Personal Finance: How to put trust back into finance

Q

uestion.

With seemingly stable companies such as AIG, JPMorgan, Fannie Mae, Freddie Mac, Lehman Brothers, MF Global and Peregrine having financial problems, how safe are investor monies held/deposited with national brokers such as Scottrade, [TD] Ameritrade, Vanguard, Schwab and others?

Answer. It's a shame that people feel compelled to ask this question, because it shows how far trust has slipped since we learned in 2008 and afterward that we cannot rely on financial companies, politicians or regulators to protect investors or taxpayers.

Yet trust is necessary to make the economy function well. Paola Sapienza, a finance professor at Northwestern University, has studied trust and investing and oversees a regular survey on trust. In countries where there is little trust in the people who handle investments, even very wealthy people will not invest in their home stock market, she said.

She has not polled people specifically on the breakdown in trust related to the companies you mentioned. But she says only 15 percent of Americans say they trust the stock market, and trust in banks was the lowest ever in her survey in June.

Only 26 percent of those surveyed said they trusted banks. In December 2010, trust in banks was at 43 percent, and in 2008, in the midst of the financial crisis, it was 40 percent.

Regardless of trust, if your money is in a bank and the bank collapses, or there is fraud, your money is protected up to $250,000 in an account. The protection comes from the Federal Deposit Insurance Corp. Before banking with any organization, see whether it falls within the FDIC's coverage.

Credit unions often have federal protection through the National Credit Union Administration.

Money in brokerage accounts is also covered in the case of the collapse of an institution.

"The Securities Investor Protection Corp. returns cash, stock and other securities when a brokerage firm fails," said Charles Rotblut, editor of the American Association of Individual Investors Journal. If an SIPC-member brokerage firm goes bankrupt, the SIPC returns assets held in the account.

SIPC also provides protection against theft - cases where securities are stolen from a brokerage, said SIPC president Stephen Harbeck. That is distinct from fraud, in which a broker might, for example, provide false or misleading information on a security. Accounts are covered up to $500,000. But be aware. This does not mean that you have any protection from a bad investment. You can find information at http://sipc.org.

Futures are a different matter, as people with accounts at MF Global or Peregrine Financial Group have learned in painful detail lately. There is no insurance for futures accounts.

Currently, Peregrine customer accounts are frozen, and what's left of the firm is being liquidated. Allegedly, Peregrine statements were falsified, and rather than $220 million of client money remaining in accounts, only $5.1 million was held.

Futures firms are supposed to be monitored through the National Futures Association and the Commodity Futures Trading Commission, but with Peregrine and MF Global it appears that supervision was deficient. MF Global held a combination of account types. Commodities and futures customers weren't covered by the SIPC. In other words: Buyer beware.

Supervision has failed in too many cases lately. The most shocking was Bernard L. Madoff Investment Securities.

Madoff had been a leader in the securities industry. He admitted to running for years a Ponzi scheme in which he defrauded clients of billions of dollars.

Some Madoff customers were able to receive money back from the SIPC. Harbeck said those cases fit the definition of theft rather than fraud.

Still, when going to an investment firm, make sure your broker is a member of the SIPC. And, as a customer, keep records of all transactions, and as well as quarterly statements, along with the statement from the last month.