The Securities Investor Protection Corporation (SIPC) was created in 1970 as a non-profit, non-government, Membership Corporation, funded by member broker/dealers. Its primary role is to return funds and securities to customers if the broker/dealer holding these assets becomes insolvent.
Who Belongs To The SIPC?
SIPC coverage applies to current (and in some cases former) SIPC members. Virtually all broker/dealers registered with the Securities and Exchange Commission (SEC) are SIPC members; those few that are not must disclose this fact to their customers. SIPC members must display an official sign showing their membership. To check whether a firm is a SIPC member go to www.SIPC.org, call the SIPC Membership Department at (202) 371 -8300, or write to SIPC Membership Department, Securities Investor Protection Corporation, 805 Fifteenth Street, NW, Suite 800, Washington, DC 20005-2207.
SIPC’s power to protect customers of former SIPC members ends 180 days after the member loses SEC registration. The SEC normally does not terminate a broker/dealer’s registration if the SEC knows that the broker/dealer owes securities or cash to customers. Customers can therefore better protect themselves and assist the SEC by reporting their losses promptly.
What Does The SIPC Cover?
In general, SIPC coverage is available in two distinct types of situations. SIPC was created to return customer property when a clearing firm became insolvent. In the securities industry, there are many cases where two separate broker/dealers work together to service a customer account. These firms are known as the introducing firm and the clearing firm.
The introducing firm typically employs the individual broker who takes the customer’s order and who sees that the order gets executed. The clearing firm will hold the customer’s cash and securities and send out statements describing the assets it holds “on deposit” for the customer. If the clearing firm becomes insolvent or otherwise cannot return the customer’s property, it is SIPC’s responsibility, not the introducing firms, to make sure the customer’s cash and securities are returned. For years, this was the most common situation where SIPC came forward to protect customers.
In recent years, SIPC has expanded its coverage to include protection against unauthorized trading in customers’ securities accounts. This coverage can include unauthorized trading by persons associated with the introducing firm and may be available even if the clearing firm is still solvent.
The following example shows how important this coverage can be: Customer Jones has $20,000 cash in his account and no other assets. Without his authorization, an individual broker of Jones’ introducing firm buys 300 shares of stock XVZ for Jones, costing $20,000. Jones’ account now has 300 shares of XYZ that the clearing firm can send to Jones upon request. However, Jones wants the $20,000 that was in his account before the unauthorized trade, not the 300 XYZ shares. It now becomes SIPC’s responsibility – not the clearing firm’s – to ensure Jones’ cash is returned if the introducing firm is not financially able to return the $20,000 to Jones’ account.
To be eligible for this important coverage, customers must clearly establish that the trades were unauthorized, and file a complaint in writing as soon as they become aware of the unauthorized trade.
What Are The Limits Of Coverage?
SIPC is limited in the risks, amounts, and investments that it covers, as described below. Market Risk Not Covered SIPC does not protect against market risk, which is the risk inherent in a fluctuating market. It protects the value of the securities held by the broker/dealer as of the time that a SIPC trustee is appointed.
Trustees are appointed through a SIPC-initiated court proceeding to supervise the liquidation of a SIPC member that is insolvent or cannot return customer cash or securities.
An example shows this risk: A broker is shut down owing a customer 100 shares of ABC stock that was worth $50 a share, for a total value of $5,000. Five months later when the SIPC trustee is appointed, the stock has dropped to $30 a share. SIPC coverage would be limited to either replacing the 100 shares of ABC or the $3,000 in cash that the customer’s stock is worth at the time of the appointment of the trustee. Conversely, if the stock rose to $ 70 a share when the trustee was appointed, SIPC would either give the customer 100 shares of ABC stock or, if the shares are not available, would give the customer $7,000. In short, the fluctuation in the value of the shares represents the market risk that is not covered by SIPC.
SIPC coverage is also limited to $500,000 per customer, including up to $100,000 for cash. For purposes of SIPC coverage, customers are persons who have securities or cash on deposit with a SIPC member for the purpose of, or as a result of, securities transactions. For example, if a customer has 1000 shares of XYZ stock valued at $200,000 and $10,000 cash in the account, both the security and the cash balance would be protected. SIPC does not protect customer funds placed with a broker/dealer just to earn interest. Insiders of the broker/dealer, such as its, owners, officers, partners, are not customers for SIPC coverage.
Not all investments are protected by SIPC. In general, SIPC covers notes, stocks, bonds, mutual fund and other investment company shares, and other registered securities. It does not cover instruments such as unregistered investment contracts, unregistered limited partnerships, and interests in gold, silver, or other commodity contracts or commodity options.
What Is The Liquidation Process?
SIPC will generally ask a court to appoint a trustee to supervise the liquidation of a SIPC member that is insolvent or cannot return customer cash or securities. The trustee’s duties include ensuring the return of customer property. The trustee will send claim forms to each customer of the liquidating broker/dealer based on the broker/dealer’s records and publish notice of the liquidation in some newspapers. Customers receiving a claim form must return it to the trustee by the deadline on the form or risk not recovering their cash or securities. The trustee reviews the customers’ forms and determines what moneys to pay and what securities to return.
How Can You Protect Yourself?
Customers should protect themselves by taking the following steps:
1. Read And Keep All Documents
Read all documents when opening a customer account and keep copies of them.
2. Check Trade Confirmations
Get and keep a confirmation for each security transaction, and check it to make sure it is accurate.
3. Review Statements
Review account statements for accuracy by checking all purchases, sales, receipt and delivery of securities, securities positions, receipts and disbursements of cash, and any other debits and credits.
4. Pay The SIPC Member
Do not make checks or other payments payable to an individual if they are to be deposited in a securities account. Be extremely careful if asked to make a check payable to any entity that is not: (1) the broker/dealer itself, (2) the broker/dealer’s clearing firm, or (3) a bank as escrow agent. Do not use abbreviations, such as initials, on checks or other methods of payment. Write out the full name of the payee.
5. Report Unauthorized Trades
Immediately report suspected unauthorized trades in writing to the broker/dealer and keep a copy of the letter or e-mail. If mailed, use certified mail to show the broker/dealer got the letter. Promptly send copies to a regulator listed below.
6. Report Problems To Regulators ASAP
Customers that cannot contact their broker-dealer, or who suspect wrongdoing or financial difficulties at the broker-dealer, should immediately contact a securities regulator. Failure to do so may endanger recovery. Regulators include the Securities and Exchange Commission, NASD Regulation, and State Securities Administrators.