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What Happens If Fidelity, Etrade, or Vanguard Goes Bankrupt?


What happens to client stocks, money, and account investments if Vanguard, Etrade, or Fidelity goes out of business, becomes bankrupt?



Overview of Brokerage Bankruptcies


Occasionally a company tries to be profitable but isn’t able to compete with some of its rivals. If a firm can’t earn a profit from its revenue, and is overloaded with too much debt and can’t pay its bills, then it may decide to file for bankruptcy. Brokerage firms in the U.S. are businesses like any other for-profit organization. If a broker like Vanguard, Fidelity, or E*Trade ever found itself in a difficult financial situation and saw no way out, it would have the legal right to file for bankruptcy protection. This scenario would create several issues that investors should be aware of.


U.S. Bankruptcy Laws for Businesses


In the United States, there are two primary types of bankruptcy for businesses: Chapter 7 and Chapter 11. These names come from the legal codes where they are described. A straight bankruptcy is described in Chapter 7. This is where a company ceases all its operations and goes out of business. The other option is a Chapter 11 bankruptcy filing. In this case, the company tries to reorganize its operations and its balance sheet, and hopes to stay in business and eventually return to profitability, with the help of a bankruptcy court. The court must approve all significant business decisions during this time.


The Securities Investor Protection Corporation


Besides bankruptcy laws, the collapse of a broker in the U.S. would also bring in SIPC, the major insurer of American securities accounts. Assuming the defunct brokerage house was a member of SIPC, and most brokers are, its clients’ accounts would be protected up to certain limits. Generally, SIPC insures one investor per firm up to $500,000, of which $250,000 can be applied to free cash balances.

Vanguard, Fidelity, and E*Trade are all members of SIPC. So if any one of them ever filed for bankruptcy, the securities held at the firm would be insured by SIPC. The bankruptcy of the brokerage would not affect the value of stocks, bonds, mutual funds, and other assets held at the firm. Shares of these assets will not disappear, as SIPC’s mission is to make sure that all investors’ accounts are safe and sound if the brokerage firm is not.


What Happens If Fidelity Goes Bankrupt?


Fidelity has an insurance policy with Lloyd’s of London in case the company ever were faced with worse-case scenario. The policy has a total backstop of $1 billion. This amount is for all customer claims, not per customer. There is also a limit of $1.9 million on cash per client. Given that Fidelity has over 20 million customer accounts and $5.7 trillion in client assets, a billion dollars doesn’t seem like a lot. It’s only 0.02% of the broker’s total client assets. Nevertheless, there is at least something beyond SIPC. The Lloyd’s of London policy would only come into effect after all SIPC resources had been exhausted. Of course, Fidelity states that it never expects to need the insurance.

Because Fidelity is privately owned, you wouldn’t see much news about its stock price if the firm declared bankruptcy. Its stock doesn’t trade on one of the major US exchanges. Nevertheless, the company does have shares of stock, so there must be a share price. That price would obviously go down, but not necessarily to zero. The Fidelity brand and logo are probably worth millions. When a company declares bankruptcy, there is still value that entrepreneurs are willing to buy.


What Happens If Vanguard Goes Bankrupt?


Vanguard isn’t publicly traded either, but it has a slightly different ownership structure than Fidelity. Technically, the broker is owned by its funds, which in turn are owned by the funds’ shareholders. You wouldn’t see any news about Vanguard’s share price, but you would hear lots of news about the bankruptcy on CNBC. That’s because Vanguard has a lot of institutional clients with deep pockets, giving the broker $4 trillion in assets under management. A Vanguard bankruptcy, which of course isn’t expected, would ruffle a few feathers.

Like Fidelity, Vanguard has purchased additional insurance for its clients. The broker has partnered with Lloyd’s of London and London Company Insurers to add additional protection above $500,000. There is an aggregate limit of $250,000,000. This is the total amount Vanguard customers can receive if SIPC insurance is exhausted. It’s just one fourth the amount Fidelity has. The policy caps each customer at $49.5 million for securities and $1.75 million for cash.


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What Happens If E*Trade Goes Bankrupt?


Unlike Fidelity and Vanguard, E*Trade is a publicly-traded company. Its stock is a component of the S&P 500. If the broker declared bankruptcy, the S&P 500 would have a bad day. Because E*Trade also operates a futures trading business and an FDIC-insured bank, other regulators would be involved with a company bankruptcy. The FDIC would ensure that the company’s deposit accounts were protected up to the government’s standard $250,000 level.

Like the other two firms, E*Trade has purchased supplemental insurance to protect its brokerage customers in the unlikely case of insolvency. The aggregate amount is $600 million. This is the total amount that can be used to cover all the broker’s clients after SIPC funds have been used to their maximum. Three fifths of a billion dollars doesn’t seem like a lot against E*Trade’s total client assets of $311 billion, although SIPC would kick in first.


Summary


The scenarios discussed in this article are all hypothetical events. There’s no reason at this time to be concerned about the financial health of any of the three brokers. Nevertheless, financial institutions can go under, as the crisis of 2008 shows. Lehman Brothers and Countrywide Financial were two casualties of the calamity. If any of the three brokers ever did file for bankruptcy, securities and cash would have adequate protection for most investors. Wealthier investors could maximize the available insurance by having multiple accounts with several brokers.