What Happens to My Money if a Brokerage Goes Out of Business?

Investors naturally worry about their money if their brokerage firm faces financial difficulty or goes out of business. While such events are uncommon, robust protections are in place to safeguard customer assets. Understanding these mechanisms provides clarity on how investor funds are handled during a brokerage failure.

Investor Protection Mechanisms

The primary protection for investors in the United States, should a brokerage firm fail, comes from the Securities Investor Protection Corporation (SIPC). Established by the Securities Investor Protection Act (SIPA) of 1970, SIPC is a federally mandated, private nonprofit organization. SIPC protects customers against the loss of securities and cash held by a brokerage firm if it goes out of business, working to return customer property.

A fundamental layer of protection for investor assets is the segregation of customer funds and securities. Brokerage firms are required to keep client funds and securities separate from the firm’s own capital and proprietary accounts. This separation helps ensure that customer assets are not used to satisfy the brokerage firm’s debts or obligations if it faces financial distress.

Regulatory bodies such as the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) oversee broker-dealers. They establish rules and conduct examinations to promote financial stability and compliance within the industry. While the SEC and FINRA focus on market integrity and operational soundness, SIPC specifically addresses the direct protection of customer assets during a firm’s insolvency. Most brokers and dealers registered with the SEC are required by law to be SIPC members.

The Process of a Brokerage Failure

When a brokerage firm begins to experience financial distress, regulatory bodies like the SEC or FINRA may become involved, sometimes referring the situation to SIPC. If a SIPC-member brokerage firm is deemed to be failing or unable to meet its obligations to customers, SIPC initiates a proceeding, typically by asking a federal court to appoint a trustee. This process transitions the firm into a liquidation under the Securities Investor Protection Act (SIPA).

Once a trustee is appointed, they immediately take control of the firm’s assets and records. The trustee’s primary goal is to return customer securities and cash as quickly as possible. In many instances, the trustee and SIPC may arrange for customer accounts to be transferred in bulk to another solvent brokerage firm.

If a direct transfer of all accounts is not feasible, the trustee will work to identify and reconcile individual customer accounts. This involves gathering customer information and setting up a process for customers to file claims. The trustee will then distribute customer assets, either by returning the actual securities or by providing cash based on the market value of the securities on the “filing date.”

Understanding Coverage Limits

SIPC protection covers specific types of assets, primarily securities and cash held for purchasing securities, within certain limits. This includes common investments such as stocks, bonds, Treasury securities, certificates of deposit (CDs), mutual funds, and exchange-traded funds (ETFs). Cash held in a brokerage account for investment purposes, including in money market mutual funds, is also protected.

The standard SIPC coverage limit is up to $500,000 per customer for securities and cash, with a sub-limit of $250,000 for cash. It is important to understand how “per customer” is defined, as this can affect total coverage. SIPC defines a “customer” based on “separate capacity,” meaning different types of accounts or ownership categories are treated as distinct for coverage purposes.

For example, an individual brokerage account, a joint account, an Individual Retirement Account (IRA), and a Roth IRA held by the same person at the same brokerage firm generally each qualify for separate SIPC coverage. However, multiple accounts of the same type held by the same person at the same firm are typically combined for coverage limits. SIPC protection does not cover market losses resulting from investment performance, or investments not considered securities, such as commodities, futures contracts, or cryptocurrencies.

Steps for Investors

Before a brokerage firm faces financial difficulties, investors can take proactive measures to protect their assets. It is prudent to verify that your brokerage firm is a member of SIPC, which can often be confirmed by checking the SIPC website or looking for “Member SIPC” disclosures on the firm’s materials. Regularly reviewing account statements for accuracy and keeping personal records of transactions and trade confirmations are also important practices.

Should a brokerage firm encounter financial distress, it is important for investors to remain calm and seek information from official sources. Investors should monitor communications from regulatory bodies and any appointed trustee. Avoiding rash decisions based on rumors and relying on verified information is advisable during such periods.

After a brokerage failure, if an account transfer to another solvent firm does not occur automatically, investors may need to file a claim with the SIPC-appointed trustee. The trustee will typically provide instructions and a claim form, which should be completed accurately and submitted within the specified deadlines. Providing supporting documentation, such as account statements and trade confirmations, is important for the claim resolution process, which may require patience as the trustee reconciles records and processes claims.