Trying to understand what happens with a brokerage firm's customers when it goes bankrupt (case of study: Lehman Brothers)

Question

I'm trying to understand how secure it is to own mutual funds/ETFs, not in terms of market volatility etc., but in terms of judicial security (i.e. what happens to your holdings if the firm goes bankrupt). To understand it, I have read this article about the bankruptcy of Lehman Brothers: What Happens to Lehman’s Customers?

Note: From now on, I'm always referring to investors who own funds/ETFs managed by Lehman Brothers, not by investors who invested in Lehman Brothers or subprime mortgages (e.g. S&P 500 ETF investors).

From the above article, what I have understood is that the funds/ETFs managed by Lehman Bros. were shifted to other brokerage firms to be managed by them. Is this what actually happened? Still, what happens with the investors if, hypothetically, no brokerage firm in the world wants to manage these financial products?

Answer 1

Here's an article which gives some insight into what happened with Lehman. Here are the highlights:

Lehman’s bankruptcy caused minimal disruptions to most customers of its broker dealer, Lehman Brothers Inc. (LBI). One reason is that, by law, customer assets and Lehman’s own assets were segregated. Also, perhaps because the bankruptcy was to some extent foreseen, a large number of customer accounts transferred out before LBI’s default.

After LBI was put into a Securities Investor Protection Act (SIPA) liquidation proceeding, most of the remaining customer accounts were transferred quickly to solvent broker-dealers. Early on, about $45 billion worth of customer claims (out of a total of about $190 billion) was transferred to Neuberger Berman. On September 19, 2008, Barclays Capital acquired select customer accounts of LBI and, by September 23, about $43 billion of LBI customer claims had been transferred to Barclays. The rapid transfer of customer accounts to rival broker-dealers suggests that opportunity costs to LBI customers were small.

Answer 2

When you purchase a share of stock from a legitimate brokerage, they hold an actual share of stock that belongs to you. Even if the brokerage goes bankrupt, your share of stock is still there.

Mutual funds work the same way. A legitimate mutual fund actually holds all the shares that their investors own.

If the brokerage is dishonest and not actually holding all the shares that their customers own, that is when SIPC comes into play.

This highlights a difference between Lehman Brothers and Bernie Madoff. While Lehman Bros. was mismanaging their own business, they were still a legitimate brokerage and held every asset that their customers owned. Everything was still there when the company went bankrupt. Madoff, on the other hand, was taking investor's money without actually purchasing any assets. SIPC had to get involved to straighten that out.

Note that this is different than how a bank works. When you deposit money in the bank, they then in turn loan it out and/or invest it in other places. The bank does not have all the money from all their depositors sitting in a vault.