If a Brokerage Firm Closes Its Doors

Have you wondered what would happen to your securities account if your brokerage firm closed its doors? The failure of a firm might understandably cause some anxiety for its customers. However, should your firm cease operations, don’t panic: In virtually all cases, customer assets are safe and typically are transferred in an orderly fashion to another registered brokerage firm.

Multiple layers of protection safeguard investor assets. Registered brokerage firms must keep their customers' securities and cash segregated from their own, meet minimum net capital requirements to reduce the likelihood of insolvency, and be members of the Securities Investor Protection Corp (SIPC).

What Is SIPC Protection?

SIPC provides limited coverage to investors on their brokerage accounts if their brokerage firm becomes insolvent. All brokerage firms that do business with the investing public are required to be members of SIPC. SIPC protection covers the replacement of missing stocks and other securities up to $500,000, including $250,000 in cash claims. However, it does so only when a firm shuts down due to financial circumstances in which customer assets are missing—because of theft, conversion or unauthorized trading—or are otherwise at risk because of the firm's failure.

SIPC does not cover:

• ordinary market loss;
• investments in commodity futures, fixed annuities, currency, hedge funds or investment contracts (such as limited partnerships) that aren’t registered with the SEC; or
• accounts of partners, directors, officers or anyone with a significant beneficial ownership in the failed firm.

SIPC coverage of $500,000 is extended to each account held in “separate capacity." For instance, if you have three accounts at a firm and one is an individually held account in your name only, another is a joint account with your spouse, and a third is an individual retirement account (IRA) in your name, each account is considered a separate account and eligible for full SIPC coverage.

SIPC coverage shouldn’t be confused with FDIC protection. FDIC insures assets in bank accounts in the event of a bank's failure. FDIC coverage doesn’t include stocks, bonds or other investment products.

What Other Regulatory Safety Nets Protect Customer Accounts?

Brokerage firms are required to follow certain rules that are designed to minimize the chances of financial failure and, more importantly, to protect customer assets if the firm does fail. SEC Rule 15c3-1—the "Net Capital Rule"—requires brokerage firms to maintain certain levels of their own liquid assets. The minimum net capital a firm must have on hand depends on its size and business.

In addition, SEC Rule 15c3-3—the "Customer Protection Rule"—requires brokerage firms that have custody of customer assets to keep those assets separate from their own accounts. Customers' cash must be placed in a special, separate "reserve" account, and fully paid customer securities must be kept separate from firm and customer margin securities.

In addition, all firms that do business with public customers are required to have their financial statements audited by an independent accounting firm annually. All brokerage firms must file financial statements with the SEC, and those that are publicly traded must file quarterly, annual and other periodic reports with the SEC. Investors use the SEC's EDGAR database of company filings to view these reports.

FINRA monitors firms for compliance with the Customer Protection Rule, the Net Capital Rule and other financial responsibility rules through its surveillance and examinations programs. FINRA also monitors the customer complaints firms receive and how firms handle the transfer of customer accounts, as well as whether a firm has adequate written policies and procedures and a practical framework to capture and monitor relevant risks related to its business activity.

If FINRA uncovers financial problems at a brokerage firm, we promptly report issues to the SEC and, if it appears that theft or fraud has occurred, to SIPC. These matters are also referred to FINRA's Enforcement Division for further action.

What Happens When a Firm Fails?

If you hear that your firm is in financial trouble, contact the firm to see what procedures you should follow. For example, there may be a window of time when you can’t trade or transfer your account.

Historically, brokerage firms that have faced financial insolvency have handled the crisis in different ways. Some have been able to find a buyer. Other firms self-liquidate. When that happens, securities regulators work with the firm to make sure that customer accounts are protected and customer assets are transferred in an orderly and timely fashion to one or more SIPC-protected brokerage firms.

If a failing firm is in compliance with the Customer Protection Rule, the Net Capital Rule and other financial responsibility rules, it will be able to self-liquidate. In the rare circumstance where customer assets appear to be missing—as, for example, in the case of fraud or theft—a SIPC liquidation may be necessary.

What Happens in a SIPC Liquidation?

If a SIPC liquidation takes place, you’ll be notified by letter that your brokerage firm has closed and that SIPC has begun a "direct payment procedure" or a liquidation proceeding in court. If you receive such a letter, SIPC advises that you promptly gather key information, including brokerage account records, monthly or quarterly statements and trade confirmations. Check these documents for accuracy: Make sure that the statements reflect all cash deposits you sent to the brokerage firm and that there aren’t any unauthorized transactions.

You’ll also want to verify your correct address to ensure that you receive a claim form. If you hear about a liquidation that involves your firm and haven’t received a letter, go to the SIPC website for contact information. Once you receive a form, be sure to fill it out completely and return it within the deadline. Pay attention to time limits set forth in the notice and claim form; under federal law, no one has the authority to satisfy claims that are filed late.

Investors should be aware that they might be unable to transfer accounts or execute trades during the liquidation process. However, once liquidation is initiated, most customers can expect to receive their assets in one to three months. The speed at which customer funds and securities are returned depends on a number of factors, including the accuracy of brokerage firm records.

Some firms carry additional insurance over the protection limits currently provided by SIPC. Such protections are generally triggered only in the event of the financial failure and liquidation of a participating securities affiliate and if the customers' securities aren’t returned by the firm or through SIPC. As with all insurance, the ability to pay claims depends on the financial strength of the carrier. In addition, some policies may have caps or other limits on the amount of protection provided.