When Financial Firms Collapse

60 Minutes re-aired a great segment called “Your Bank Has Failed: What Happens Next?” on the Federal Deposit Insurance Company (FDIC) and what goes on behind the scenes when a troubled bank is taken over by FDIC. IMHO, what they showed was impressive. Kudos to Scott Pelley.

The FDIC was created under the Banking Act of 1933, better known as the Glass-Steagall Act (the second one). It was not part of the Gramm-Leach-Bliley Act, signed by President Clinton, which repealed Glass-Steagall. (Although unrelated to this article, the repealing of Glass-Steagall is the reason why the United States is in the financial mess we are in right now.)

The securities industry has something similar called the Security Investors Protection Corporation (SIPC). The SIPC gets involved when a Broker / Dealer becomes insolvent. On their website, they say “When a brokerage firm fails owing customers cash and securities that are missing from customer accounts, SIPC usually asks a federal court to appoint a trustee to liquidate the firm and protect its customers.”

SIPC insurance covers up to $500,000 per separate customer, of which $100,000 can be cash. So if you have a $500,000 account with $350,000 in securities and $150,000 in cash, you are covered up to $450,000 in this case: $350,000 in securities and $100,000 in cash. You will become a General Creditor for the $50,000 not covered in cash.

But only cash is cash. Money Market Funds are mutual funds with a set Net Asset Value of $1 per share. Those are considered securities.

You can think of “per separate customer” to mean per separate account title. Michael Martin is a customer. Michael Martin IRA is another customer. MartinKronicle.com is yet another. Yet all three could hypothetically be controlled by one person (me).

The SIPC does not cover commodity futures contracts nor currency. Neither are exempt securities such as Limited Partnerships nor Fixed Annuity Contracts. These are not registered under the ’33 Act (The Securities Act of 1933, slangly known as the Prospectus Act).

The SIPC was founded by an act of Congress called the Security Investor Protection Act of 1970. It is a non-profit, non-government, member corporation. SIPC is funded by member Broker / Dealers who pay premiums based upon their size.

Coverage limits will decline for some accounts in 2014.