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What to do if your brokerage firm closes

Andrew Todd Yocum

Ever wonder what would happen to your securities account if your brokerage firm closes?

Though history does not contain too many examples of brokerage firms closing, it does happen.

You have a regulatory safety net.

There is a multi-tier safeguard system in place to protect investor assets. Most of these protections are in the form of rules that brokerage firms must comply with.

Such rules help minimize the chance of a total brokerage collapse and also help shield clients should a brokerage fail.

  • Rule 15c3-1, “Net Capital Rule” of the U.S. Securities and Exchange Commission (SEC) makes it mandatory for brokerages to maintain a minimum of prescribed capital in liquid form.
  • Rule 15c3-3, “Customer Protection Rule,” requires brokerage firms to keep client assets (both cash and securities) in a segregated account from the firm’s own assets in order to avoid any kind of mix up.
  • SecuritiesInvestor Protection Act of 1970 requires all broker-dealers already registered under the Securities Exchange Act of 1934 to be a member of Securities Investor Protection Corporation (SIPC), a nonprofit, membership group that also functions as insurance for the customers of the industry. SIPC protects customer securities accounts up to $500,000. SIPC protection comes into play in case of firm failure where customer assets are missing because of theft or fraud.

What does SIPC cover?

Investors must be clear about the protection provided by SIPC. There can be a misconception that the SIPC is to brokerage accounts what the Federal Deposit Insurance Cover (FDIC) is to bank accounts. But SIPC and FDIC differ. While FDIC protects the customer cash in an account at an insured bank, SIPC does not safeguard the absolute value of the securities the customer holds, only the number of shares.

For example, say an investor is holding 200 shares of a stock originally purchased through a failed stock broker. SIPC will work to replace or restore the same number of shares to the investor. However, if the stock price has plummeted during the time period between when the stock broker went bust and the SIPC steps in, the SIPC will not reimburse the money the investor lost.

SIPC does not cover the following:

  • Ordinary market loss;
  • Investments in commodity futures, fixed annuities, currency, hedge funds or investment contracts (such as limited partnerships) that are not registered with the SEC; and
  • Accounts of partners, directors, officers or anyone with a significant beneficial ownership in the failed firm.

What happens when the doors close?

Once the liquidation process begins, the court appoints a trustee for the broker-dealer. The firm’s office is closed for scrutiny of all documents, records, and books by the trustee and his staff. During the process, SIPC plays a supervisory role. In case the records of the failed brokerage firm are found accurate, provision is made to transfer the customer accounts to another brokerage firm by SIPC and the trustee.

The customers are notified about the transfer of accounts who can continue with the new assigned broker or further pick a broker of choice. But the customer should file a claim with the trustee on receiving the initial notification about transfer of account. Remember, SIPC is not liable to protect customers who do not file a claim.

In certain cases, the SIPC may follow a direct payment procedure. This is an out-of-court process. This usually happens when all customer claims fall within the SIPC protection limits (i.e., do not exceed $250,000 in aggregate). In such cases, there is no court proceeding or appointment of a trustee.

Due Diligence

Although relatively rare, stock broker firms do go out of business. Investors should select a stock broker after detailed research, which includes ensuring that the broker offers SIPC protection (see the full list of SIPC members).

Once you begin trading or buying investment products, ensure your records are in order. Doing a bit of paper work, which could include keeping either a hard copy or electronic record of holdingsaccount statements, and trade confirmations, can come in handy for filing an insurance claim with the SIPC.

This information is all publically available and being provided to you by The White Law Group. For a free consultation with a securities attorney please call 888-637-5510.

The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Seattle, Washington.  For more information on The White Law Group visit https://whitesecuritieslaw.com.


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