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SIPA – Securities Investor Protection Act

The Securities Investor Protection Act is a U.S. Federal Act enacted in 1970.  It is also referred to as the SIPA.  The provisions of SIPA are codified at 15 USCS § 78aaa through 15 USCS § 78lll.  The SIPA is legally considered as an amendment to the Securities Exchange Act of 1934.  It is a law that established the Securities Investor Protection Corporation or the SIPC.  The SIPA aims to boost public confidence in securities markets by passively reimbursing customers for losses due to broker failures.

The SIPC is a nonprofit government sponsored independent membership corporation.  Most brokers and dealers registered under the Securities Exchange Act are required to take the SIPC membership. SIPC members are required to pay an “assessment” to the SIPC.  The assessment is based on each firm’s gross securities generated business.  The amount paid as assessment goes to a SIPC fund, which constitutes an insurance program.  The fund is intended to protect the customers of brokers or dealers registered under the SIPC.

The SIPC insurance provides protection to the customers’ cash and securities, in case the broker-dealer becomes bankrupt.  The SIPC insures investors for up to $500,000 when the brokerage firm is a member.  However, the cash accounts are limited to $100,000.  Some firms purchase private insurance to increase investor’s coverage even beyond these limits.  It is important to understand that the SIPC does not protect the investors from any losses due to market conditions.

When a brokerage firm fails, the SIPC takes steps to transfer the failed brokerage’s accounts to a different securities brokerage firm.   However, if an accounts’ transfer is not materialized, the failed firm is liquidated.  And in such situation, the SIPC sends investors either a check for the market value of the shares or certificates for the stock that was lost.

The provisions under 11 USCS § 741 et seq. of the Bankruptcy Code provides for a stockbroker liquidation proceeding.  But a failing brokerage is normally seen involved in a Securities Investor Protection Act of 1970 (SIPA) proceeding.   The SIPC can apply for a protective decree with the district court and initiate the SIPA proceedings.  However, if the SIPC does not make such an application or if the district court finds that customers of the brokerage firm are not in need of protection under the SIPA, then the brokerage firms may be liquidated under the Bankruptcy Code.

Under the Bankruptcy Code liquidation, the trustee is responsible for converting securities to cash as quickly as possible.  S/he is also charged with making cash distributions to customers of the debtor in satisfaction of their claims, with the exception of the delivery of customer name securities.  On the other hand, an SIPC trustee is asked to distribute securities to customers to the maximum extent practicable in satisfaction of their claims against the debtor.  This is one of the main differences between the Bankruptcy Code and SIPA liquidation proceedings.  

Inside SIPA – Securities Investor Protection Act