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The Importance of Segregated Assets at Brokerage Firms
April 25, 2023
Recent events in the banking world have once again highlighted the importance of understanding how Federal Deposit Insurance Corporation (FDIC) insurance covers deposits, which prompts similar questions about how investment assets are treated in the event of a brokerage firm (broker-dealer) failure. While there is comparable—but not identical—insurance coverage for brokerage assets through the Securities Investor Protection Corporation (SIPC), it is important to first understand how creditors look differently at segregated assets (like those held in the typical brokerage account) versus non-segregated assets (like bank deposits) if there were ever the need for the liquidation of a brokerage firm’s assets.
Segregated assets are investment assets held in dedicated, individual accounts at a broker-dealer, and they are the first line of defense that provides a crucial part of the regulatory framework that governs broker-dealers. This definition of individual accounts includes not only regular individual accounts, but also joint, custodial, and trust accounts. The Securities Investor Protection Act of 1970, which established the SIPC, requires broker-dealers to maintain separate accounts for customer assets to deliberately segregate them from the broker-dealer’s own assets, hence protecting them from any potential bankruptcy or insolvency.
Beyond the segregated account itself, if a broker-dealer should fail, the SIPC insurance would get triggered, if necessary, to help cover most types of underlying assets in customer accounts, including typical stocks, bonds, and mutual funds; only certain less-common assets like futures contracts and directly held commodities are not covered by the SIPC (and we do not invest in such assets). It is important to keep in mind, though, that the SIPC provides insurance protection for customers of failed broker-dealers, but not protection against possible investment value losses due to market activity. SIPC insurance provides coverage up to $500,000 per customer (including $250,000 for any cash claims).
If a broker-dealer should fail, the SIPC appoints a trustee to take over the broker-dealer’s business and liquidate its assets, using only the broker-dealer’s non-segregated assets to pay off its creditors. Customer segregated assets, on the other hand, are not part of the broker-dealer’s assets in the first place and are therefore not available to pay off its creditors.
While the recent bank-related events will likely continue to impact markets over the coming weeks and months, we believe the case for highly diversified portfolios, across asset classes and allocated and rebalanced in a straightforward and philosophically consistent manner, will serve you well. And importantly, assets placed in a brokerage account belong to the individual and not the institution. At Sand Hill, we work with both Fidelity and Schwab—two of the largest and most well-known broker-dealer firms in the industry—and both carry excess SIPC coverage through other insurers such as Lloyd’s of London for their clients’ portfolios. That is why we believe that our structure of using registered third-party custodians remains the most secure approach to ensuring the safety of your assets.
Sources: Securities Exchange Commission (SEC), Ropes and Gray, Financial Industry Regulatory Authority (FINRA), Charles Schwab, Fidelity Investments, SIPC.
Articles and Commentary
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