Investing involves many different types of risks. One of the less common risks people tend to think about is what happens if the brokerage you use trade stocks, bonds or other assets goes out of business?
This is a good question to ask, as investors throughout history have been faced with this exact event. Even as recent as 2008, investors were facing a difficult question of whether to pull their money out of their brokerage account with the fear of their brokerage firm going out of business.
In this article, we will explain the details of what may happen if the brokerage M1 Finance goes out of business.
There are countless new investing apps popping up daily, so it is a good question to consider.
If you are a long term investor, focused on 20+ years into the future, will your new investing app still be around?
Most brokerages are established as broker-dealers.
This means they are in the business of brokering transactions between buyers and sellers of securities. When an investor wants to purchase a certain security, the broker will try to pair a seller to buy the shares being offered for sale.
While M1 Finance acts as the broker of transactions, Apex Clearing Corporation works as M1’s clearing house for transactions and holds custody of all assets held in M1 Finance brokerage accounts.
A clearing house is a firm the broker-dealer will work with to complete a transaction when a buyer or seller submits a buy or sell in an M1 Finance account.
Certain brokers act as custodians when they hold custody of your assets (cash, stocks, bonds, etc).
In the case of M1 Finance, they use a clearing firm called Apex Clearing Corporation to hold custody of all assets held in M1 Finance accounts.
The role of the custodian is to hold client assets in a separate account. The clients always retain ownership of their assets. Ownership is never transferred to the custodian or broker-dealer.
According to U.S. Federal Law, and required by the Securities and Exchange Commission (SEC), all assets held by a broker-dealer custodian, must be held separate from the custodian’s own financial assets.
In the case of insolvency, there is no way for creditors to access custodial assets held by the custodian. This strict client asset segregation law requires annual reporting and compliance by the custodian each year.
So you may be asking “if custodians are required by law to keep my assets separate from their own, then why would I ever need to use SIPC insurance?”
SIPC comes into play when brokerages break the law and engage in unauthorized trading or theft of your personal securities.
The Securities Investor Protection Corporation was established to protect investors from the theft or loss of securities.
SIPC protects up to $500,000 of securities held by each investor at an institution. SIPC specifically does not protect against the decrease in value of securities, but rather the loss or theft of the securities themselves.
Apex Clearing is a member of SIPC. Federal laws require them to abide by all laws set forth by SIPC.
When a broker goes insolvent or cannot return assets to clients, SIPC will step in during the liquidation process.
In the case there are missing client assets, SIPC will ensure that clients will be made whole again during the brokerage's liquidation process.
If there are no assets to make the client whole, then SIPC will reimburse security theft up to $500,000 per client.
An example of SIPC insurance being used is the famous case of Bernie Madoff.
Madoff orchestrated the largest Ponzi scheme in history, stealing over $50 billion dollars from his investors.
Since Madoff created false statements and never held securities owned by his clients, SIPC insurance was forced to step in. SIPC approved $231 million in payouts to Madoff victims. This is a small amount when you look at the actual sum that they stole.
Many of us have probably heard of FDIC insurance when they visit their local bank. The Federal Depository Insurance Corporation is a Federal program that protects deposits in Federally registered banks. FDIC came into play after the Great Depression when there were many runs on banks and some people lost all their savings.
FDIC insures each individual depositor at a bank up to $250,000.
This is specific to each individual and not each account at a member bank.
Apex Clearing, as custodian of M1 Finance accounts, is a member of FDIC.
When you hold cash in your M1 Finance account, Apex Clearing is holding your cash at FDIC insured banks. Apex Clearing then passes through FDIC insurance to you as the investor and owner of the cash.
Under most circumstances, brokerages that go out of business will not have a financial impact on the clients using their services.
You still own your securities as an individual, not the broker. Unless the brokerage is breaking other laws, you will receive all your rightly owned securities. If in the case the brokerage has engaged in theft or unauthorized trading of your securities, then SIPC insurance may step in to compensate investors.
You can read more about Apex Clearing and M1 Finance safety of customer assets here.