How does SIPC insurance work on the American stock exchange

Suppose you decide to trade on the US stock market through an American broker. As you know, broker bankruptcies are rare, but they still happen! What should you do if you encounter exactly such a problem? It’s nothing special. All instructions will be sent to your email address, and without special request. There is an organization that will make sure that the assets are returned to you safely. And this organization is called SIPC.

To begin with, I recommend watching my video about the bankruptcy of brokers.

SIPC is an American non–governmental non-profit organization that performs the functions of an insurance agent in case of bankruptcy of a broker. It was established in 1970 by order of the U.S. government in accordance with the Securities Investor Protection Act (SIPA). The abbreviation SIPC stands for Securities Investor Protection Corporation, which in Russian means «organization for the protection of investors in securities.»

Auditing brokers and reviewing their relationships with clients are not within the authority of SIPC. They are limited solely to reimbursing investors for losses, and not only US citizens. The main and mandatory condition for obtaining this insurance is that the broker must be a member of SIPC. You can check it here: sipc.org/list-of-members /.

Official SIPC website
Judging by the amounts, by US standards, we are talking about small and medium-sized investors. The maximum amount of compensation is $500 thousand per person. Of this amount, up to $250 thousand may be in cash, if the investor had them in such a volume. If there was a larger amount in the account, SIPC insurance will no longer cover it. However, most of the top American brokers have an agreement with large insurance companies (Wedbush, Lloyd’s, etc.), so not everything is so bad.

U.S. government bonds on the SIPC balance sheet
The SIPC Reserve Fund is formed by contributions from the organization’s participants. According to the data from the website sipc.org At the end of 2018, the fund’s size exceeded $3.1 billion. If the fund’s funds turn out to be below $2.5 billion, its participants must replenish reserves by transferring a certain part of their operating income. This proportion changes periodically, but does not exceed 0.01%. In addition to these funds, SIPC can use the Treasury’s $2.5 billion credit line. Finally, another source of replenishment of the fund is US government bonds, which are regularly bought by SIPC.

How does SIPC work if the broker is bankrupt

In case of bankruptcy of a broker, the algorithm for working with affected investors consists of the following steps:

• SIPC goes to court, and it appoints a trustee (trustee) – a company entrusted with working with investors;
• The Trust sends instructions to investors on how to file a compensation claim;
• Investors attach all the necessary information to the compiled request: transaction history, account status before bankruptcy, correspondence with the broker;
• These documents are reviewed by the trust, after which it determines the amount of compensation;
• Investors receive notification of the decisions taken and further instructions;
• In case of disagreement, the investor can appeal this decision in court within a month;
• Compensation in the form of money and securities is credited to the accounts specified by investors.

The maximum period for registration of documents by the investor is 6 months from the beginning of the bankruptcy procedure of the broker. However, with such a delay in time, the investor risks not receiving part of the assets. Instead, he will be transferred the monetary equivalent at the prices on the day of the appeal to the court. In order for the composition of the portfolio to be reimbursed accurately, the documents must be issued no later than 60 days. By a court decision, the period may be reduced to 30 days. It turns out that the sooner the investor draws up the documents, the better. This is also important because, theoretically, a broker can exit SIPC on the eve of its bankruptcy. In this case, the investor protection program will work 180 days after the broker’s announcement of withdrawal from SIPC.

SIPC: legal protection of investors
If the total losses of all clients of the broker do not exceed $250 thousand, SIPC does not go to court, but makes decisions on its own. To receive compensation, the investor must open a new account with another company. It is possible that SIPC, in agreement with the trust, will appoint an authorized SIPC member broker for this purpose. The investor is not obliged to follow this decision, he has the right to open an account where it is more convenient for him.

When the transfer of securities from a bankrupt broker is impossible for any reason, they have to be bought on the market. In this case, the value of the securities is fixed on the day of the appeal to the court. If the securities have fallen in price since then, the investor will suffer losses. In the same way, he will make a profit if the securities have risen in price. It is important for SIPC to compensate not the exact amount of assets, but their composition.

Not all assets are reimbursable by the SIPC fund. For example, futures and options contracts are generally non-refundable. An exception is made if these contracts serve as margin collateral for portfolio investments. Thus, only stocks and debt securities fall under the guaranteed investment protection program.