The recent failure of a Midwest securities firm has highlighted a fact that many community bankers may be confused or misinformed about: the protection afforded them for their own securities held by a broker dealer when the broker-dealer fails.
The issue is the coverage provided by SIPC, the Securities Investor Protection Corporation, a nonprofit corporation (not a government agency) formed under the Securities Investor Protection Act of 1970.
SIPC coverage extends to customers of brokerage firms, but a bank acting for itself rather than for its own customer or customers is excluded by statute from SIPC protection. While SIPC coverage does not guarantee market value or principle or protect against investment fraud, it does ensure that customers get their stocks or bonds back when a brokerage firm collapses. SIPC coverage limits are $500,000, including cash (not money market funds which are securities) up to $100,000. As a result of the statutory exclusion, banks do not have this assurance for their own assets. In the event of such a collapse, banks may find their own securities placed in a pool of assets used to satisfy claims of other covered accounts. The net result can be that the bank's brokerage account (and securities therein) may be illiquid for an extended period, and the bank may suffer an ultimate loss when liquidation of the broker-dealer is complete.
MJK Clearing Failure
The recent failure of MJK Clearing, a subsidiary of Minneapolis-based Stockwalk Group, Inc. has left a number of community banks-whose brokers used MJK for clearing and safekeeping their customers' securities-holding the bag. When the firm failed, SIPC stepped in to oversee what is the largest liquidation case it has ever handled. The banks, which are not covered by SIPC, face losses. Initial estimates of the ultimate loss range from 1/2 of 1 percent to 3 percent, but could be higher or lower pending final liquidation. It will likely take two or three years to resolve all claims.
Community banks affected by the MJK Clearing failure should be mindful of the January 14, 2002 claim filing date. Customer claim forms must be received by the court-appointed Trustee by that date, otherwise maximum recovery could be jeopardized. Claim forms and further information about the MJK Clearing case can be found at www.sipc.org and www.mjktrustee.com.
So long as bank-owned securities are ineligible for SIPC protection, bankers should be diligent and cautious when using safekeeping services. Bankers must realize that their broker dealer may be an introducing broker for yet another firm-the clearing broker-that actually holds the securities. Since it is the failure of the clearing broker that will trigger a SIPC action, the banker should be thoroughly familiar with the business activities, capital sufficiency, and procedures of the clearing broker.
Does the clearing broker have procedures to protect the bank's interests to the maximum extent possible? Can the securities owned by the bank be hypothecated-used as collateral for borrowing-by the broker dealer? Does the broker provide a safekeeping receipt-again reinforcing the role of the broker as a safekeeping agent and differentiating the bank's securities from other customer securities that may be hypothecated and may be subject to SIPC coverage? Is the broker dealer holding the securities involved in other activities that could impair its capital and thus trigger a SIPC action?
Absent SIPC coverage, the decision to place securities in the hands of another (which is hard to avoid in the electronic age) is almost like a credit decision-will the firm holding the securities be responsible and here when the customer wants their securities back.