An article by MorningstarAdvisor begs the question: “How Safe Is Our Clients’ Money?” We thought you might like some of the insights we found in the article.
It highlights the downfall of MF Global, who filed for bankruptcy on October 31, 2011 as a recent example of why broker-dealer firms fail. However, the article argues that despite the recent failure of such firms as MF Global and Lehman Brothers, there are safeguards for investors to prevent loss of funds.
- It is essential to know that your firm is a member of the SIPC. If they are not, in the case of a failure, your cash and securities will not be insured. Be aware that SIPC does not cover futures contracts, precious metals, limited partnerships or fixed annuity contacts.
- If possible avoid margin accounts
- Only make deposits and payments to firms that FINRA registered, not to an advisor or registered representative
- Never abbreviate the name of the brokerage firm on checks, spell out the full name
- Check your monthly statements! Check that deposits and transfers are recorded accurately. Inaccurate statements or failure to provide routine statements is a warning sign of a failing firm.
- Use a broker-dealer who does not engage in proprietary trading.
Many of the reasons that MF Global filed for bankruptcy was because they had two business objectives: being a broker-dealer for clients but also engaging in risky proprietary trading for itself. Losses from the risky trading may have caused executives to be in a situation where they unable to meet the liquidity requirements of the SEC. When the SEC became aware of the issues, they audited MF Global and found them in failure.
The SEC requires that firms meet liquidity requirements to back the securities they are trading. By regulating liquidity requirements, the SEC attempts to prevent situations like these. If these preventative measures do not successfully work, as in this case, the Securities Investor Protection Corporation will back any insured firms. This insurance guarantees securities up to $500,000, including up to $250,000 in cash. Many of the top broker-dealer firms carry these insurance policies, and often times carry excess insurance policies. These excess policies will cover up to $145 million in securities including $900,000 in cash. Firms that carry these policies include TD Ameritrade, Charles Schwab, Pershing and Fidelity. Despite the failure of firms such as MF Global and Lehman Brothers, with these preventative measures and insurance policies, there are a few reasons to worry about the safety of these firms.