No protection against fraudFrom its inception in 1970 through December 2007, the SIPC paid investors only $508 million from its reserve fund. SIPC coverage comes into play only when an institution fails and assets are missing from an investor's account. If a brokerage is in business and you believe assets are missing from your account due to fraud, the SIPC will not help you. You'll have to hope that the brokerage can determine what happened and reimburse your account, or perhaps you'll need to turn to the Securities and Exchange Commission.
"In the past I've always said that, all things being equal, (an investor) is better off with a large firm, a major name, than a small firm," says Stuart Meissner, a securities arbitration attorney in New York and former prosecutor with the New York State Attorney General's Office.
"Usually, the supervision is much better as far as overseeing brokers and the enforcement of compliance standards. Secondly, if there is a problem and you need to file a claim, generally you can be confident that the firm will be around to pursue a claim against. That enables you to get an attorney to take on your case. When you have a no-name firm, you may not even get to the point of seeing if the firm can pay. However, in the past year and a half, that has somewhat gone out the window with Lehman Brothers."
Excess coverage from brokerageMost large brokerages have what's called "excess SIPC" coverage and will reimburse customer accounts when it is determined that funds were removed from your account through unauthorized transaction through no fault of your own. Often the coverage extends into the millions of dollars. Fidelity, for example, has no limit on its stock and bonds coverage, although there is a $1.9 million cap on cash.
Meissner advises investors who opt for small brokerages that don’t have excess SIPC to make sure the firm is covered by errors-and-omissions insurance. This is comparable to malpractice insurance. If you end up suing the brokerage, you want to know that there is money to pay your claim.
"A lot of small firms talk about SIPC, and that's misleading -- it (can) give a false sense of comfort to investors. Ask the firm if they have errors-and-omissions insurance, and ask to see a copy of the policy. If they don't want to tell you or they don't know, it may be a sign to go elsewhere."
Get your plan in writingMeissner also says having an investment plan in writing is crucial.
"There's a distinction between an investment advisory firm and a brokerage firm. The advisory firm isn't covered by SIPC. With anyone you deal with, ask for a plan, in writing, that shows how they are going to invest your funds and how the plan meets your objectives. Later, down the road, if they don't do what was in the plan, it's a pretty straightforward case of comparing what was in the plan and what happened -- or looking at the plan in the beginning and saying this isn't suitable for your needs."
As mentioned, the SIPC doesn't cover mutual funds, but that doesn't mean you should shy away from them in your investment account. Vanguard, the giant mutual fund company, carries a fidelity bond to cover its funds, says spokeswoman Rebecca Cohen.
"We have a fidelity bond that covers in excess of SIPC on the brokerage side of the business, and we have a fidelity bond on the mutual fund side of the business that covers fraud and illegal acts, but our funds also have insurance against negligence and pricing errors. Most of the errors we see are clerical and can be easily remedied."
Attached are profiles of four entities, the FDIC, the SIPC, the SEC and the Financial Industry Regulatory Authority, or FINRA, that every saver and investor should know about. Knowing what protections are afforded you is just as important as being vigilant about your accounts on a routine basis.