In times of great economic uncertainty around the globe, many people likely find themselves worrying about their financial situations both in the present and the coming future. Amidst a rising tide of record inflation and fears of an oncoming recession, protecting one’s investments is undoubtedly a top-of-mind concern for anyone confused and fearful of what comes next for global financial markets.
Nearly a decade and a half after the great recession following the 2008 financial crisis, renewed concerns about the financial health of banks and brokerage houses have governments, policymakers, and ordinary citizens gripped with the unenviable prospect of financial ruin should things continue down the current path. For ordinary investors, of course, questions abound about what will happen if the global financial system suffers another hit like it did in 2008, which saw brokerage house behemoths like Lehman Bros. go belly up in a spectacular fashion, with implications felt around the world for years afterwards.
Many individual investors, who may be staking their retirements on their investments and modest pensions, are rightly worried about what the future may hold for their portfolios. Will I be protected if my investment broker goes bankrupt? Will my money still be there if there’s a run on my bank? What would happen to my pension if the market dips and doesn’t recover?
Luckily for retail investors and customers of brokerage firms, a number of protections exist to safeguard their investments should their broker go broke and become insolvent. But even with those protections in place, that doesn’t mean the stock market is without risk to both individuals and institutions. Meanwhile, regulators are ideally supposed to step in when brokerage firms break the rules and put customers’ funds at risk, whether through incompetence, outright negligence, or worse, fraud or misrepresentations.
Investor protection funds and regulations in North America
For mom-and-pop investors in Canada and the United States, those with brokerage accounts can breathe somewhat easier when it comes to fear of their broker going bankrupt. Investment firms are heavily regulated on both sides of the border, and while any investment carries certain risks, investor protection and insurance funds exist to protect your funds in the event of a collapse of a brokerage firm, which is rare but not unheard of in the last couple of decades.
But like bank deposits, which are insured in Canada by the Canada Deposit Insurance Corporation and the Federal Deposit Insurance Corporation in the United States, securities accounts are also insured by investor protection funds. As well, the Mutual Fund Dealers Association of Canada has the MFDA Investor Protection Corporation, which is a non-profit entity that administers an investor protection fund for those burned by mutual fund dealers that go bankrupt.
Canadian Investor Protection Fund
In Canada, the Canadian Investor Protection Fund was set up by the country’s provincial securities regulators to safeguard retail investors’ assets, whether they’re made up of securities, cash, commodities futures, or what are known as “segregated insurance funds.” If they’re held by a brokerage house that becomes insolvent, those assets are protected up to certain limits by the CIPF. According to the CIPF website, property that is covered by the fund also includes that which may have been “unlawfully converted” by a fraudster or unscrupulous broker.
But should your brokerage firm not actually hold such assets, such as securities or share certificates, but rather hand them over to you for safekeeping, then that property isn’t covered by the fund. The property or assets must be held beneficially for a client by the firm for it to come under the protection of the CIPF.
The fund’s mandate is to protect peoples’ investment property, including securities and stocks and bonds, if they don’t get paid back should a brokerage become insolvent. As long as it’s a member firm, the fund will insert itself between a customer and the bankrupt firm in the event of insolvency and, in most cases, will see that a client’s account is moved over and transferred to a solvent brokerage firm in order to ensure a person has access to their funds and accounts.
What investment protection doesn’t cover
But the protections offered by the CIPF only go so far. For example, it doesn’t cover investors who find the value of their portfolios drops because of a dip in the market. In addition, the CIPF’s mandate doesn’t cover investors who are victims of a bad broker, who may have given bad advice about unsuitable investments according to a client’s risk profile and tolerance level. Moreover, it doesn’t cover victims of fraud, misrepresentation, or someone whose broker simply gave them bad advice without disclosing adverse but material information about a particular investment product.
In other words, the Canadian Investor Protection Fund doesn’t protect or guarantee to preserve the value of your investment, but rather the investment itself only when a member firm becomes insolvent. So, if in the weeks or months before your broker goes bust, say you buy a block of shares in a company for $100 apiece. If those shares drop in value to $70 when the broker becomes insolvent, the CIPF will work to get the block of shares back to the investor, but not at the original $100 per share price. The fund also has set limits for individual investors, covering up to a million dollars for most general investment accounts including tax-free savings accounts (TFSAs), as well as an additional million for registered accounts such as Registered Retirement Savings Plans and Registered Education Savings Plans.
Corporate accounts for companies and partnerships, meanwhile, are also covered by the CIPF up to a million dollars as well, though the fund places certain exceptions for corporate-held accounts since their owners are often a step removed from the individuals who control them. A list of firms that are members of the CIPF can be found here. Members of the Investment Industry Regulatory Organization of Canada, an industry-led self-regulatory body, are automatically made members of the CIPF.
What happens if investment funds fail?
The CIPF website features a checklist of first steps people should take if the firm that holds their investment funds fails. First, it says to make sure the brokerage firm is a member of the CIPF by checking the list linked to in the preceding paragraph. After confirming the membership, the CIPF says people should check the most recent statement of their account and find out if there were any pre-insolvency changes in the account’s holdings, while also making sure there are no “discrepancies.”
After reviewing your account statement, the CIPF urges people to find out if there’s been a receiver or trustee appointed by the court to oversee the insolvency process. If a trustee doesn’t get in touch shortly after the failure of your brokerage firm, you can contact the IIROC and ask them about it, or the CIPF’s website may have information on the company and its insolvency trustee. Once you’re in contact with the trustee, they’ll keep investors informed about the progress of the insolvency process, which includes transferring client accounts to a different member firm. One important thing to check, according to the CIPF, is making sure that all securities and cash that were in the account on the day the brokerage declared insolvency are transferred to the new firm.
Working with an insolvency trustee
You don’t necessarily need to go with the new firm chosen by the insolvency trustee, though. You can choose a firm of your own and make a transfer request through the new firm. Should you find that not all the assets you had in your portfolio were returned, you can likely make a claim with the investor protection fund. You can make a claim as long as the property is covered by the fund, and you fill out the paperwork correctly while meeting the deadline to make a claim.
Brokerage firms going belly up may be a rare occurrence, but it’s certainly not unheard of in Canada and the United States in the last few decades. Back in 2011, for instance, the bankruptcy of MF Global sent a scandalous shockwave throughout global futures markets when it was revealed the company didn’t properly protect client funds, using customer’s money to cover company losses before they mounted too high to keep the firm going. Instead, the firm of the future was said to have wrongfully commingled client funds with its own before its stunning collapse into bankruptcy in the U.S. Its Canadian arm suffered a similar fate, and that’s where the CIPF stepped in, while accounting firm KPMG was appointed to oversee the firm’s insolvency in Canada.
In November 2011, the IIROC and the CIPF announced that they had obtained a bankruptcy order against MF Global Canada Co., appointing the accounting firm to “ensure the fair and orderly management of customer accounts.” The move came just a few days after the company’s American parent firm, MF Global Holdings Ltd., had filed for bankruptcy itself. The Canadian affiliate was suspended as a dealer member of the IIROC the next day because it was admittedly “capital deficient.” Similar proceedings were happening in parallel in the U.S. thanks to the CIPF’s American counterpart, the Securities Investor Protection Corporation.
Dealing with mutual funds regulators
But the collapse of MF Global in Canada and the U.S. in 2011 paled in comparison to the spectacular fall of Lehman Bros. in 2008. Even with the United States Securities and Exchange Commission, the Commodities Futures Trading Commission, the Financial Industry Regulatory Authority, and other regulators at play in the country’s financial markets, the fall of Lehman Bros. still came as an unexpected shock to global capital markets.
At the time of its bankruptcy in September 2008, Lehman was one of the largest investment banks in the country with tens of thousands of employees around the world. What started as a dry goods store in the 1840s run by a group of brothers in Alabama, the firm had grown into a financial behemoth before going bankrupt, listing $639 billion in assets against $619 billion in debt at the time of filing. What brought the company down, of course, was the complete and utter failure of the murky, extremely risky subprime mortgage market, which Lehman had entered into in the early 2000s with several acquisitions of mortgage lending firms.
The market for securitized mortgages had exploded and the U.S. housing market was seen as a safe bet no matter how many bad loans were on these companies’ books. Eventually, though, mortgage defaults ramped up to a point where millions of people were under water, leaving the firms that traded in debt-backed investment paper holding the worthless, toxic bag. The American government, for its part, bailed out a few other firms such as Bear Stearns but allowed Lehman to falter.
Investment brokers going bankrupt conclusion
Fortunately, for most individual investors in Canada, the United States, and elsewhere, investor protection funds are set up to step in if a brokerage firm goes bankrupt. While there are limits to the coverage afforded by these funds, such as the CIPF in Canada and the SIPC in the United States, most people of modest means can rest easy knowing that their assets are protected even if the company that manages them goes out of business.
But there are limits to the protections these funds afford people since they only cover property held by brokerage firms at the time of their insolvency, which like Lehman Bros., may be brought on by a colossal failure in our globalized capital markets as it did with the subprime mortgage market in 2008.
The funds don’t cover investment losses caused by dips in the market, or as a result of bad, negligent, or outright fraudulent investment advice. For investors who find themselves out of pocket due to a broker’s bad faith actions or bad advice, there’s no fund set up for that, but rather for the courts to decide.
Author: Alistair Vigier runs www.clearwaylaw.com, a website that is working hard at improving the access to justice problem. The goal is to get the public to leave reviews for their attorneys.