On March 2, while the market was experiencing huge gains, the Robinhood trading app was overwhelmed by traffic and went down. For a period of 16 hours, traders were not able to use the app.
While Robinhood dealt with the public outcry from their app’s failure, an even more concerning situation was taking place behind the scenes. The LA Times reported that, in February, Robinhood drew its entire $200 million credit line from Barclays, Citigroup Inc., and JPMorgan Chase.
This revelation caused many to speculate and worry that Robinhood could have a serious cash-flow problem. Robinhood denied that they were dealing with any financial issues saying the $200 million draw was simply precautionary and the funds have already been replaced.
This story brings up an important question. What would happen if an investment app went bankrupt during a recession? Your bank deposit funds are protected by FDIC insurance. But what protections exist for brokerage account customers? Here’s what you need to know.
Learn more about what Robinhood offers to investors here.
Why Investment App Bankruptcies Are Rare
Broker bankruptcies are highly unusual. Currently, the Securities Investor Protection Corporation (SIPC) only has three open cases, one from 2013 and two from 2008.
Why is it so rare for investment apps to go bankrupt? One of the biggest reasons is that they must follow government guidelines that are designed to prevent financial failure. The most important rule that is meant to help brokers avoid bankruptcy is the SEC's Rule 15c3-1, commonly referred to as the Net Capital Rule.
The Net Capital rule requires that brokerage firms keep a certain amount of liquid capital at all times in order to remain an SEC-registered broker (the exact amount depends on the firm’s size and business). Its meant to protect customers and creditors by ensuring that brokers have enough cash on hand to quickly satisfy claims.
The amount of liquid capital that an investment app company is required to keep varies based on its size. But, in general, a smaller broker’s debt-to-net capital ratio must remain below 15 to 1. Larger firms can keep a smaller percentage of net capital on hand, but must never have less than $500 million of net capital and $1 billion of tentative net capital available.
What Happens to Your Money If Your Investment App Goes Bankrupt?
Most investment apps that follow the Net Capital Rule will find that it helps them avoid the need to file for bankruptcy. However, financial insolvency can still happen. Even if your broker can’t meet its financial obligations, there’s a good chance that your money will be fully protected.
The first reason is that registered broker-dealers must also abide by the Customer Protection Rule, which requires that they keep their customers’ assets separate from their own. This means that your investment app can’t touch your fully-paid securities or cash to help cover their debt obligations.
Because of the Customer Protection Rule, your money and securities should be fully protected even if your broker goes bankrupt. If your investment app files for bankruptcy, securities regulators would step in and make sure that your assets are carefully transferred to another registered broker.
What SIPC Insurance Covers (And What It Doesn’t)
All brokers that sell securities to the public are required to be members of the SIPC (Securities Investor Protection Corporation). SIPC insurance provides up to $500,000 of protection ($250,000 limit for cash) for customers of SIPC-member brokers that go bankrupt.
It’s important to understand, however, that SIPC insurance does not protect against a decline in the value of your securities. Market loss is an inherent risk of investing. But the SIPC will cover any of your securities that are missing due to theft or unauthorized trading.
For example, let’s say that you own ten shares of Coke stock in your investment app. Unfortunately, your investment app goes bankrupt, and must transfer your assets to another SIPC-registered broker. However, you notice that your Coke shares are missing after the transfer. This would be an example of an SIPC-covered event.
In addition to market decline, SIPC insurance also doesn’t protect commodity futures contracts, foreign exchange trades, or fixed annuity contracts. And, of course, the SIPC does not protect the accounts of any brokers that are not SIPC members.
How To Find Out If Your Investment App Is An SIPC Member
According to the SIPC, 99% of investors who are protected by its insurance get back their investments. This track record shows why it’s so critical to make sure that your investment app is registered with the SIPC.
Thankfully, the chances are highly likely that your investments app is an SIPC member since this is a legal requirement for all brokers that sell stock and bonds to the public. All of Doughroller’s favorite robo-advisors like Betterment, Wealthfront, M1 Finance and discounts brokers like TD Ameritrade and E*TRADE are SIPC members.
|Wealthfront||First time investors|
|Personal Capital||Large investors|
|Acorns||Students and young investors|
|M1 Finance||Customizing your portfolio|
|Ally Invest||Portfolio diversification|
|Vanguard Personal Advisor Services||High net worth, buy and hold investors|
But if you want to make sure that your particular investment app is covered, you can see the full list of SIPC-member brokers and dealers here.
Related: Are Sin Stocks Recession-Proof?
How To File An SIPC Insurance Claim
If your broker goes bankrupt and decides to self-liquidate, you’ll want to immediately collect your brokerage account records. Even if you only have online copies of your statements, download them to your computer so that you can print them later, if needed.
Next, keep an eye out for your claim form. If your broker doesn’t send you one, you can download your own copy from the SIPC website. You can also request a claim form from the trustee of the liquidation proceeding. Or you can ask for a claim form by emailing the SIPC at email@example.com or by calling them at 202-371-8300.
Finally, fill out your claim and form and send it to your trustee. The deadline for filing a claim is usually 60 days after the notice of the bankruptcy proceeding is published. Your specific deadline could be shorter or longer. But the maximum deadline to receive SIPC protection for a claim is six months after the publication date.
The Bottom Line
The chances are slim that your investment app will go bankrupt thanks to stringent government guardrails and safety nets. And even if you’re one of the few unlucky ones whose investment app shutters, your account would most likely be transferred smoothly to another broker.
However, if you discover that any of your funds or securities have gone missing due to the negligence of your bankrupt broker, you’ll want to immediately file a claim with the SIPC to make sure that your funds are recovered.