Limits
The SIPC may be liable from its fund for up to $500,000 in asset value per customer, of which up to $250,000 may be for investment cash.[17] These limits apply after the SIPC has pursued recovery from the broker/dealer's liquidation estate or other related parties, although it can make advances for customers facing hardship, as it did in the Madoff case.
If an investor has multiple accounts at a failing brokerage, the $500,000 limit is not strictly applied per account, instead, the notion of "capacity" is used by the SIPC, and the $500,000 (or $250,000) limit is applied per capacity. Multiple accounts are aggregated into capacities. The list of capacities is:[18] For example, if an investor had two Roth IRAS of $400,000 each, and an individual (non-IRA) account with $500,000, the two Roth IRAs would be considered a single "capacity" and the $800,000 sum would only be covered to the $500,000 limit (so $300,000 would be lost). The individual account is a distinct capacity and would be covered for its full $500,000 value.
- Individual account
- Joint account
- Corporate account
- Trust created under state law
- IRAs
- Roth IRAs
- Executor of an estate
- Guardian of a ward
Recovery in kind
Although modeled loosely on the Federal Deposit Insurance Corporation (FDIC) which protects bank customers, the SIPC has wider discretion in satisfying customer claims. When securities are missing, it can arrange to provide either replacement securities of the same kind, or their cash value on the date that its trustee was appointed to the case. The SIPC does not protect investors against any loss in the value of their securities, nor does it assume responsibility for any promises about investment performance. Unregistered securities, annuities and commodity contracts are not covered by the SIPC, even when brokered by a member firm.[19] Account disputes with a brokerage that remains in business are not handled by the SIPC, but typically by the Financial Industry Regulatory Authority (FINRA) and the Commodity Futures Trading Commission (CFTC).[20]
Inasmuch as SIPC does not insure the underlying value of the financial asset it protects, investors bear the risk of the market. In addition, investors also bear any losses of account value that exceed the current amount of SIPC protection, namely $500,000 for securities. For example, if an investor buys 100 shares of XYZ company from a brokerage firm and the firm declares bankruptcy or merges with another, the 100 shares of XYZ still belong to the investor and should be recoverable. However, if the value of XYZ declines, SIPC does not insure the difference. In other words, the $500,000 limit is to protect against broker malfeasance, not poor investment decisions and changes in the market value of securities. In addition, SIPC may protect investors against unauthorized trades in their account, while the failure to execute a trade is not covered.
SIPC application in unusual situations
The limitations of SIPC protection caused significant confusion among a number of investors following the collapse of Bear Stearns and Lehman Brothers[21] and perhaps, most prominently, following the exposure of Bernard Madoff's and Allen Stanford's and the Stanford Financial Group's ponzi scheme frauds.
In the Madoff fraud, where securities had allegedly not actually been purchased, SIPC and the SIPC Trustee challenged and disposed of the claims of approximately one-half of customers of the Madoff firm, arguing that over the course of time those investors had withdrawn more funds than had been invested, resulting in a negative "net equity", and, therefore, not eligible for SIPC protection.[22]
If the brokerage becomes insolvent, there are some situations where the investors assets may be recovered beyond the $500,000 insurance limit, for example, if the investor's specific assets can be identified and recovered. Under rules of the regulatory SRO governing brokers and dealers—the Financial Industry Regulatory Authority (FINRA), the investors' and the brokerage firms' assets must be segregated; they may not be commingled. It could be a civil or criminal violation if an investor's assets were inappropriately commingled.
