Discussion in 'Retail Brokers' started by maxplanck, Dec 11, 2011.
Does SIPC insurance cover rehypothecated cash or securities?
This seems to be a core question
Yes. That is why the SEC's rules relating to the protection of customers have not been written without consideration of coverage provided to those same customers under the Securities Investor Protection Act through which SIPC was created and operates. The SEC customer protection rule is intended to ensure that the customer assets in a failed broker are sufficient to satisfy claims, and in doing so limit SIPC exposure.
This is accomplished through the following:
- Each broker is required to maintain a "Special Reserve Bank Account for the Exclusive Benefit of Customers" which is separate from any other bank account of the broker and where customer cash balances or investments of cash balances are to be held.
- If the broker elects to hypothecate (technically invest) customer cash, it may only do so in what are referred to as "qualified securities" (securities issued by the United States or a security in respect of which the principal and interest are guaranteed by the United States).
- In the case of customer securities, if the securities have been paid for in full by the client or meet the definition of excess margin securities (i.e., exceed 140% of the margin debit/loan), then the broker may not hypothecate or pledge those securities but must maintain possession and control by custodying those securities in a good control location (e.g., segregated bank or central custodian account such as DTC).
- In the case of securities for which the customer has borrowed money from the broker to purchase, the broker has the right to pledge or hypothecate those securities at an amount up to 140% of the margin debit/loan.
A couple things to keep in mind:
- SIPC is only going to insure you to up the the lesser of your account balance or the statutory limit ($500,000 with $250,000 cash sublimit). That means if your account balance consists of $100,000 in long stock and a cash debit of $25,000, you are only eligible to be covered up to the extent of your net liquidating equity of $75,000. SIPC is not going to extinguish your obligation to repay your loan.
- You can control (restrict) your broker from hypothecating or pledging your securities by simply paying for them in full. Your not likely to find a broker willing to waive their rights to apply a lien to an asset that they loaned you money to acquire and to, in turn, finance that loan. In addition, to the extent you maintain a long cash balance, you are not going to be able to restrict your broker from reinvesting that cash, although the qualified securities and reserve account requirements would seem to reasonably address any concerns of undue credit or counterparty risk.
- The above applies solely to assets/positions held in a securities account and not a commodities account.
One of the reasons nearly every substantial player has a prime brokerage arrangement is that it gives them the ability to negotiate a set of terms that can be far different than the standard retail customer agreement.
I've received payments in lieu of dividends on fully paid for securities. See this post:
The SEC requirement that brokers reduce to possession and control fully-paid and excess margin securities does contemplate operational and settlement timing differences in which these situations can occur. I can't speak to your situation without investigating clearing records. I will be more than happy to do so next week if you PM me with your information.
The above applies only to Reg T accounts. Portfolio Margin accounts are different:
"The hypothecation rules under the Securities Exchange Act of 1934 (Rules 8c-1 and 15c2-1) prohibit broker-dealers from permitting the hypothecation of customer securities in a manner that allows those securities to be subject to any lien or liens in an amount that exceeds the customer's aggregate indebtedness. However, all long option positions in a portfolio margining account will be subject to the OCC's lien, including any positions that exceed the customer's aggregate indebtedness. Furthermore, all long positions, including margin equity securities, in a portfolio margin account are held subject to a lien by the carrying broker-dealer, even if fully paid.
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