Stockbroker, default of

Quick definition

Stockbrokers can occasionally find themselves insolvent, and clients in most countries are protected by a central fund from which compensation may be paid.

Key details

• Stockbrokers can go bankrupt or fall into default
• This often happens during periods of economic volatility, or occasionally as the result of negligence
• Licensed stockbrokers typically subscribe to a compensation fund that provides insurance to clients in the event of insolvency

Can stockbrokers go out of business?

Yes some brokers fail. You just need to look at the global recession in 2008 for a long list of examples.

Fortunately, many jurisdictions have regulations in place that protect investors’ assets if a broker closes due to client segregated accounts. These regulations ensure that if a broker closes, the only assets that will likely evaporate are those belonging to the broker and its executives. The objective of the regulations is to ensure traders do not lose confidence in the market because of poorly run business operations. These regulation allow brokers to suffer the consequences of business failure to the maximum ‘without spilling innocent blood.’

Can you lose money and assets if your broker closes?

Most countries and jurisdictions have measures in place to reduce the chances of investors losing their money in case of an insolvent broker. However, these measures only secure assets lost following bankruptcy, not market-induced losses.

• Investor protection agencies: Investors in the United States count on the Securities Investor Protection Corporation (SIPC) to secure their assets and money. The SIPC is the equivalent of the Federal Deposit Insurance Corporation (FDIC). The SIPC is a U.S. government agency that compensates customers in the event a broker fails. The compensation process involves the appointment of a trustee that oversees the whole activity. However, the SIPC only covers up to $500,000. Therefore, you may want to find out more from your broker in case your account is worth more. Some brokers go for additional insurance from private firms. In Canada, the Canada Investor Protection Fund (CIPF) offers protection similar to the SIPC in the U.S.
• Regulations: Protection agencies offer one layer of security for investors. Other security measures include regulators who oversee the industry to prevent fraud and events that could lead to investors losing their money. For instance, Canada has the Investment Industry Regulatory Association of Canada (IIROC) that regulates the conduct and business operations of brokers. In the U.S., the Securities and Exchange Commission (SEC) ensures that brokers have clear separations between clients’ assets and company assets. The SEC enacts provisions prohibiting brokerages from accessing client accounts for any reason whatsoever.

What happens if the broker closes?

Two scenarios can take place when a broker goes under. First, the SIPC in the U.S. appoints a trustee that oversees the compensation of the investors. This compensation often comes in the form of cash where investors receive the cash equivalent of their account’s worth. Notably, the agency compensates up to $500,000 only. If after liquidation the broker cannot raise enough money for compensation, the SIPC can step in to plug the gap.

The second scenario involves the transfer of accounts to another broker. After the appointment of a trustee, the SIPC conducts a thorough audit of the broker’s accounts. If everything falls into place neatly, the agency can initiate plans to transfer the investors to another broker. After the transfer is complete, investors are free to look for new brokers.

During this process, investors must stay up to date with developments. For instance, the SIPC might call upon all investors to file a claim before compensation or account transfer. Failure to do this within a given timeline might result in losses.