Is Your Cash Protected from Broker Bankruptcy?

Is Your Cash Protected from Broker Bankruptcy?

Undoubtedly, one of the first things every investor wants to be assured of is the safety of his or her account’s value, should the responsible financial institution go belly up. In this instance, however, the concept of “safety” might be anything but – and that very possibility is what makes this is an important issue in the first place. So let’s rephrase the question to explore which guarantees are in place to ensure that you’ll get out of your brokerage account everything you put into it.

There is a lot of misinformation around this topic, so I hope this will help clear it up. Let’s use this scenario to clarify: Mr. White needs to finance a project, so he liquidates a little over $80,000 of the securities in his brokerage account. But a few fine-tuning issues will delay his need to make the payment for four to six months, so he doesn’t need the cash right away. Thinking ahead, he wants to be sure that in the event of any financial troubles at the brokerage firm, his cash will not be compromised.  

His broker reminds him that the firm is a member of the SIPC and therefore, should financial challenges befall the brokerage, Mr. White would be made whole, up to $500,000, out of which not more than $100,000 could be in cash. He needn’t worry, because his total account balance is significantly below the threshold.

Here’s the problem. Although the $80,000 in Mr. White’s brokerage account is below the $100,000 cash limit, it has absolutely no SIPC coverage – none! That’s because only “incidental cash” is covered by SIPC. If the cash is in the account for the purpose of earning interest, it’s not covered.

While I wouldn’t say this broker’s statement was intentionally misleading, his assessment about the SIPC coverage of the cash in Mr. White’s account is totally and completely wrong. I would also say the broker is offering some potentially dangerous advice. Of course, this brokerage firm might be solvent for the next 100 years. But does that make this whole argument moot? Not a chance. I don’t have a crystal ball, and neither does Mr. White. And since brokers generally wither up almost instantaneously – without giving their investors any time to react – we just don’t know what might happen within the four to six months before Mr. White has to make his payment, do we?

Given the specifics of this case, I’d recommend that Mr. White lodge his cash in a savings account with an FDIC member bank, keeping in mind that protection in his name is limited to $250,000 at any given bank. Under FDIC rules, although his $80,000 is intended to earn interest, it is still covered.

Lastly, please remember that every financial situation is different, so don’t take my conclusions here as a matter of general rule. Your situation might lend itself to the exact opposite solution.  Happy investing!

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