What Happens if My Brokerage Fails?

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Find out what safety nets are in place to protect your investments. 

With all the uncertainty that’s been swirling around the banking industry recently, you may have wondered what would happen if your brokerage fails. Most importantly, would your assets be safe?

Banks may house our checking and savings accounts, but brokerages are home to our longer-term investments, including our 401(k)s and retirement funds. The idea of that money disappearing is at best unnerving and at worst, downright scary. But if you’re losing sleep over it, know that there are a lot of safeguards in place to protect your funds.

The law demands brokerages protect your money

Let’s start by talking about the laws that should stop your assets getting pulled into a brokerage collapse. Following a spate of brokerage failures and lost consumer funds, in 1970, Congress passed the Securities Investor Protection Act (SIPA) in an attempt to restore confidence. Years later, the Dodd-Frank Wall Street Reform and Consumer Protection Act strengthened some of those protections.

One important rule requires brokerage firms to keep customer assets in a separate account. Legally, they are not allowed to touch your investments. So, if your brokerage is in trouble because it made some bad deals, it can’t dip into your retirement savings or other investment accounts to try to dig its way out. Check out our beginners guide to brokerages for more information on how they work.

Another directive means brokerages are required to have enough funds on hand to cover all their obligations. In other words if your brokerage fails, it is supposed to have enough liquid capital to make people whole.

FINRA and the SEC — the Financial Industry Regulatory Authority and the Securities and Exchange Commission — are responsible for ensuring brokerages toe the line. There have been times when those firms have not followed the rules. But broadly speaking, those regulations go a long way to keeping your investments safe.

There’s another important safety net in the shape of the Securities Investor Protection Corporation (SIPC), which was created as a result of the SIPA. It won’t help if your investments nose dive in value, but it will help if your brokerage goes bust.

How SIPC works

There’s a lot of similarities between SIPC insurance for brokerages and FDIC insurance for banks — both cover consumers up to certain thresholds if their financial institution fails. Like the FDIC, the SIPC gets involved when a brokerage is in trouble and its job is to protect your money. The SIPC says that 99% of eligible customers get their money back.

According to its site, the SIPC’s first priority is to try to transfer customer accounts (and assets) to a different brokerage. This happened when Lehman Brothers failed in 2008. The SIPC says it transferred over 110,000 customers’ funds, worth over $92 billion within weeks. A 14-year liquidation process followed for other accounts, particularly institutional ones.

This isn’t to say that the financial crisis that followed Lehman’s collapse didn’t cost investors across the board. It did. It took a long time for the stock market to recover from the dramatic drop in value. But while the value of Lehman’s U.S. customers’ portfolios may have taken a hit — like those of many other investors — a study by Liberty Street Economics showed many of them were able to access their portfolios relatively quickly after they’d been transferred.

If the SIPC can’t move your account to another firm, it will move to liquidation. This is where things can get a bit more complicated. The short version is that the corporation will try to either return your assets to you or use the SIPC fund to cover your losses. It’s worth knowing that the SIPC’s priority is to preserve your portfolio and give you securities rather than their cash value. So if you own 50 stocks of a certain company, you’d get those stocks back even if they’d decreased in the meantime.

Steps you can take to protect your assets

Unfortunately, history shows us that sometimes brokerages do fail, even if it’s a rare occurrence. One important step to take is to make sure your brokerage account is covered by SIPC insurance. If you have more than $500,000 (the SIPC threshold), look at ways to cover any excess. This might include opening a different type of account, or finding out if your broker offers excess SIPC protection.

Another useful move is to maintain your own records of what’s in your brokerage account. If the worst happens and your firm goes belly up, you might not be able to access your statements. If it turns out that the firm was not maintaining its records, you may need your documents to prove what you own.

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