The FDIC has issued an alert to banks, prompted by losses that some banks will suffer after the failure of a large regional broker-dealer and its subsequent liquidation by the SIPC (Securities Investor Protection Corporation), the largest liquidation in SIPC history. The FDIC issued the alert to warn all banks of the potential risks involved when banks maintain custodial relationships with broker-dealers for the safekeeping of securities.
When a broker-dealer fails, SIPC will generally return to investors property registered in a specific customer's name. SIPC will then pay customers their pro rata share of "customer property" that is not registered in a specific customer's name. Finally, SIPC will cover up to $500,000 in losses caused by missing securities or cash (not loss of principle or interest), although banks investing for their own account are excluded from this last coverage by statute. Therefore, it is important that banks be able to differentiate between bank-owned and bank customer-owned securities held in custodial accounts at broker-dealers.
The FDIC reminds banks to use due diligence when selecting a broker-dealer for custodial services. Banks should periodically reassess the broker-dealer relationship, including an inquiry into the broker-dealer's creditworthiness and its reputation by checking with state securities authorities and the NASD. And, because these steps may not protect against all risks, the FDIC encourages banks to maintain "properly diversified custodial relationships." The full text of the FDIC alert (FIL-38-2002) can be found at www.fdic.gov (click on "Newsroom").