This is not investment advice. The information provided is for educational and informational purposes only and does not constitute a recommendation to buy or sell any financial product.
A brokerage firm is not a bank, and the protections on a brokerage account are not the same as the protections on a bank deposit. The FDIC covers bank deposits in the US up to $250,000 per depositor, per insured bank. The SIPC covers brokerage accounts in the US up to $500,000 per customer, with a $250,000 limit on cash. The trader who holds a brokerage account should know the difference, and the trader should know what to do if the brokerage fails.
What the SIPC covers
The SIPC is a US non-profit corporation that protects customer accounts at SIPC-member brokerages. The SIPC covers up to $500,000 per customer, with a $250,000 limit on cash. The coverage applies to the loss of cash and securities held at the SIPC-member brokerage, and the coverage is triggered when the brokerage fails and the customer's assets are missing from the brokerage's records.
The SIPC does not cover losses from a decline in the market value of the securities. If the trader's account holds $100,000 of a stock that falls to $50,000, the SIPC does not cover the $50,000 loss. The SIPC covers only the loss of the assets themselves, not the loss in the value of the assets.
The SIPC does not cover all brokerages. The SIPC covers brokerages that are members, and most US-registered brokerages are members. A brokerage that is not a member of the SIPC is not covered, and the trader should check the membership status before funding the account. The membership is usually disclosed on the brokerage's website, and the trader can confirm the membership on the SIPC's website.
What the SIPC does not do
The SIPC does not insure the value of the securities. The SIPC protects the trader against the loss of the securities, not against the loss in the value of the securities. The distinction is important: the trader who holds a $100,000 position in a stock that falls to $50,000 has lost $50,000, and the SIPC does not cover the loss. The trader who holds a $100,000 position in a stock and the brokerage fails without returning the position has lost the $100,000 of securities, and the SIPC covers the $100,000 (within the limit).
The SIPC does not cover all asset classes. The SIPC covers stocks, bonds, mutual funds, and other registered securities. The SIPC does not cover futures, FX, CFDs, or other derivative products that are not registered securities. The trader who holds a futures position at a failed brokerage is exposed to the loss of the position, and the SIPC does not cover the loss.
What to do if the brokerage fails
The first step is to contact the trustee appointed by the SIPC. The trustee is responsible for liquidating the brokerage's assets and returning the customer assets to the customers. The trustee will contact the customers directly, and the trustee will provide instructions for filing a claim.
The second step is to gather the documentation. The trader should have copies of the account statements, the trade confirmations, and the position reports. The documentation is the basis of the claim, and the trader should keep the documentation up to date.
The third step is to file the claim with the trustee. The claim is a form that asks for the customer's name, the account number, the assets held, and the value of the assets. The trustee reviews the claim and either accepts or rejects it. The accepted claim is paid out of the SIPC fund, up to the coverage limit.
The fourth step is to open a new account at a different brokerage. The trader who is waiting for the SIPC payout can still trade, and the new account is the basis for the trading activity. The new account should be at a SIPC-member brokerage, and the new account should be funded with cash that is not part of the failed brokerage's assets.
The European and UK equivalents
The investor compensation scheme in the EU protects up to €20,000 per claimant. The scheme is operated by the national regulator in each EU country, and the coverage is triggered when a brokerage fails and the customer's assets are missing. The coverage is lower than the SIPC's coverage, and the trader who holds a large account should be aware of the limit.
The Financial Services Compensation Scheme (FSCS) in the UK protects up to £85,000 per claimant. The scheme is operated by the FSCS, and the coverage is triggered when a UK-regulated brokerage fails. The coverage is similar to the EU scheme, and the trader should be aware of the limit.
The trader who holds a brokerage account in a non-tier-one jurisdiction is exposed to a lower level of protection, or no protection at all. The offshore brokerages are not subject to the SIPC, the EU scheme, or the FSCS, and the trader's recovery path in a failure is longer and less certain.
How to manage the risk
The honest answer is to hold a smaller balance at any single brokerage than the compensation scheme's limit. The trader who holds €30,000 at a single EU brokerage is exposed to the limit of €20,000, and the excess €10,000 is at risk. The trader who holds €20,000 at each of two EU brokerages has €40,000 of total assets with €20,000 protected at each, and the risk is reduced.
The second answer is to use a tier-one jurisdiction. A brokerage regulated by the FCA, BaFin, or ASIC is subject to the compensation scheme in its jurisdiction, and the protection is real. A brokerage regulated only by a small offshore authority is not subject to a meaningful compensation scheme, and the protection is not real.
Related resources
Where to start
If you are choosing a brokerage, the most useful exercise is to check the regulator, the compensation scheme, and the coverage limit. Our broker comparison lists the regulator and the coverage at each broker, which together tell you what the protection looks like before you fund the account.