Brokerage account coverage -- it's not
In a moment of weakness, Alfred Francis said yes to
a slick salesman who cold-called him from Stratton Oakmont, a boiler-room,
penny stock brokerage based in New York.
"I had a few extra dollars at that point and
for some reason I got suckered in," he says.
That's how Francis learned that you don't get the
same insurance protection at a stock brokerage that you do at a
bank. In fact, he learned you don't get much protection at all.
Stratton Oakmont swindled thousands of customers out
of hundreds of millions of dollars. It was shut down for fraud in
1996, and the people who ran it are finding out what life is like
Francis says he had about $4,400 worth of stock in
his account when Stratton Oakmont collapsed. He tried to sell the
stock and was told he couldn't. He eventually filed a claim with
the Securities Investors Protection Corporation.
Three years and numerous letters later, the Finksburg,
Md., man still hasn't received a cent.
Francis, like millions of other brokerage customers,
thought SIPC coverage was the securities industry's version of Federal
Deposit Insurance Corporation coverage on a bank account. It's not.
FDIC coverage ensures you get whatever
was in your deposit account, up to $100,000 for
non-retirement accounts and $250,000 for retirement
accounts, if your bank fails. The U.S. government
backs FDIC coverage.
SIPC is not insurance, and the government does not
Congress created the SIPC, but its members, the brokerage
companies, fund it. Customer accounts are covered for up to $500,000
in securities and $100,000 in cash.
But, SIPC only gets involved if a brokerage firm becomes
insolvent. If your broker is stealing from your account but the
firm is up and running, SIPC coverage doesn't come into play. And,
it only covers losses due to theft or proven unauthorized trading.
Losses due to fraud are not covered.
"Most people think SIPC is like FDIC. It's anything
but," says William Thornton, an attorney with Stevens &
Lee in Reading, Pa. "It only provides coverage in the event
monies or securities disappear. SIPC generally requires some documentation
to show a securities account was maintained, but in a fraud operation
there may not have been adequate documentation developed or maintained."
Mark Maddox, former Indiana securities commissioner
and now an Indianapolis-based attorney representing some of Stratton
Oakmont's former customers, including Alfred Francis, says seeing
the SIPC logo plastered on your broker's Web site or paperwork is
"People are shocked when they find out how weak
the coverage is, and in the few instances when SIPC does cover,
how difficult SIPC makes it to recover. They act like a run-of-the-mill
insurance company. They act like it's their money and they don't
want to give it out," Maddox says.
In its defense, SIPC isn't meant to bail out people
when they make bad investment decisions or get snowed by someone
pushing the latest hot stock. Hand over money to a broker who cold
calls you, you'll probably lose your wallet.
In fact, SIPC's mission, as set forth in the statute
that governs it, is very narrow.
"We protect the custodial function that brokers
perform," says SIPC general counsel Stephen Harbeck. "We
never guarantee the underlying value of the portfolio. The risk
of loss never leaves the customer just as the rewards never leave
But critics say SIPC takes its narrowly defined mission
to an extreme.
One complaint is that in instances of unauthorized
trading, SIPC reimburses people for the value of the account on
the day bankruptcy was declared instead of at the time of the unauthorized
"You have these firms that manipulate the price
of some stocks, and they're the only ones out there making a market
in that stock," Maddox says. "When they go out of business
there's nobody left to support the stock, so it goes down to zero
or pennies on the dollar.
"SIPC says they have to give the value of the
stock on the day the firm failed. We say the amount covered should
be the value on the day they were sold. We've persuaded a bankruptcy
court that is the proper measure. The issue is on appeal, and we
expect a decision in two or three months."
Another complaint is that SIPC sometimes reimburses
customers with worthless stock instead of cash.
Harbeck explains it this way.
"Pretend I'm the broker. I urge you to buy 1000
shares at $1 each of Fly Out the Window Inc., a company that makes
a pill that you take once, and it allows unassisted human flight
for the rest of your life.
"If my brokerage firm fails, it's SIPC's job
to get you 1,000 shares of Fly Out the Window Inc., even if it's
just worth one penny now -- not the $1 you paid. If there's any
truth to the claim, the price may go up -- but it's SIPC's job to
get you 1,000 shares.
"We don't protect. Congress tells us to return
shares or claims for shares."
The General Accounting Office recently reviewed SIPC's
policies, in part because "the large number of claims denied
in several recent SIPC liquidation proceedings has raised concerns
that certain SIPC policies and practices may unduly limit the actual
protection afforded customers."
The GAO criticized the Securities and Exchange Commission,
which oversees SIPC, and said it needs to better monitor SIPC liquidation
proceedings. The SEC has set up a program to do that, but whether
that means there will be any changes beneficial to consumers has
yet to be seen.
The GAO criticized SIPC for doing a poor job of explaining
to investors what SIPC covers.
For it's part, SIPC has reworked its Web site to explain,
in plain English, what SIPC covers and what the procedures are for
filing a claim.
It's all happening too late for Francis, who says
he's sticking with mutual funds from now on.
"I have no feeling of safety with stocks and
stockbrokers. I will not deal with stockbrokers anymore."
Although SIPC coverage applies to all its member firms,
the firms that become insolvent are usually the small ones -- mom
and pop or even small regional dealers that usually have to affiliate
with a large brokerage firm to do their trading for them.
Attorney Mark Maddox has tips for anyone who invests
in the stock market.
- Never deal with anyone who cold calls you.
- Never respond to an unsolicited e-mail.
- Deal with a financial adviser or registered representative
who has a good reputation in the community in which they practice.
- Check the financial adviser's public record by
calling your state securities commissioner's office. Ask for the
broker's compliance history. If there are two or more complaints,
don't do business with that adviser.
- Pay attention to the relationship once it's started,
and make sure it proceeds the way you expect it to.
here for more information on SIPC and its coverage.
-- Posted: June 5, 2002