- Like banks using customer deposits as a source of capital, brokers likely would use cash in customer accounts for their own operational purposes. But the SEC requires brokers to maintain a portion of liquid assets to promptly satisfy customer withdrawals at any time, including security purchases. Brokers may also use customers' securities for lending and as collateral to borrow operational capital. However, the SEC requires brokers to maintain possession and sole control of customers' fully paid securities and margin securities whose value is in excess of 140 percent of a customer's borrowing balance. Only with proper separation of customer assets, customer interests may be better protected in the event of a broker bankruptcy.
- When a SIPC-member brokerage fails, it ordinarily files for bankruptcy under the Securities Investor Protection Act (SIPA), rather than the Bankruptcy Code. SIPA liquidation seeks to recover both cash and securities for customers of the failed brokerage, whereas a normal liquidation under the Bankruptcy Code would sell off all assets for cash distributions to creditors. The SIPC administrating the liquidation is allowed to use its funds to purchase securities to satisfy certain security claims from customers. Before liquidating any assets, the SIPC may try to transfer customer accounts to another SIPC-member broker so that customers can continue their investment activities.
- Upon a broker's bankruptcy filing, customers can file their claims in the amount of their account's net equity value, which is determined and fixed as of the SIPC filing date. Customers are given preferential claiming rights relative to the broker's other creditors in the distributions of customer property. In other words, non-customer creditors essentially have no rights to customer property. Unlike creditor-contributed capital, customer capital is not intended to be used in broker's operations. However, beyond customer assets, broker customers may claim further distributions on an equal basis with other creditors.
- In the best scenario, proceeds from liquidation would be enough to cover the full scope of customer claims. In the case of any shortfall, the SIPC would step in to provide additional coverage. SIPC protections offer each customer account up to $500,000, including $100,000 in cash. In general, customers are expected to get back all their securities unless there are not enough shares at the broker and the total share value exceeds the SIPC cap of $400,000 for securities. Some brokers may have their own insurance beyond the SIPC protection. However, distributions of securities back to customers don't guard against any potential security losses in value during the liquidation process. Only the number of shares under the protection limit is guaranteed.
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