SIPC insurance is an extremely important level of protection for investors, yet few investors know much about it.
Everyone wants to ensure their assets are protected from losses. While you can’t guarantee that you won’t lose money in the stock market, you do have other ways of keeping your portfolio safe from other risks.
Insurance from the Securities Investor Protection Corporation, or SIPC, is one of the more important protections for assets in a brokerage account. Most investors don’t even realize they have this protection, and in reality this type of insurance is very rarely used. But SIPC protection is important to preventing losses related to a failed brokerage company, which is a real possibility.
What does SIPC insurance cover?
SPIC insurance covers a significant amount of risks to your assets that you may not have even considered. It is mainly intended to help restore any money or securities you lose as a result of a brokerage firm facing financial hardships or bankruptcy.
You don’t buy this insurance yourself. Rather, the brokerage company that holds your assets has SIPC insurance if they are members of the SIPC.
SIPC insurance covers brokerage accounts with assets like stocks, bonds, CDs (certificates of deposit), Treasuries and money market mutual funds. SIPC insurance will provide for up to a total of $500,000 in coverage, including for cash or for securities held in a brokerage account. Of that, up to $250,000 of your money will be protected if it’s held in a brokerage account as cash but not invested yet.
The SIPC is not a government agency and it doesn’t regulate broker-dealers, although it was created by federal law. It’s actually a private nonprofit organization that was founded in the early 1970s in the wake of major market declines, and is now overseen by the Securities and Exchange Commission (SEC), which itself is a federal agency. It’s led by seven directors appointed by either the brokerage firms that are members or the U.S. President. Now, most legitimate broker-dealers are members of the SIPC.
To learn whether your assets enjoy SIPC coverage, you can check your brokerage company’s website for an SIPC disclosure. If you don’t see a membership disclosures listed, your firm may not be a firm that’s protected by the SIPC, so you might want to consider moving your assets to a financial institution that does have SIPC protection. That way, your assets will be better protected in the event the firm goes bankrupt.
Still, the vast majority of major brokerage companies in the U.S. do have SIPC coverage. In fact, according to a 1970 law, they are required to be SIPC members if they buy or sell securities or other investments.
What doesn’t SIPC cover?
SIPC insurance does offer protection against some serious possible threats to your money, but it doesn’t provide coverage against all risks.
This insurance will not cover, for example, losses related to hacking if somehow a hacker could funnel your money away from the brokerage company. It does not cover theft related to identity fraud. (However, if the brokerage company was forced into bankruptcy or liquidation because of a hacking incident, your assets may be covered in that case – if it the losses were specifically connected to the company’s downfall.)
In addition, if you receive bad investment advice and lose money as a result of that advice, don’t expect SIPC insurance to cover your losses, even if the professional who gave you bad advice was connected with your brokerage account. If investors have claims related to bad investment advice, those complaints are taken by the Financial Industry Regulatory Authority (FINRA) or the Securities and Exchange Commission (SEC), not by the SIPC.
As far as assets, SIPC insurance does not cover certain investment types like precious metals, commodities contracts, fixed annuity contracts or any investment contracts such as with a limited partnership.
Finally, any losses related to how the asset performs as an investment are not protected by SIPC insurance. Those are losses the investor assumes when they take the risk of investing.
SIPC and retirement accounts
If you have two separate tax-advantaged retirement accounts at the same brokerage, your SIPC protection may cover up to $1 million.
Different types of retirement accounts – such as both a traditional IRA and a Roth IRA – are treated as separate accounts even if they are held by the same individual and at the same brokerage company. If you have two IRA accounts, they are lumped together for protection as a single entity. The SIPC affords up to $500,000 in protection for each them, or a combined $1 million.
IRAs have distinct tax advantages. You can contribute up to $6,000 annually as of 2020, or $7,000 if you are over 50. With a Roth IRA, you deposit the funds after you have already paid income tax on them. The tax advantage here is that when it comes time to withdraw those funds when you retire, you can withdraw them with no taxes charged on the withdrawn amount, even if your assets have made gains. With a traditional IRA, you can deduct the amount you contributed from your taxable income that year, but when you go to withdraw those funds you will still pay taxes on any gains you made while they were invested.
SIPC and other accounts
In the same way, the SIPC also affords its $500,000 protection to other account types, even if they are held by the same person, and can lump them together for insurance purposes.
These accounts include an accountholder’s trust, a joint account with a spouse, a spouse’s account or a child’s account that is under custody.
If a firm fails, the accounts of the company’s directors, partners or office or the accounts of anyone with a significant ownership or stake in the company will not be covered by SIPC insurance.
How is SIPC different from FDIC?
The SIPC is modeled on the FDIC, but it has some key differences with its insurance coverage. For one, the SIPC does not protect against any losses in your account related to market value or fraud, including identity fraud.
The Federal Deposit Insurance Corporation (FDIC) protects your assets in a similar way as the SIPC, but instead of insuring your brokerage account, FDIC insurance protects your bank account holdings.
If you bank is has FDIC insurance (and most do), then your assets are protected up to $250,000 in the event that the bank fails. Those assets include money in a check or savings account, Certificates of Deposit (CDs), money in deposit or money market deposit accounts.
The FDIC does not provide insurance for investments like stocks, bonds, or mutual fund investments, including mutual fund money market accounts. Nor does it cover Treasuries, annuities, or life insurance policies. Finally, FDIC insurance also excludes the contents of a safe deposit box.
SIPC insurance in use
SIPC insurance is rarely used because there just aren’t that many cases where consumers need to file a claim for losses related to a failed brokerage. However, since its inception in 1970, the SIPC has helped an estimated 773,000 investors recover $141.4 billion in assets, advancing $3 billion to make those recoveries possible. In 1973, Weis Securities Inc. was the first New York Stock exchange member to liquidate following the inception of the SIPC.
While brokerage firms rarely fail, no one can predict the future of the economy and its impact on financial firms. As we saw with the 2008 financial crisis, even large reputable financial firms can fail under certain financial stresses.
Here are five recent major cases where SIPC provided some recovery to accountholders when their brokerage firm failed:
- MF Global Inc. MF Global failed in 2011 as the 8th largest bankruptcy in U.S. history. By 2016, the Trustee for MF Global Finance had provided for 95% distribution to general creditors and 100% distribution to customer and commodities claimants.
- Bernard L. Madoff Investment Securities LLC. When Bernie Madoff was found to have conducted the largest Ponzi scheme in history in 2008, the SIPC stepped in to try to recoup some of his victim’s losses. So far, payment has been made on 63% of claims, or $11.4 billion.
- Lehman Brothers Inc. When Lehman Brothers failed in 2008, it was the largest bankruptcy in U.S. history. By 2014, 100% of claims made to the SIPC were satisfied with distributions.
- MJK Clearing Inc. In 2001, MJK Clearing’s liquidation was the largest at the time. The SIPC assisted with transferring about 175,000 accounts with a total of more than $10 billion in assets.
- Adler, Coleman Clearing Corp. In 1995, the SIPC quickly transferred more than 50,000 customer accounts to other firms after the liquidation of Adler, Coleman Clearing Corp.
How to File an SIPC Claim
If you have an account with a brokerage that has failed or filed for bankruptcy, you must take certain steps to recoup any money you lost in your accounts as a result. The SIPC has specific deadlines for filing your losses, which are named in each case.
For example, when Lehman Brothers collapsed in 2008, the SIPC started a case on Sept. 19,2008. Lehman Brothers clients could first file to recoup their losses with the SIPC on Jan. 30, 2009, with a final deadline to file of June 1, 2009.
The SIPC is tasked with organizing the distribution of cash and securities, as well as with making an effort to change the customer’s account to another brokerage.
Other ways to protect your investments
One way to take extra cautions in protecting your investments is to carefully vet your personal financial advisors. When you screen your financial advisor, you should be able to ask them a range of questions about their process. You should also get a sense that they are on board with your specific financial goals, not working for their own agenda.
Once your investing plan is in place, regularly review your financial statements for suspicious activity to monitor your personal accounts for hacking as a result of identity fraud.
The bottom line
SIPC insurance is a significant benefit for investors, offering protections against risks associated with the failure of the brokerage company. Still, SIPC insurance doesn’t mean that your assets automatically have no risk of loss – investors are ultimately responsible for how their assets perform.
With the Securities Investor Protection Corporation’s protections, investors can worry less about is whether they will lose all their assets if their brokerage firm goes bankrupt. In the event a firm does liquidate, investors can take several steps to make a claim to recoup their money – at least up to the covered amount by the SIPC. Meanwhile, they can also benefit from the SIPC’s efforts to transfer their accounts to a more stable financial institution.