruled that securities purchases hadn't actually happened so there was nothing to protect" . So question is how does a common investor make sure that securities have been really purchased?

So question is if a brokerage does that kind of fraud, will the investor be covered if he/she can show the proof that the security was purchased per the brokerage statement?

My question is also relevant when the brokerage fees are decreasing and how to be certain that the brokerage houses are really not using/stealing client money.

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    I am struggling to see how this question is different from the linked one. (Although I suppose, it might be) – JTP - Apologise to Monica Feb 16 at 20:49
  • respectfully, the other question was not focused on if brokerage does not actually make the purchase of securities and was focused on the withdrawal of funds after growth. – Neil Feb 16 at 21:02
  • Got it. Fair enough. – JTP - Apologise to Monica Feb 16 at 21:15
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    Will not adding a mechanism like DEMAT account ( money.stackexchange.com/questions/106479 ) will help ? – Neil Mar 20 at 13:59
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You asked: "So question is if a brokerage does that kind of fraud, will the investor be covered if he/she can show the proof that the security was purchased per the brokerage statement?"

The answer is no, the SIPC would only become involved if the firm becomes insolvent. The SIPC protects against the failure of an investment firm, not fraud by an employee or employees of the firm. That is specifically stated on their website including the quote: "SIPC was not chartered by Congress to combat fraud." You can confirm the details through the links on the page I linked, including to the Securities Investor Protection Act of 1970

The fraud you described would likely to be covered under the firm’s errors and omissions insurance, commonly known as E&O insurance. So to protect yourself you could attempt to verify the firm’s E&O policy is in force and it’s terms.

If it’s not covered by that then fraud is illegal and you can simply sue.

You could also file a complaint through the SEC or FINRA.

You also asked: "So question is how does a common investor make sure that securities have been really purchased?"

You really should be able to rely on the statements the brokerage sends. The Madoff ruling that the securities weren't actually purchased seems to be a cop out because the Madoff fraud was so large that it overwhelmed the SIPCs ability to cover it. But should isn't something you can rely on so the answer to the question is if you don't trust the firm you are investing with you would have to obsessively verify the transactions on each statement. Here is a detailed article on the statements from the Madoff scandal on how the fraud could have been caught. One of the tips from that article is:

In the past, there have been cases where brokers at large Wall Street firms diverted the customers actual statements to their own post office boxes and issued fraudulent statements akin to what Madoff was doing. To safeguard against that possibility, investors can directly call the back office of their investment firm once a year (not the local branch phone number) and ask to have a statement mailed directly to them while also checking that the address of record for the statements is their actual address.

Also, Here are some tips from FINRA on checking out investment firms.

The short answer is it would be difficult to truly verify that the securities on your statement were actually purchased. You would need to trace the actual trades through any clearing firms, verify the amount and price of the transaction, and other details. Luckily this type of fraud is very difficult to pull off without giving away some signs that there is fraud.

Another way to verify your securities exist in your account would be to transfer them in kind to another brokerage firm that is independent of the one you purchased them through. If they were fraudulent trades they wouldn't be able to transfer the securities.

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If firm failure occurs along with this theft, then small investors will be covered up to an extend. This is evident in https://en.wikipedia.org/wiki/Madoff_investment_scandal where his firm did not do purchasing the securities, but gave false statements.

As such there is no direct mechanism where small investors are safe from brokerage stealing. This direct stealing has not happened yet on wide scale by management but is limited to employees of the firm, but will happen at some point in future by management as the management of brokerage firms make mistakes with their own funds and tries to cove with customer's fund, bringing some market crash. Then government will make rules and regulations that will be too tight and will benefit those wall street firms( who may be responsible for the issue), and benefiting more to big investor and giving some minor relief to small investors.

So till that cleaning point in US stock market, be careful with keeping records and not putting every dime in stock market.

If this stealing of securities occurs without firm failure then it may not be covered.

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    Your second paragraph involves some heavy speculation of the future without supporting facts. – T. M. Mar 23 at 15:17
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    The link that #T.M. have included itself support(worded as "there have been cases where brokers at large Wall Street firms diverted the customers actual statements") my argument that such kind of theft is possible. The question is not about what to do in case of theft( a developing country case), but what mechanism already exists in a developed country like USA, where a common person expect a level of safety. – Raj Mar 23 at 17:16
  • The part that's unsupported is the part beginning "bringing some market crash..." then going on to speculate about regulation and a "cleaning point". The link I gave and other facts don't support that kind of speculation given as fact. – T. M. Mar 23 at 17:20

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