Safety and Security
National Financial Services LLC (NFS) serves as the clearing firm for Commonwealth Financial Network®(Commonwealth).1 As such, NFS provides trade execution, clearing, custody, and other related services for Commonwealth’s customers’ brokerage accounts. As registered broker/dealers, both Commonwealth and NFS are subject to the rules and regulations of the SEC, FINRA, and any other exchanges either firm is a member of, as well as of the Municipal Securities Rulemaking Board. Each of these regulatory organizations has certain rules and regulations regarding the safeguarding of customer assets, including, but not limited to, keeping accurate books and records, net capital requirements, and the Customer Protection Rule.
The Customer Protection Rule (Rule 15c3-3 of the Securities Exchange Act of 1934) generally requires a broker/dealer to (1) take physical possession or control of all fully paid securities and excess margin securities on its books and records; and (2) maintain with a bank a special reserve account for the exclusive benefit of its customers containing the net funds it owes its customers. Under the Customer Protection Rule, NFS is prohibited from pledging or borrowing a customer’s fully paid (non-margin account) securities in its proprietary business. The rule also limits the amount of customers’ securities NFS can pledge to third-party lenders to support customer margin debt owed to NFS.
SIPC—Protecting Customers from Broker/Dealer Failure
Both Commonwealth and NFS are members of the Securities Investor Protection Corporation (SIPC). SIPC was created in 1970 as a nonprofit, nongovernment membership corporation funded by member broker/dealers. Its primary role is to return funds and securities to investors if the broker/dealer holding their assets fails financially. SIPC does not reimburse customers for market loss, investment fraud, or worthless securities; instead, it steps in to help individuals whose money, stocks, and other securities are at risk when a broker/dealer files for bankruptcy or becomes insolvent. The SIPC fund currently stands at $1.9 billion; it has borrowing power of up to $2.5 billion more from the U.S. Treasury through the SEC.2
It should be noted that, from the time SIPC came into existence through December 2009, SIPC has advanced $2.1 billion in order to make possible the recovery of $133 billion in assets for an estimated 625,000 investors. Although not every investor is protected by SIPC, SIPC estimates that no fewer than 99 percent of those persons who were eligible have been made whole in the failed brokerage firm cases that it has handled to date.3 As discussed below, NFS has arranged for additional protection beyond SIPC for its customers’ cash and securities.
SIPC steps in when a firm has either failed and filed bankruptcy or is in danger of doing so. Upon either of these two events, SIPC would request a federal court to issue a protective decree and appoint a trustee to liquidate the firm’s assets.
For purposes of a liquidation under SIPC, a firm’s assets are divided into three categories: (1) securities (including stocks and bonds) registered in the customer’s name, which are either returned directly to the customer or transferred on behalf of the customer to another brokerage firm; (2) cash and other securities held for customers (including stocks, bonds, and money market funds that are invested in securities) in “street name,” which are divided pro rata among all customers; and (3) general assets of the firm, which are used to pay any remaining unsecured claims of customers (after SIPC payments discussed below) and expenses of the liquidation.
If the securities and funds in (1) and (2) above are insufficient to cover customers’ claims, SIPC will cover the remaining shortfall owed to customers up to $500,000 (including a maximum of $250,000, which a customer may have at the time held in cash with the firm). If there is any shortfall remaining after the SIPC payment, customers become general creditors of the firm.
To reiterate, if a broker/dealer fails and is subsequently liquidated under SIPC, any securities registered in a customer’s name would be transferred to another firm. Cash and securities held in street name would be paid out to customers in a pro rata portion of the aggregate amount of the cash and securities actually held by the broker/dealer. Any remaining shortfall would be covered by SIPC, up to a maximum of $500,000, only $250,000 of which may be the recovery of cash held at the broker/dealer.
A customer may increase his or her SIPC coverage by having different account registrations. For example, a customer with an individual account, a joint account, an IRA, and a 401(k) plan account would be eligible for $500,000 coverage in each account, for a total of $2 million.
Although most customers are eligible for SIPC assistance, SIPC’s funds may not be used to pay claims of any failed brokerage firm customer who is also:
- A general partner, officer, or director of the firm;
- The beneficial owner of 5 percent or more of any class of equity security of the firm (other than certain nonconvertible preferred stocks);
- A limited partner with a participation of 5 percent or more in the net assets or net profits of the firm;
- Someone with the power to exercise a controlling influence over the management or policies of the firm; or
- A broker or dealer or bank acting for itself rather than for its own customer or customers.
In addition, it should be noted that not all investments are protected by SIPC. In general, SIPC covers notes, stocks, bonds, money market funds invested in securities, mutual fund and other investment company shares, and other registered securities. It does not cover instruments such as unregistered investment contracts; unregistered limited partnerships; fixed annuity contracts; currency; and interest in gold, silver, or other commodity futures contracts or commodity options.
If a customer buys mutual funds through a brokerage account, those funds are protected by SIPC. If a customer buys mutual funds directly from the fund company, however, he or she is not protected by SIPC because no protection is necessary. Every mutual fund is set up as a separate entity, apart from the investment advisor that manages the fund. The employees at a mutual fund company do not have direct access to customers’ assets. Mutual fund assets by law are not held at the mutual fund, but rather are held in a trust account at a custodian bank. The trust account is not considered part of the bank’s assets. While banks can and do fail, the mutual fund trust accounts are not involved in that failure.
After SIPC steps, in most customers can expect to receive their property in one to three months.