Following the 2008 financial crisis, confidence in financial institutions was at an all time low, and for good reason – many people lost their savings and jobs. However, the crisis had certain beneficial outcomes as well.
How did the 2008 crisis help make online brokers safe?
First, it led to the fintech revolution that we are experiencing at present – this is because people wanted a more efficient financial system. Second, the government developed certain acts, such as the Dodd Frank, that imposed stringent regulations on financial institutions. Online brokers have not been immune to effects of these external changes. However, they were made to straighten their acts long before.
The SIPC and the CIPC
During the 60’s there was an insurmountable and unexpected increase in trading volume, and brokers were not equipped to handle such an increase. Most of them were understaffed and used outdated record keeping systems. As a result, problems such as mistaken entries, recording errors, or system breakdowns were quite common. Moreover, at that time firms weren’t required to separate their own money from that of the firm. Thus, when a broker went bust it was not able to return the investor’s money.
Following these incidents, Congress stepped in to protect investors, and the Securities Investor Protection Corporation (SIPC) was created.
So what is the SIPC and CIPF?
The SIPC is a non-profit industry membership organization that protects private investors in case their brokerage firm defaults, becomes insolvent, or runs into a financial crisis. SIPC protection is limited up to $500,000 for securities and cash, or $250,000 for only cash. Hence, unless you plan to invest more than the amounts stated above, the government will be there to protect you. According to the SIPC’s own estimates, no fewer than 99 percent of persons who are eligible have been made whole in the failed brokerage firm cases that the organization has handled. The CIPF, or Canadian Investor Protection Fund works hand in hand with the SIPC covering these issues in Canada and the United States.
How does it work? What happens when a brokerage firm fails?
- SIPC first attempts to transfer the investor’s securities to another broker.
- If step 1 doesn’t work, the SIPC will buy securities to match the investor’s portfolio before the brokerage went bust.
- In the rare case the investments are not available, the SIPC will give the investor cash for the value of their securities.
What if I want to invest more than the $500,000 that the SIPC covers?
If that is the case then, the broker’s personal insurance policies will cover you.
Another important point to consider is that unlike banks, most brokers are involved only in the task of providing a platform for transactions. This implies that they do not usually get involved in risky businesses, which was the case with Lehman Brokers and other banks in the 2008 financial crisis.
What about the act of online trading in general? Are you protected from hackers and other fraudulent online activities? Surely, we have seen movies where evil hackers break into accounts and steal money. What about viruses that wreak havoc and destroy everything, even steal personal information?
Online brokers are well aware of these problems – more so than the average person. Hence, brokers spend huge amounts of money on online security because they know that just one case of online hacking is capable of completely destroying their reputation – in other words, the stakes are high.
So what is my broker doing to prevent this?
They use the highest level of security allowed by US law – 128 bit high end encryption – which is virtually impossible to hack. This is important to understand, you cannot be with a corporation that offers a higher level of security – whether it be a bank or any other financial institution.
On top of that there are two levels of security that protect customers. First, you need to have a password to enter your personal account. The second level of security is through a PIN, think of it as having a password to send e-mails. You cannot trade securities without this PIN. Thus, unless you actually give your password and PIN to someone, or you know psychics who can read minds, your account is completely secure.
Will my broker try and take advantage of me?
What about brokers selling you sub-par deals? Well, let me ask you this – are you susceptible to buying a piece of clothing that will not fit you? Silly question, right? Why would I buy something that does not fit me. It is because you are educated about your body and your needs. You know what will or will not fit you!
Investing is the same. Unless you do your homework and have a good understanding of what you are buying, you might end up with the wrong security. This is why we are offering Stocktrades to you, completely free. Learn before you invest. If you learn to invest then the broker will not be able to take you for a ride.
Do you still question the safety of online brokers?
Hopefully this information will reduce some doubts in online stock brokerages. At the end of the day their reputation is at stake when it comes to protecting your money. This is why the bigger players in the game like Questrade have the strictest of security measures in place. If you want to take a look at what some of the online brokers have to offer, here is our most recent review of the top brokerages in the US and Canada.