What Happens If Your Brokerage Goes Broke?
Roger Acord woke up to every investor’s worst nightmare last Thursday.
His brokerage firm, Century City-based Boston Group LP, was forced to suspend stock-market-making activities because its capital fell below minimum requirements set by the National Assn. of Securities Dealers.
Acord, who says his Boston Group account is filled with low-priced stocks that plummeted in the days leading up to the firm’s sudden revelation of capital problems, couldn’t get through to the brokerage late last week, leaving him without access to his money--although the firm insisted late Friday that it is still able to execute certain transactions.
The trouble at Boston Group followed by one week the demise of a Glendale brokerage, W.S. Clearing, that had processed trades for 18 mostly small brokerages nationwide. The accounts of the 15,000 investors who dealt with W.S. Clearing are frozen while a court-appointed receiver sorts through the firm’s books to figure out who’s owed what.
Brokerage troubles on this scale are rare, but they are nonetheless a painful reminder of what can go wrong for the millions of small investors who have poured into securities markets in the 1990s.
The good news is, investors do have protection--to a point. The Securities Investor Protection Corp., or SIPC, steps in when brokerages fail, as W.S. Clearing did on March 6.
The SIPC was created by Congress in 1970. All brokers and dealers registered with the Securities and Exchange Commission and with the major stock exchanges are required to become SIPC members.
The agency insures customer assets at failed brokerages up to $500,000 per customer, including a maximum of $100,000 coverage for each customer’s cash accounts.
In the case of W.S. Clearing, the court-appointed receiver is in the process of identifying customer claims against the firm, so that the SIPC can reimburse accounts accordingly. The receiver, Charles D. Axelrod of Stutman, Treister & Glatt in Los Angeles, said claim forms will be mailed to all customers in the near future.
Michael Don, president of the SIPC in Washington, describes the process as follows: First, the receiver attempts to locate and return to customers the actual securities in their accounts at the time the brokerage failed.
If the receiver finds that an account is missing securities--in other words, the account has been a victim of fraud--the receiver can go into the market and purchase the same securities with SIPC funds and return them to the account.
If, for whatever reason, the securities can’t be returned to the account, the receiver will reimburse the customer for the market value of the missing securities as of the day the SEC filed court papers to liquidate the firm.
What the SIPC does not protect against is any market-related losses while accounts are frozen or in the process of liquidation or transfer to another brokerage.
Investors with stock held in accounts at W.S. Clearing, for example, won’t be compensated for any decline in the prices of those shares between the time the accounts were frozen and the time they are freed up.
And of course, there’s no compensation for the mental anguish incurred by customers while their money is in limbo.
Naturally, most people would prefer to avoid that kind of anguish in the first place. The question is, can individual investors ever know enough about brokerages to steer clear of those that are at high risk of winding up wards of the SIPC?
It’s unlikely many customers of W.S. Clearing could have foreseen trouble. As a trade processor, it was essentially just the “back-room operation” for its 18 “introducing” brokerages, small firms that dealt directly with investors.
W.S. Clearing’s end came after one of those 18 brokerages got slammed with losses after taking a big position in a stock that collapsed. The brokerage couldn’t pay what it owed to settle trades with W.S. Clearing, causing W.S. Clearing to suffer a major “haircut” on its net worth and triggering its demise.
The SEC also alleges that W.S. Clearing’s owner, William Sedkey Saydein, illegally transferred funds from customers’ accounts to the firm’s accounts to try to mask its capital shortage, and that two days before the firm crumbled, Saydein transferred $1.9 million to his personal bank account from a W.S. Clearing account.
Saydein has been unreachable and apparently has not designated a lawyer to handle his case.
In Boston Group’s case, its troubles apparently were caused by plunging values of many of the low-priced stocks it has underwritten and makes markets in (i.e., it owns the shares with its own capital).
At least two of those stocks, Diedrich Coffee and Craig Consumer Electronics, last week reported business problems that sent their stocks tumbling--pulling down Boston Group’s capital as well.
The firm’s vice chairman, Kye Hellmers, said Friday that the brokerage is attempting to raise additional capital so it can begin actively making markets again. In the meantime, without the firm’s support as a market maker, many of the small stocks in which it was the primary dealer continued to fall in price on Friday.
Diedrich Coffee, for example, fell 44 cents Friday to $3.56 on Nasdaq. It started the week at $7.38. Craig plunged 50 cents Friday to $1.38. It started the week at $2.50.
Boston Group’s problems point up one big risk investors in low-priced stocks should understand: Whenever you’re dealing with thinly traded issues that are heavily dependent on one brokerage for market-making support, you should ask what might happen to the stocks’ prices if that brokerage were forced to pull back.
The fact that the SIPC is there to protect you against the ultimate disaster--a firm’s failure--is nice to know, but the SIPC can’t help you with market-related losses that lead up to or follow that kind of disaster.