Is My Money Safe if E-Trade Fails?

Another big story yesterday (the other one I thought was the 170+ points reversal of the Dow, extending the index’s losing streak to 4 and closing below 13,000 the first time since late August) was the nearly 60% drop of E-Trade Financial shares. Following a Citigroup analyst downgrade of the stock to Sell over the weekend and the suggesting that the company may seek bankruptcy protection, questions arise on whether investors accounts with E-Trade are safe if the brokerage indeed fails.

I have a small account with E-Trade ($1,100 Global Trading Account and $7,000 cash in Complete Savings Account yet to be transferred to the Global Trading Account to invest in Alibaba.com). Though it’s not a lot of money, the news that E-Trade may bankrupt still concerns me about the safety of my money and investment in the trading account. After reading a MarketWatch.com news, my nerve eased a little bit, knowing my money is basically safe.

The company’s website states that both “E-Trade Securities LLC and E-Trade Clearing LLC are members of SIPC, which protects securities customers of its members up to $500,000 (including $100,000 for claims for cash).”

This is the first time that I actually tried to get to know a little bit more about SIPC, the Securities Investor Protection Corporation, though I am no stranger to the name. According to SIPC website, in the event that a brokerage firm fails, SIPC will protect investors from losing their investments:

When a brokerage firm is closed due to bankruptcy or other financial difficulties and customer assets are missing, SIPC steps in as quickly as possible and, within certain limits, works to return customers’ cash, stock and other securities. Without SIPC, investors at financially troubled brokerage firms might lose their securities or money forever or wait for years while their assets are tied up in court.

That sounds like the protection savers will receive when the bank holding their deposits go out of business. However, the protection from the SIPC is different from that of the FIDC, as explained in a SIPC brochure (PDF):

SIPC is not the FDIC. The Securities Investor Protection Corporation does not offer to investors the same blanket protection that the Federal Deposit Insurance Corporation provides to bank depositors.

How are SIPC and the FDIC different? When a member bank fails, the FDIC insures all depositors at that institution against loss up to a certain dollar limit. The FDIC’s no-questions-asked approach makes sense because the banking world is “risk averse.”? Most savers put their money in FDIC-insured bank accounts because they can’t afford to lose their money. That is precisely the opposite of how investors behave in the stock market, in which rewards are only possible with risk.

Most market losses are a normal part of the ups and downs of the risk-oriented world of investing. That is why SIPC does not bail out investors when the value of their stocks, bonds and other investments falls for any reason. Instead, SIPC replaces missing stocks and other securities where it is possible to do so…even when investments have increased in value. SIPC does not cover individuals who are sold worthless stocks and other securities. SIPC helps individuals whose money, stocks and other securities are stolen by a broker or put at risk when a brokerage fails for other reasons.

Well, it won’t be a desirable situation for anybody who has a relationship with the brokerage, whether it’s investing or banking. But, as long as my money and investment won’t disappear just because E-Trade may file for Chapter 11 protection, I think I will leave them with the company for now.

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