What is SIPC? Stanford Case Set to Challenge What is Eligible

Anyone with some type of broker account has seen the term, “Insured by SIPC” but what does that mean? Is it like your bank account being FDIC Insured? In short, No.  The “I” in SIPC is often confused for insurance, but it actually stands for Investor. The Securities Investor Protection Corporation otherwise known as SIPC has a pretty clear mission statement:

When a brokerage firm is closed due to bankruptcy or other financial difficulties and customer assets are missing, SIPC steps in as quickly as possible and, within certain limits, works to return customers’ cash, stock and other securities, and other customer property. Without SIPC, investors at financially troubled brokerage firms might lose their securities or money forever or wait for years while their assets are tied up in court.

Although not every investor is protected by SIPC, no fewer than 99 percent of persons who are eligible get their investments back from SIPC. From its creation by Congress in 1970 through December 2011, SIPC advanced $1.8 billion in order to make possible the recovery of $119.0 billion in assets for an estimated 767,000 investors.

SIPC Does Not Provide Insurance Against Bad Investments

The Securities Investor Protection Corporation was not created as an insurance policy against bad investments, but rather as a way to provide funds to individuals who have been financially injured by a broker-deal failing.  Wikipedia provides a perfect clarification on the topic,

SIPC does not insure the underlying value of the financial asset it protects. In other words, investors still bear the risk of the market. For example, if an investor buys 100 shares of XYZ company from a brokerage firm and the firm declares bankruptcy or merges with another, the 100 shares of XYZ still belong to the investor and should be recoverable. However, if the value of XYZ declines, SIPC does not insure the difference. In other words, the $500,000 limit is to protect against broker malfeasance, not poor investment decisions and changes in the market value of securities. In addition, SIPC may protect investors against unauthorized trades in their account, while the failure to execute a trade is not covered.

The SIPC does not even cover Fraud if the broker-dealer is still solvent.  Rather the SIPC gets involved when,

…a brokerage firm fails owing customers cash and securities that are missing from customer accounts, SIPC usually asks a federal court to appoint a trustee to liquidate the firm and protect its customers. With smaller brokerage firm failures, SIPC sometimes deals directly with customers.

There are also instances when SIPC would get involved for unauthorized trading in  your account.

What are the SIPC Limits?

SIPC has both Eligibility Limits and Dollar Limits.

Dollar Limits of SIPC

SIPC coverage is limited to $500,000 per customer including up to $250,000 in pure cash.

Eligibility Limits of SIPC

According to FINRA,

SIPC covers notes, stocks, bonds, mutual fund and other investment company shares, and other registered securities. It does not cover instruments such as unregistered investment contracts, unregistered limited partnerships, fixed annuity contracts, currency, and interests in gold, silver, or other commodity futures contracts or commodity options.

Testing SIPC: Recent Case Involving SIPC Coverage

I was thinking about writing a post about SIPC when I saw an article in the April 2012 Investment Advisor Magazine titled, SIPC Fights SEC’s Stanford Suit written by Melanie Waddell that I thought was a perfect connection between pure definitions and an actual situation.

The facts of the case are superficially simple (aren’t they always “simple”):

  • Investors gave money to Allen Stanford allegedly knowing that the money was going to be moved from a broker-dealer covered entity to CDs in a Caribbean Bank (i.e. not a covered entity).
  • The investments turned out to be a ponzi scheme (interesting side note Mr. Stanford hasn’t please guilty yet – should lead to some exciting testimony)
  • The Securities and Exchange Commission wants SIPC to pay out those affected

When researching this post I was shocked to find that the SIPC created a website as a very public response to the SEC.  Their argument, which is pretty sound, is that,

    • This case is about investments in certificate of deposits (“CDs”) issued by the Stanford International Bank Ltd. in Antigua. Stanford International Bank Ltd. is an offshore bank: it is not a SIPC-member brokerage firm and has never been a SIPC member.
    • The Securities Investor Protection Act only covers the custodial function of a SIPC-member brokerage, by offering limited protection to customers against the loss of missing cash or securities when a SIPC-member brokerage firm is holding cash or securities for an investor but fails financially.
    • The Act does not authorize SIPC to protect monies invested with offshore banks or other firms that are not SIPC members. The Act also does not protect investors against a loss in value of a security, including because of mismanagement or fraud.
    • In addition, this case involves CDs that were delivered, not a situation in which a SIPC-member brokerage firm had custody of securities but failed before delivery could occur.

Granted it is from an industry source, but from Ms. Waddell’s article it seems that the SEC is simply trying to bully SIPC into paying up because their auditors missed the boat on yet another Ponzi Scheme.

Luckily most people do not run into SIPC all that often, but it is there to provide a little more protection to investors.

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