SIPC protection for mutual funds

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The Securities Investor Protection Corporation (SIPC) protects against the loss of cash and securities – such as stocks, bonds, and mutual funds – held by a customer at a financially-troubled SIPC-member brokerage firm.[1]

The limit of SIPC protection is $500,000, which includes a $250,000 limit for cash. Most customers of failed brokerage firms when assets are missing from customer accounts are protected.[1]

It is important to recognize that SIPC protection is not the same as protection for your cash at a Federal Deposit Insurance Corporation (FDIC) insured banking institution because SIPC does not protect the value of any security.[1]

Investments in the stock market are subject to fluctuations in market value. SIPC was not created to protect these risks. That is why SIPC does not bail out investors when the value of their stocks, bonds and other investment falls for any reason. Instead, in a liquidation, SIPC replaces the missing stocks and other securities when it is possible to do so.[1]

To be clear, SIPC protection is only for brokerage firms. If you own a mutual fund or other security that is not part of a brokerage firm, SIPC protection does not apply.

Holding securities with regards to SIPC protection

Question: If you have a fund that is not held in a brokerage account, is it prudent to move it into a brokerage account just to get SIPC protection?

The answer is "no" and explained here.

First, the situation applies to any broker-dealer firm that is a member of the SIPC. A membership list can be found at SIPC - List of Members. Charles Schwab, Fidelity Institutional, TD Ameritrade, and Vanguard Marketing Corporation are a few examples of SIPC members.

  • Mutual funds and stocks are both examples of financial assets.
  • Financial assets, though commonly held in brokerage accounts, can often be held directly with no brokerage involved.
  • You can hold a mutual fund directly with a mutual fund company, with no brokerage involved. You can hold stocks directly, with no brokerage involved, although this is very rare nowadays. (This sometimes happens, for example, when employee purchase company stock in an ESOP plan, or when people own policies at a mutual insurance company that demutualizes and receive stock in the insurance company).
  • You can hold a mutual fund in a brokerage account. You can hold stocks in a brokerage account.
  • No government agency insures the value of stocks. If you own GE stock and it goes down, you lose money. If you own Enron stock, and it becomes worthless due to fraud, you lose money. It doesn't matter where the stock is held. No government agency insures you against loss, even loss due to fraud. A brokerage customer who bought Enron stock was no better off than an Enron employee who held Enron stock directly, even though the brokerage customer had SIPC protection.[2]
  • No government agency insures mutual funds against loss of value. Theoretically this would be true even in the case of fraud. Mutual fund investors are protected in many ways by the regulations of the Investment Company Act of 1940. For example, the mutual fund company itself does not hold the assets in the fund; they are held independently by a custodian bank. Nevertheless, there is no kind of government backing or insurance behind a mutual fund. In particular, the SIPC does not provide any protection.[3]
  • When assets are held in a brokerage, the fact that the brokerage is holding them for you, rather than your holding it yourself, adds a layer of risk. The risk is that the brokerage might mismanage or lose the assets it says it is holding for you, or might even commit fraud. In the Bernard Madoff case, among other things, his firm supplied customers with printed statements saying that the customer's account included holdings in a Fidelity money market fund that did not exist at that time.[4]
  • The purpose of SIPC insurance is basically to guarantee the accuracy and integrity of your brokerage statements. If your statement says that you own 100 shares of GE stock, then if it turns out that you do not because of any kind of problem at the brokerage, the SIPC is supposed to make good on your losses.
  • If you hold mutual fund shares directly, not within a brokerage account. then your holding is not protected by the SIPC.
  • If you hold assets within a brokerage account, then your holding is protected by the SIPC, but you are no safer, because the SIPC merely protects you against the extra risk you incur by trusting a brokerage firm to hold them for you.
  • Just as with stock, the SIPC is guaranteeing that the brokerage has really bought shares for you and earmarked them as belonging to you. However, if there were any problem within the mutual fund itself, the SIPC would not be involved in it. The SIPC did not help investors in the Reserve Primary money market fund when it "broke the buck,"[5] nor did it help investors in the Third Avenue Focused Credit Fund.[6][7]
  • Your risk is the same whether mutual fund shares are held within or outside of a mutual fund account. If you hold a mutual fund directly and therefore have no SIPC protection, you do not gain anything by moving them into a brokerage account if the only reason is to obtain SIPC protection.

Vanguard and SIPC protection

Vanguard is transitioning from a system in which mutual fund accounts and brokerage accounts were separate, and many customers did not have brokerage accounts, to one in which most customers will have brokerage accounts and hold their Vanguard funds within the brokerage account.

Customers may have received statements such as:

Vanguard funds not held in a brokerage account are held by The Vanguard Group, Inc., and are not protected by SIPC.

As noted previously, funds not part of Vanguard Brokerage Services do not require SIPC protection.

Securities in a Vanguard brokerage account are held in custody by Vanguard Brokerage Services, a division of Vanguard Marketing Corporation. Vanguard Marketing Corporation is a member of the Securities Investor Protection Corporation (SIPC), which protects securities customers of its members up to $500,000 (including $250,000 for claims for cash).[8]

Vanguard has purchased excess-SIPC coverage protection, which is subject to terms and conditions of the insurance company.[8]

This purchase of excess-SIPC insurance is for the purpose of insuring customers against losses in customer property above and beyond the distributions they would receive in a liquidation proceeding, including advances from SIPC. In other words, payments under excess-SIPC insurance policies are only determined when all distributions from the liquidation are completed, and a customer has not been satisfied in full.[9]

See also

References

  1. 1.0 1.1 1.2 1.3 SIPC - What SIPC Protects, viewed May 19, 2017.
  2. Employees and shareholders, Enron scandal. wikipedia
  3. Claire Boyte-White (October 2, 2015). "Mutual Funds Are Not FDIC Insured: Here Is Why". investopedia.
  4. The Madoff Affair, Frontline, PBS
  5. Are money market funds protected, SIPC Faqs
  6. Charles Stein (December 10, 2015). "Third Avenue Blocks Redemptions From Credit Fund Amid Losses".
  7. Jonathan Stempel (March 31, 2017). "Third Avenue in $14.25 million settlement over junk bond fund collapse". Reuters.
  8. 8.0 8.1 Information about account protection, Vanguard.com, viewed May 19, 2017.
  9. SIPC - Investor FAQs, SIPC, viewed May 19, 2017

External links