SIPC $500K Coverage

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SIPC $500K Coverage

Postby Jim180 » Fri Jun 28, 2013 8:16 pm

I'm thinking of moving greater than $500K to a large investment firm. Large firms such as Vanguard, Fidelity and Schwab claim they have additional coverage from Lloyd's of London, so I've been told by them everything should be fine. ( Of course what else would they say?) I have a two part question. First, what exactly counts toward that $500K? Every dollar of my account? Second, do you think the three firms I mentioned are solid enough to have greater than $500K with them?
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Re: SIPC $500K Coverage

Postby nisiprius » Sat Jun 29, 2013 7:01 am

I don't have any answers when it comes to extreme worst-case "black swan" scenarios. There are two things you should keep in mind that I'm not sure you're aware of.

a) The distinction between what I'll call "promising something" and "holding something." An example of "promising something" is a gift card or a gym membership or an airline ticket. You pay them money now. They promise that when the time comes you can use the gift card, visit the gym, or get on the airplane. An example of "holding your property" would be a bank safe deposit box.

In the case of "promising something," you are really worried about the firm's solvency, because keeping the promise depends on their continuing to operate. If they fold, everything descends into legal bankruptcy limbo. The store is closed, the gym is locked, there is no plane to get on.

In the case of "holding your property," it's your property. You can put a stack of bills or a jade pendant into a safe deposit box. They are there the day you put them in and they stay there. The bank doesn't take them out, use them itself. They are not promising you a stack of bills or a jade pendant. They stay in the box. No matter what happens to the bank's business, they stay there and you can probably get in somehow and get them.

The point is this. A brokerage account, and a mutual fund, are examples of "holding something." You give them money and right away they use the money to go and buy shares, mark them with your name, and keep them. It's not a fractional-reserve thing like a bank. If you invest $1,000, it buys however many shares $1,000 will buy, say 21.78, marks with your name, and held. Your statement shows 21.78 shares from day one. The brokerage had 1,000,000 shares, you place your order, they place theirs, they now have 1,000,021.78 and their computers know that 21.78 of them are yours.

b) The distinction between mutual fund risk and brokerage risk. I'm going to begin with mutual funds because it's less well understood. I didn't understand it for years. When you buy shares of a mutual fund, the mutual fund promptly buys the shares of stock, which are held in the mutual fund's account at a "custodial bank," often JPMorgan Chase for Vanguard funds. This is an example of "holding something." Protection is provided by the regulations of the Investment Company Act of 1940, the requirement for a separate custodian, etc. The SIPC is not involved. If you only buy Vanguard mutual funds "at Vanguard," your statement only shows the name "The Vanguard Group" and there is no SIPC symbol printed on the statement.

I have no idea how good that protection is. Everyone pretty much assumes it's perfect. I don't know of any historical cases that would bear on it, but then there is often a paucity of public information about extreme events. In any case, there isn't any magic $500,000 number. And there is no government insurance. The mutual fund company and its custodian bank carry private insurance called "fidelity bonds;" I'd dearly like to know how often they've ever had to make a claim. Because it's a "holding" situation and not a "promise" situation, in theory, if a mutual fund company were to become insolvent, you shouldn't lose anything, because all the stocks and assets that are "in" your mutual fund shares would all continue to exist. What happens in the real world, in what order and how or when you get your stuff back I have no idea and would like to know.

SIPC protection is a separate layer and deals with a separate, specific risk. It's best understood by looking at the historical events that led to its creation. In the late 1960s brokerages were in a bad way, many were failing. Electronic data processing was new, and the capability of keeping track of accounts and stock certificates, the "back office operations," were stressed and apparently sloppy. The New York Times reported that there were rumors that it wasn't just sloppiness, that there was organized crime involvement, and there was at least one actual case where stock certificates that were supposed to be at a brokerage were physically missing, and later discovered to be physically at a labor union's pension fund office.

All the that SIPC does is to guarantee the accuracy of your brokerage statement--if it shows you own 100 shares of GE, the brokerage really bought them and is really holding them for you, and if for any reason it can't find them when you sell them, the SIPC is supposed to make good.

Notice that mutual fund shares can be held directly, or they can be held for you at a brokerage. In either case, there is what I might call "mutual fund risk," no SIPC involvement, protected by the provisions of the Investment Company Act of 1940.

Holding mutual funds at a brokerage there are two risks: the mutual fund risk is still there and gets no extra protection. In addition to that there is also "brokerage risk," the extra risk because you are holding the funds indirectly, and the SIPC protection counters only that extra "brokerage risk."
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Re: SIPC $500K Coverage

Postby Call_Me_Op » Sat Jun 29, 2013 8:06 am

You should also be aware the SIPC (and related insurance) only covers fraud my the mutual fund company. It does NOT cover fraud perpetrated by an outside entity.
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Re: SIPC $500K Coverage

Postby livesoft » Sat Jun 29, 2013 8:07 am

The reality is that there are really no better options than using a major well-established financial institution to keep your assets. That is, if not these folks, then who?
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: SIPC $500K Coverage

Postby dodonnell » Sat Jun 29, 2013 9:30 am

Three recent cases of custodian risk are:

    Lehman Brothers bankruptcy - no SIPC needed
    Madoff Ponzi - SIPC paid 500k for fake statements
    MF Global - SIPC only covers brokerage accounts, not commodity accounts, customers lost 1.2B of "cash" in their commodity accounts

SIPC covers up to $500k, but only $100k in cash, don't hold large amounts of cash.

Don't assume a globally diversified top institution cannot fail. We now know that Lehman, Bear Stearns, Washington Mutual, Wachovia, AIG, Fannie and Freddie were essentially insolvent just a few years ago. Make sure your holdings at those institutions would have withstood a failure.
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Re: SIPC $500K Coverage

Postby Call_Me_Op » Sat Jun 29, 2013 9:42 am

livesoft wrote:The reality is that there are really no better options than using a major well-established financial institution to keep your assets. That is, if not these folks, then who?


How about an "all of the above approach" or at least a couple of them?
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Re: SIPC $500K Coverage

Postby livesoft » Sat Jun 29, 2013 9:47 am

Well, I use Fidelity, WellsFargo, TDAmeritrade, TIAA-CREF, and last but also least Vanguard, so I am all for spreading it around.
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: SIPC $500K Coverage

Postby scrabbler1 » Sat Jun 29, 2013 11:30 am

Jim180, remember that if you have two different accounts with the same firm, each one is covered up to $500k. For example, if you have a brokerage account and an IRA with the same place, each one is covered up to $500k rather than combining the value of the two then subjecting that total to $500k.
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Re: SIPC $500K Coverage

Postby Jim180 » Sat Jun 29, 2013 11:34 am

scrabbler1 wrote:Jim180, remember that if you have two different accounts with the same firm, each one is covered up to $500k. For example, if you have a brokerage account and an IRA with the same place, each one is covered up to $500k rather than combining the value of the two then subjecting that total to $500k.


Thanks! That's very helpful. That would be my situation, so I guess I'm good then.
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Re: SIPC $500K Coverage

Postby pkcrafter » Sat Jun 29, 2013 12:14 pm

It's a good idea to review the SIPC terms occasionally. Here'a a link:

http://www.sipc.org/How.aspx

Once there, click on Read Our Brochure. The brochure states 500k per customer, not account. Cash is now covered up to 250k within the 500k limit. This insurance was created mainly to cover losses from brokerages that failed, but is also will cover brokerage fraud. SIPC does not directly cover mutual fund companies.

The 500k limit "per customer" is not well-stated as an "account" is actually how it's registered:

SIPC coverage is extended to each 'legal customer.' For instance, if you have three accounts at a firm—an individually held account in your name only, a joint account with your spouse, and an IRA in your name—each account is considered a separate 'legal customer,' and each will be eligible for $500,000 in SIPC coverage.

http://www.ameriprise.com/budgeting-investing/planning-and-budgeting/financial-analysis/market-update/2008-09-30c.asp



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