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When your broker goes belly up

By Sheyna Steiner ·
Thursday, November 3, 2011
Posted: 3 pm ET

By now the entire story of MF Global has unfolded, revealing a series of bad decisions and errors in judgment.

MF Global made highly-leveraged bets on short-term sovereign debt from cash-strapped European nations such as Spain and Italy. Those investments were ultimately the firm's undoing, but defaults on the investments weren't what brought them down -- instead it was margin calls on their investments that caused a cash shortfall.

And at that point, they may have reached into client accounts to find some extra money or, in the confusion, misplaced $600 million in customer funds.

And then they were forced into bankruptcy.

That's the short story. For a longer version, Felix Salmon summed it up effortlessly over on his Reuters blog under the title, "What happened at MF Global."

For MF Global clients, a filing with the Securities Investor Protection Corporation, or SIPC, will likely be in the future.

Investing with a brokerage that is not a member of SIPC is like having a checking account at a non-FDIC-insured bank, there's simply no reason to. However SIPC and the FDIC should not be confused.

The only time SIPC will get involved is in the event of a brokerage firm failure in which customers are owed money or in case of unauthorized trading in your account.

From the SIPC Web site:

Typically, when SIPC asks a court to put a troubled brokerage firm in liquidation, the financial worth of a customer's account is calculated as of the "filing date." Wherever possible, the actual stocks and other securities owned by a customer are returned to him or her. To accomplish this, SIPC's reserve funds will be used, if necessary, to purchase replacement securities (such as stocks) in the open market. It is always possible that market changes or fraud at the failed brokerage firm (or elsewhere) will result in the returned securities having lost some -- or even all -- of their value. In other cases, the securities may have increased in value.

SIPC's reserve funds will cover a maximum of $500,000, including $250,000 on claims for cash. Funds recovered from the bankrupt company will go to investors with claims above $500,000 or some brokerages carry "excess SIPC" for just such situations.

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