Many of you know that I worked as a computer software programmer and designer for the NASDAQ stock market from 1997 until 2002 during the peak of the “dot com bubble”. I am not a securities lawyer and I don’t give investment advice, beyond answering questions about how the actual process works. I became an employee in 1998 in a managerial position doing software design and supervision of programmers.
While working there, I was curious what the SIPC was or was not. Until 2014, I had never owned individual stocks other than one I had purchased while I was an employee in the employee stock purchase plan. After researching SIPC a bit, I concluded that was mostly a facade to reassure stock investors that their brokerage accounts were as safe as money in the FDIC insured banking system.
The 1929 stock market crash could never happen again because we have the SIPC! If you believe that story, you completely misunderstand its purpose.
My opinion has not changed. Here are two little factoids from my looking at the SIPC again today to see if anything has changed. The SIPC currently has a little over $4 billion in its emergency fund. There are an estimated $40 trillion in publicly traded securities in the United States. So far, I have been unable to find a figure of how much of that is sitting in stock brokerage accounts. My sense is that people have been moving away from owning individual stocks to investing in mutual funds and real estate.
Mutual funds are NOT insured by anyone, unless they are held in a stock brokerage account, but even that is meaningless. Let’s say you have 512.2 shares of a mutual fund worth $1,000 a share ($512,200), and the mutual fund collapses. The SIPC only guarantees that you still own 512 shares in the mutual fund, each of which is now potentially worth $0.00.
The SIPC does not protect you from bad investment decisions. This is not to encourage you to sell mutual funds because you’re scared. For the big mutual funds to go bankrupt would mean that the entire system has collapsed and it doesn’t matter where you think your wealth is invested. Hopefully, we don’t get to that point.
The other thing that concerns me is that between 1996 and 2008, the participating stockbrokers paid absolutely nothing into the emergency fund. $0. Nada.
The 2008 crash wiped out whatever money the SIPC had, and they’ve been collecting about $400 million a year since 2008. If you do the math, that probably means about $3 billion dollars went to cover losses incurred in 2008.
There have been two major emergencies they’ve had to deal with. The first was the collapse of Lehman Brothers. Lehman Brothers itself was not a big retail brokerage, but they had products that they sold to other financial institutions and institutional investors like pension funds, and financial institutions put money into short-term deposits at Lehman Brothers that got tied up. In the case of Lehman Brothers, it was bad decision making and not monitoring the risk profile of the things they were doing.
The other problem was Bernie Madoff, which was a very different situation. It was outright fraud. People had “bought”securities through the Madoff’s firm and had them in their account, but Madoff had never actually bought the securities.
So when the firm collapsed, people found out that their stock brokerage statements were fabrications. Normally, when a stock brokerage fails, most of what the SIPC does is just does “bulk transfers” of the stocks from the failed broker to a new one that’s healthy.
But when the failed broker doesn’t actually own the stocks they reported to own, that put SIPC right on the hook. That case is still open. They’re slowly still clawing back money and trickling it back to the people who lost money.
You might be wondering where the SIPC has that $4 billion invested. Of course, the only “safe” place to invest that kind of money “risk free” is in long-term treasury securities, which is exactly how Silicon Valley Bank and Signature Bank in New York became insolvent.
I’m considering doing some more writing on how things work, but I’m somewhat reluctant to spend the time if only three people are going to read it.