5

The Securities Investor Protection Corporation (SIPC) insures investor accounts up to $500K:

Terms of SIPC help. Customers of a failed brokerage firm get back all securities (such as stocks and bonds) that already are registered in their name or are in the process of being registered. After this first step, the firm's remaining customer assets are then divided on a pro rata basis with funds shared in proportion to the size of claims. If sufficient funds are not available in the firm's customer accounts to satisfy claims within these limits, the reserve funds of SIPC are used to supplement the distribution, up to a ceiling of $500,000 per customer, including a maximum of $250,000 for cash claims. Additional funds may be available to satisfy the remainder of customer claims after the cost of liquidating the brokerage firm is taken into account.

However SIPC is a corporation, supposedly just like any other, and it can run out of money.

  • What if some fraud takes place that's too big for even it to fund?
  • What makes SIPC safer than, say, equivalent insurance provided by Lloyd's of London (assuming the insurance premium is payed by the broker) ?
5

SIPC is a corporation - a legal entity separate from its owners. In the case of SIPC, it is funded through the fees paid by its members. All the US brokers are required to be members and to contribute to SIPC funds.

Can it go bankrupt? Of course. Any legal entity can go bankrupt. A person can go bankrupt. A country can go bankrupt. And so can anything in between.

However, looking at the history of things, there are certain assumptions that can be made. These are mere guesses, as there's no law about any of these things (to the best of my knowledge), but seeing how things were - we can try and guess that they will also be like this in the future. I would guess, that in case of a problem for the SIPC to meet its obligation, any of the following would happen (or combinations):

  1. Too big to fail - large insurance companies had been bailed out before by the governments since it was considered that their failure would be more destructive to the economy than the bailout. AIG as an example in the US. SIPC is in essence is an insurance company. So is Lloyd's of London.

  2. Breach of trust of the individual investors that can lead to a significant market crash. That's what happened in the US to Fannie Mae and Freddie Mac. They're now "officially" backed by the US government. If SIPC is incapable of meeting its obligation, I would definitely expect the US government to step in, even though there's no such obligation.

  3. Raising funds through charging other members. If the actuary calculations were incorrect, the insurance companies adjust them and raise premiums. That is what should happen in this case as well. While may not necessarily solve a cashflow issue, in the long term it will allow SIPC to balance, so that bridge loans (from the US government/Feds/public bonds) could be used in between.

  4. Not meeting obligations, i.e.: bankruptcy. That is an option, and insurance companies have gone bankrupt before. Not unheard of, but from the past experience - again, I'd expect the US government to step in.

In general, I don't see any significant difference between SIPC in the US and a "generic" insurance coverage elsewhere. Except that in the US SIPC is mandatory, well regulated, and the coverage is uniform across brokerages, which is a benefit to the consumer.

  • Well written. Though I would believe being a Govt entity has a slightly more chances of being steped into by Govt than a large pvt company. – Dheer Nov 18 '13 at 9:47
  • 2
    SIPC is not a government entity. Its existence is required by law, but it is not in itself a government agency of any kind. – littleadv Nov 18 '13 at 9:47
2

Not sure if I follow your question completely. Re:

What if some fraud takes place that's too big even for it to fund?

SIPC does not fund anything. What it does is takes over the troubled brokerage firm, books / assets and returns the money faster. Refer to SIPC - What SIPC Covers... What it Does Not and more specifically SIPC - Why We Are Not the FDIC.

SIPC is free for ordinary investors. To get the same from elsewhere one has to pay the premium.

Edit:
The event we are saying is a large brokrage firm, takes all of the Margin Money from Customer Accounts and loses it and also sell off all the stocks actually shown as being held in customer account ... that would be to big. While its not clear as to what exactly will happens, my guess is that the limits per customers will go down as initial payments. Subsequent payments will only be done after recover of funds from the bankrupt firm.
What normally happens when a brokrage firm goes down is some of the money from customers account is diverted ... stocks are typically safe and not diverted. Hence the way SIPC works is that it will give the money back to customer faster to individuals. In absence of SIPC individual investors would have had to fight for themselves.

  • Please see my edit for clarification. – t0x1n Nov 13 '13 at 17:16
  • Excellent links! And a very good answer. – Ellie Kesselman Nov 16 '13 at 10:28
  • +1 but to refine my question, is there anything that makes SIPC membership better than some other insurance purchased by the broker ? (the premium is payed by the broker) – t0x1n Nov 16 '13 at 19:02
  • @t0x1n I believe SIPC membership is mandatory – littleadv Nov 17 '13 at 3:32
  • @littleadv even if it is for US brokers, it isn't for, say, European brokers. I'm trying to understand if SIPC membership is safer than some other insurance. – t0x1n Nov 17 '13 at 9:19

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.