Securities Investor Protection Corporation

The Securities Investor Protection Corporation (SIPC) is a non-profit corporation created in 1970 to protect customers of brokerage firms. If a broker fails, SIPC steps in to recover customer securities and cash from the firm’s assets. SIPC protection covers up to $500,000 per customer account — $250,000 for securities and $250,000 for cash.

What SIPC covers

SIPC protects customer securities and cash held at a brokerage firm. If you own 100 shares of Apple held in your brokerage account, and the broker fails, SIPC ensures you get back those 100 shares (or the equivalent value) because the shares belong to you, not the firm. If you have $50,000 in cash in the account waiting to be deployed, SIPC ensures you get that $50,000 back.

The limit is $500,000 per account per firm, with a $250,000 sub-limit for cash. If you have $600,000 at one broker, SIPC covers $500,000. If you have accounts at two different brokers, each account is covered separately to $500,000.

Critically, SIPC does not cover losses from bad investments. If you buy a stock and it falls 50%, SIPC does not compensate you. It only covers the risk that the broker itself becomes insolvent and fails to return your securities or cash.

How SIPC works in a broker failure

When a SIPC member brokerage fails, SIPC is notified. SIPC applies to a court for a receiver to be appointed. The receiver takes control of the firm’s assets and holds them in trust while SIPC works to return customer securities and cash. SIPC has a fund (the SIPC Fund) backed by member assessments (fees charged to brokers). It uses this fund to pay customers whose securities or cash cannot be recovered from the firm’s assets.

The process is called “Direct Payment” if SIPC pays the customer, or “Transfer” if customer accounts are moved to another broker. Most broker failures are resolved through transfers — the new broker takes over customer accounts and SIPC never needs to dip into the fund. But if there is a shortfall, SIPC makes up the difference.

What SIPC does not cover

SIPC does not cover commodity futures, forex, or options traded on the side. If you trade futures through a broker, SIPC coverage for those positions is limited or nonexistent (futures are more often protected by the CFTC’s separate insurance regime through the derivatives clearing system). SIPC also does not cover a customer’s failure to pay for securities — if you buy $100,000 of stock on margin and the broker cannot force you to pay, that is between the broker and you, not SIPC’s problem.

Moreover, SIPC does not cover fraud by the broker’s employees. If a broker runs a Ponzi scheme (as Bernie Madoff did), SIPC coverage may apply, but only to actual securities and cash held in the account. If a broker misappropriated customer funds, SIPC can only return what is actually recovered.

SIPC’s financing and limitations

SIPC is funded by member assessments. Each brokerage firm pays an annual fee based on the amount of customer assets held. If the SIPC Fund is depleted — which would happen if many brokers failed simultaneously — SIPC is authorized to borrow from the US Treasury. This has never happened, but it shows that SIPC’s capacity is ultimately limited. If the entire financial system were to collapse, SIPC coverage, like all insurance, would be tested.

The Madoff case and SIPC’s limits

Bernard Madoff operated a Ponzi scheme that defrauded customers of roughly $65 billion (notional; the actual cash loss was much lower). When the scheme collapsed in 2008, SIPC became involved. SIPC was able to recover some customer assets, but most customers filed claims for losses. The case revealed SIPC’s limitations: it was designed to cover broker insolvency, not fraud. Nonetheless, SIPC and courts tried to calculate what customers would have had if the fraud had been discovered earlier, and customer claims were paid from the SIPC Fund. This set a precedent that SIPC can cover fraud losses, though with limits.

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