Are You Covered Against Online Stock Broker Failure?

Understanding the rules to an online stock broker for trading stocks is no easy task. Recently the FDIC, in conjunction with marketing-maven Suze Orman, launched a PR website to help bank depositors understand what accounts and amounts are covered by the FDIC and what aren’t.

The case studies on the website are a little absurd considering the fact that the families profiled all have more than 1 million dollars in assets (less than 1% of the U.S. population fits that demographic) but it raises some good questions for online stock brokers:

• Are investors covered in similar ways?
• Is it important to be covered as an investor?

Being an investor in any market comes with risk. Most of the risk you sustain on a daily basis is market related. Maybe the market will move in your favor and maybe it won’t.

That seems relatively straightforward, but have you considered some of the systemic risks not associated with market movement?

If your broker or dealer fails, it could destroy all, most or some of the profits and deposits you have made over many years. If this only happened once in your lifetime, it would be enough to change your financial status forever.

Investors in CDs or bank deposits have some coverage (usually up to $100,000 per account holder per FDIC covered bank), but do trading account holders have similar coverage benefits?

Yes and no. Finding out whether or not you are covered is important and definitely relevant in today’s unstable economic environment.

Stocks and Options Accounts

Traditional brokerage accounts are usually covered in two ways. First, your broker may offer a sweep account that will qualify for coverage by the FDIC (like Suze Orman’s examples) and your positions and remaining balances are usually covered by the SIPC (another Federal insurance agency) up to $500K.

If your broker were to fail�

If your broker were to fail, your account positions and balances would be transferred to another clearing firm. The process takes some time, but ultimately you can anticipate getting your money back. The SIPC has done this 317 times, and a little over 99% of investors involved have been paid what they were owed.

Exchange Trade Futures Accounts

If you own a futures account, things get a little more complicated but not by much.

Your futures account is actually separated and designated to your sole benefit. This means it cannot be attacked in a bankruptcy or receivership process. Ultimately, the account and your open positions are transferred to another clearing firm where you can access it.

Recently, this happened to the futures account holders at Refco. There is no upper limit on how much you can have in your account for this kind of coverage.

Forex Dealers

If you have an over-the-counter forex account of any kind, you are typically out of luck if your dealer fails.

Forex dealers do not segregate accounts (especially outside the U.S.) in the same way a futures broker does, and it can be attacked in a bankruptcy. This is what happened recently to traders with forex accounts at Refco. This makes it even more important to be very picky about who you trade with and to have more than one account.

Why Does This Matter?

If you have a single uncovered account or partially uncovered account and your broker or dealer fails, it doesn’t matter how profitable you have been � its gone.

Over the last year, we have learned that no bank or financial institution can be considered immune to sudden and catastrophic failure. There have been 57 bank failures in the U.S. over the last 12 months � marque names like Lehman, Bear Stearns and Citigroup have lost all or most of their value and Standard and Poors has lost their rating credibility. This is a new market, and nothing should be taken for granted.

Your homework is to call your brokers and/or dealer and find out exactly how you are covered and what you need to do to improve that coverage. Don’t get burned by ignorance. Take action now to make sure your exposure is reduced.

This article is brought to you by LearningMarkets.com.

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