With Bankruptcies Looming --- Brokerage Account Insurance Pitifully Insufficient and Getting Worse

In times like these, and stupidly only in times like these, people begin to look at the protection (insurance) coverage underwriting their own, individual brokerage accounts.  And what one finds is a real eye opener.  If you have more than $500K in a brokerage account, everything over that amount is totally unprotected.   And this is as true for the big ones (Merrill and Citi/Smith Barney) as for the smaller ones (E*Trade and TD Ameritrade).   If you don’t have more than a half million, you can rest easy.  If you do, you are on your own.  If this economy falls apart – if we move into severe recession and some banks go into bankruptcy – there is a real likelihood of loosing a lot of wealth – that means you, not just the guys with multiple millions.

 

Most brokerages belong to and fund the private SIPC (Securities Investor Protection Corporation), created in 1970.  SIPC covers the first $500K which includes $100K in cash and the rest in securities.  But, after that, most institutions have nothing or suggest they have another level that is so poorly funded (most are self insured policies) that what they offer is worthless.  The big guys, Smith Barney and Merrill proudly tout their second level coverage (after SIPC).  Both say they have $600 million additional insurance underwritten by Lloyds.  But, if you read carefully, that is not per account, but “in the aggregate.”  That means that they are carrying insurance on all their client accounts – in the trillions of dollars – in the amount of six hundred million dollars.  It is smoke, not real, and absolutely meaningless.  It is just plain misrepresentation.

 

Smith Barney and Merrill will agree, when pressed, that the Lloyd coverage isn’t worth much more than the paper it is written on, but they will also say that all client assets are segregated and not likely to fall into the hands of creditors in the event of a bankruptcy.  That’s probably true in most cases, but not good enough if we really have trouble – or if one of them really has trouble.  They could carry more insurance if pressed, and they could even offer individual clients the opportunity to buy their own additional insurance at very low cost.  But, no one is pressing them, and they are not independently stepping up to the plate.

 

Quite the contrary.  E*Trade which has been going through hell in recent weeks and which is still teetering (in spite of a recent infusion of new monies) appears to have just dropped the insurance – however meager – they were offering over and above the SIPC limits.  That’s incredible and to date unnoticed.  But, it gives you a good idea of what companies in trouble, even if they have some additional coverage, are likely to do.

 

Individuals need to ask more questions and get more savvy about this matter.  There are some things you can do now.  If you have more than $500K in an account, open up another one in another brokerage.  Or, transfer some assets to a spouse who also has a brokerage account.  Or, insist that your brokerage offer you additional insurance (though you are not likely to get very far).  Indeed, the best thing you can do to protect yourself is to split your moneys up among a number of brokerages. 

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Comments

  • ktexas

    December 06, 2007

    Found this Kiplinger's article on this topic http://www.kiplinger.com/columns/ask/archive/2007/q1115.htm

    It suggests several reasons why the risks are small:

    "brokers have to follow strict SEC rules about segregating the firm's money from the customers' investments. Even if the broker has financial trouble, the investors' money should still remain intact."

    "That $500,000 limit only applies to the maximum amount SIPC will spend on its own to make up for any missing securities; not the total amount of money you can get back. If many of the customers' assets remain intact, you can get back a lot more than that SIPC limit."

    So for a brokerage customer to lose their investments over $500k, it seems the brokerage would not only have to go bankrupt, but it would also have to be heavily involved in illegal practices (violating SEC rules). I'm sure there are cases where this has happened and will happen, but I'm not sure what the risk is.

  • jonathan

    December 07, 2007

    I have read Kiplinger and Freedman, and I come down in favor of thinking about this and not just keeping a head in the sand. Sure, they are supposed to segregate and sure they have to be involved in inappropriate practices, but aren't we now facing a situation where many of these institutions were engaged in the sub-prime mess, fully knowing what they were doing? I for one believe it is pure foolishness to ignore the fact that most accounts are seriously unprotected beyond SIPC.

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