CNBC money man Jim Cramer has taken a lot of flak for his pronouncement last month that "Bear
Stearns is fine!" just a few days before the company was forced to merge with JPMorgan Chase & Co. to avoid collapse.
You can see Cramer's screaming proclamation that "Bear Stearns is not in trouble!" by searching for the phrase "Bear Stearns is fine" on YouTube.
Quite obviously, neither Bear Stearns nor its shareholders were fine. However, Cramer wasn't really offbase when he advised Bear Stearns' brokerage customers not to pull out their money. Even if JPMorgan hadn't ridden to the rescue with the backing of the Federal Reserve, the brokerage customers probably would have been fine.
Customers have a wide range of protections when brokerages go bankrupt, even if it turns out securities are missing from their accounts. However, there are limitations investors need to know about. With questions swirling about the value of assets that brokerages carry on their books, this is a good time to review the basics.
First and foremost: The assets in your account, minus any money you owe the brokerage, belong to you, not the brokerage. The Securities and Exchange Commission requires a brokerage to keep customer assets separate from its assets. That means customer assets are never supposed to be used to pay the company's creditors and usually they aren't.
But what happens if the brokerage broke the rules and customer assets are missing?
That's when the Securities Investor Protection Corp. steps up to the plate. It becomes the trustee or works with a court-appointed trustee to liquidate the failed brokerage and recover customer money.
First investors get back the securities registered in their names or are being registered in their names. Then investors' claims for missing securities take priority over those of other creditors in the liquidation process. If there isn't enough to pay customers what they are owed, SIPC will pay up to $500,000 of customer claims for missing investments, including a maximum of $100,000 for missing cash.
Many brokerages, including Bear Stearns, have bought extra insurance from private carriers and offer customers millions of dollars of protection.
A private corporation created by Congress in 1970, SIPC says it has advanced more than $500-million as part of the recovery of $15.7-billion in assets for customers of failed brokerages.
But SIPC coverage has some major limitations. It does not cover losses in market value, even when those losses were because of fraud or the result of the inability to sell a stock during liquidation. If the brokerage being liquidated stole stock from your account, that's an SIPC-covered loss. But if it sold you a stock that became worthless, that's not covered.
Also, SIPC coverage does not extend to unregistered investments, including investment contracts, limited partnerships, fixed annuity contracts, currencies and interests in gold, silver or other commodity futures contracts or options. Owners and partners in the failed brokerage are not eligible for SIPC coverage.
If the brokerage being liquidated had good records, customer accounts may be transferred to another brokerage within a few weeks. But when records were poor or fraud was involved, the process can take months. Customers who don't want to stay with the new brokerage can have their accounts transferred elsewhere.
Fortunately, brokerage liquidations are rare. Last month's announcement of the liquidation of a Louisiana broker was the first initiated by the SIPC in 14 months.