Minimize your exposure to brokerage failures.

What would happen if extreme economic turmoil pushed your brokerage firm into bankruptcy?  Every stock brokerage firm in the US is required to follow specific rules about segregating customer investments .  Therefore, even if the brokerage firm fails, your account remains separate from the broker’s assets.  Brokers are also required to satisfy certain net capital requirements, laid out in SEC Rule 15(c)3-1.  To determine a broker’s ratio of liabilities to net capital, just ask.  If you are then unable to monitor its compliance with 15(c)3-1 or are concerned that your broker may be conducting riskier business than that of other firms, dig deeper. 

Are accounts at brokerage firms insured?  The brokerage firm itself should be a member of the Securities Investor Protection Corporation (SIPC, www.sipc.org), an independent organization set up by Congress in 1970.  Ask your broker whether their firm is an SIPC member (all companies registered with the Securities and Exchange Commission are required to be members), or call SIPC Membership at 202-371-8300.  Both TD Ameritrade and Charles Schwab are SIPC members. 

The SIPC covers the first $500,000 of a customer's assets (for combined accounts at the firm), with a limit of $100,000 for uninvested cash balances. (Money market funds are considered securities, not cash.)  It does not cover losses on futures contracts, currencies, limited partnerships and annuities.  Nor does it cover losses resulting from investment fraud.  The SIPC states that these coverages are to be considered a "floor" rather than a ceiling, with each investor of a failed brokerage firm receiving a prorated distribution of customer assets.  

Since 2004, SIPC has reportedly stepped in seven times, with consumers being fully reimbursed in all but one of those cases.  However, since the SIPC is grossly underfunded, with current capitalization just a little over $1 billion, if brokerage account losses escalate in the current economic environment, the SIPC could be hard-pressed to pay the basic guarantee.  If the SIPC runs out of money it would no doubt appeal to Congress for emergency help.  If that failed the SIPC would likely function by replacing cash or value with non-transferable treasury bonds of medium duration such as five years.  Or it could simply melt down.  

How about customers with over $500,000 in a firm?  Brokerage firms carry secondary insurance for this purpose.  They will tell you who the carrier is.  Additional insurance at both TDA and Schwab are provided through Lloyd’s of London (which required a cash infusion from Berkshire-Hathaway [Warren Buffett] a couple of years ago). 

How about money market accounts?  Derivative losses are popping up everywhere; several money market funds (which invest primarily in overnight loans between banks and corporations) have already “broken the buck” (had the net asset value of their fund fall below $1 per share).  But the US Government has just announced a program to guarantee losses in money market funds!  Individual brokerage firms are required to pay a fee to receive this guarantee—so you should ask your broker whether they are participating in the program.  Government-backed money market funds, on the other hand, contain some measure of guarantee against loss (since the government can always print more fiat currency to discharge its obligations). 

• We have moved client accounts at TD Ameritrade to The US Government Portfolio Class (ZTD81), which is currently yielding 0.55% less than the “Class A” money market fund: 13% of ZTD81 is in Treasury bills, and 75% in US Government Agency obligations (FNMA, FHMC and FHLB (yes, the same Fannie and Freddie that were just bailed out).
• The money market default for Schwab 401k accounts has been changed to SWMXX.

In the current environment, bank CD’s or Treasury bills are preferable to money market for holding excess cash. 

Are my stock positions vulnerable?   Yes, if they are held in “street name”, i.e. the name of the brokerage firm, as they sometimes are.  That’s why it’s imperative that you either take delivery of your paper stock certificates or make sure that your position is an entry on the book of each company’s transfer agent. 

Every public corporation employs a transfer agent—a record keeper who prepares and maintains records related to the accounts of its shareholders.  You need to make sure that the stock positions you hold in your brokerage accounts are “book entry” (or “direct registration”)—with your name recorded in the transfer agent’s book.  If they are held in street name and the brokerage firm fails, it could be difficult for you to reestablish your ownership of the investment. 

If you are unable to assure yourself that your positions are all book entry, contact your broker and insist on the brokerage firm delivering stock certificates for each of the holdings that you are not planning to trade.  Ignore the broker’s objections and cries of “old fashioned” or “retarded.”  The broker may even charge you $25-$100 for the service.   

It is very important that you store your certificates in a safe place where they can be easily retrieved.  Do not lose them!  If you sell, you will need to provide the certificates within three business days.  If you cannot secure them yourself, store your assets only with an entity you know thoroughly. 

How about mutual funds?  Mutual funds held in brokerage accounts are insured by the funds themselves. Your confidence (or lack of confidence) in a mutual fund’s safety should be based on your regard for the fund’s ownership and performance history, much the same as you assess the management and resources of a company before you buy its stock.  Read the funds quarterly reports.  In addition, mutual fund rating agencies exist.  Reputation should be a factor in selecting a fund—possibly even more important today than past performance.