Are You Covered if Your Broker, Bank or Fund Fails?

As some of Wall Street's most venerable firms topple, even the most hardened individuals are wondering if their assets are adequately protected.

This week the markets opened with the news that investment bank Merrill Lynch

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[MER  Loading...      ()   ] was scooped up by Bank of America

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[BAC  Loading...      ()   ], ending its 94-year reign as one of the world's most recognized brokerage houses. Lehman Brothers

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[LEH  Loading...      ()   ], another investment bank, announced its filing for Chapter 11 bankruptcy. This follows the collapse of other financial institutions, most notably Bear Sterns, bought up in March by J.P. Morgan Chase

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[JPM  Loading...      ()   ].

Officials and other experts were quick to assure investors that money is safe.

"People don't need to be panicking. Unless you've had some massive fraud and conversion, and the brokerage is stealing money -- and there's no evidence of that -- the funds should still be good," says Mark Maddox, former securities commissioner for the state of Indiana and investor attorney. "Consumers don't need to worry; they don't have to stand in line and draw assets from brokerage accounts."

In a statement, Lehman said that none of its broker-dealer subsidiaries or other subsidiaries are included in the bankruptcy filing. Furthermore, it is "exploring the sale of its broker-dealer operations, which continue to operate." Its customers, including those of Lehman and Neuberger Berman, can "continue to trade or take other actions with respect to their accounts," Lehman said.

Meanwhile, the Securities and Exchange Commission said in a statement that Lehman customers "will benefit from their extensive protections under SEC rules, including segregation of customer securities and cash as well as insurance by the Securities Investor Protection Corp."

That's all well and good. But how do the Securities Investor Protection Corp., or SIPC, and other agencies protect you? As it turns out, there are safety nets to catch you, but how much protection you have depends largely on the kind of assets you own and where you hold them, be they certificates of deposit, a pension plan or a checking account.

Security for brokerage accounts
SIPC is funded by private "member" firms. Brokerage losses, including 401(k) and other retirement plans held at Fidelity or Vanguard, for example, are protected by SIPC up to $500,000 per person, per account. Of that amount, up to $100,000 in cash losses are included. If you have, for instance, a retirement fund and a "rainy day" fund at a brokerage, each of those separate accounts would be protected up to the $500,000 threshold, says SIPC President Stephen Harbeck.

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Worried About Your Assets? Timely Advice from Bankrate.com:

• Bankrate Calculator: How Much Should You Invest in Your 401(k)?
• What FDIC Protects
• How to Tell if Your Retirement Plans are on Track

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To qualify for SIPC protection, your brokerage must be a member. Most firms are. In fact, firms that are registered brokerages with the Securities and Exchange Commission, "are virtually required to become members of SIPC," says Harbeck.

In the event your brokerage firm goes out of business, the SIPC wouldn't likely be involved in making you whole (unless funny business, such as fraud, was involved on the firm's side). Your holdings would likely be transferred to another brokerage firm, where you could lay claim to them. If fraud was the problem, then the SIPC would step in and oversee the transfer of any remaining assets as well as replace any missing securities.

But doing business with a SIPC-member institution isn't a guarantee for an automatic bailout. Investors who have losses due to improper trading must prove they complained about how transactions were conducted. If you've done nothing to prove you objected to how assets were handled, SIPC "has to assume you assented to the trade," says Harbek.

William P. Thornton Jr., a lawyer at Stevens & Lee in Reading, Pa., represented a client against SIPC when Old Maple Securities failed. Thornton spent two and a half years in court before getting back roughly $100,000 cash from SIPC.

"SIPC typically hires a trustee, and they either grant or deny claims that were filed. Historically, there have been a high number of denials forcing investors to litigate with SIPC," says Thornton. "Every case is unique."

Read More: When a Pension Fails