Insurance is meant to provide a safety net in the case of an emergency. Health insurance covers the cost of a broken limb; dental insurance covers a root canal; homeowners insurance covers leaky plumbing.

The Securities Investor Protection Corporation (SIPC) provides insurance that protects your investments, including those held by our broker, Betterment Securities. It covers up to $500,000 of missing assets, including a maximum of$250,000 for cash claims.1 But the difference between SIPC and some other types of insurance is that there’s a very good chance you’ll never have to use it.

Since the inception of SIPC in 1971, fewer than 1% of all SIPC member broker-dealers have been subject to a SIPC insolvency proceeding.2 During those proceedings, 99% of total assets distributed to investors came directly from the insolvent broker-dealer’s assets, and not from SIPC.3 Of all the claims ever filed (625,200), less than one-tenth of a percent (352) exceeded the limit of coverage.4

History suggests that even if you had millions of dollars invested with a brokerage firm that became insolvent, it is extremely likely that you would be made whole.

## How SIPC Insurance Works

All brokers are required to be SIPC members. The $500,000 coverage limit applies to each legally distinct account. For example, if you have a taxable account, an IRA, and a trust, each is eligible for its own$500,000 of coverage.

The limit applies only to the value of missing securities, not losses due to market volatility. If there are securities identified as belonging to the customer, these (or their equivalent value) will be returned regardless of account size, and the $500,000 limit will apply only to the difference. Some investors mistakenly think that they should never have more than$500,000 in a single brokerage account, but the coverage applies to what’s missing, not to the overall balance.

Let’s walk through an example to see how it works.

You have an account with three different brokers, and each account holds $2 million in assets. Each of those accounts is covered separately by SIPC, up to$500,000. If one of those brokerage firms were to go bankrupt, a judge would appoint a trustee to sort through the broker’s books and distribute assets back to you and other clients. Here are some possible outcomes, with specific numbers just to illustrate:

• The trustee recovers your original assets—that’s your $2 million—from the insolvent broker-dealer, and you are made whole. You would experience zero loss on your account. (Since the inception of SIPC in 1971, 99% of total assets distributed have come directly from the insolvent broker-dealer, not from SIPC.)5 • If the trustee can only recover$1.5 million of your assets, the remaining $500,000 would be covered by SIPC insurance, and you’d be made whole. • If the trustee can only recover$1 million, you would still be covered for $500,000 on the missing amount, but you would incur a partial loss for the remaining$500,000. Historical data shows how extremely rare this is: Over the 46 years that SIPC has existed, there have only been 352 people who have ever had a loss where SIPC wasn’t able to make them whole.6

#### Three Illustrative Outcomes for an Investor After Brokerage Failure

While SIPC is sometimes compared to the Federal Deposit Insurance Corporation (FDIC), it is neither a government agency nor a regulatory body. It’s a private nonprofit group funded by the brokerage industry (every member pays semi-annual dues).

It’s not completely on its own, however. SIPC is allowed to borrow from the U.S. Treasury if its own resources are strained—so there is very little chance that SIPC would not meet its coverage obligations. It’s also important to note that FDIC guarantees your principal up to its coverage limit, whereas SIPC does not cover market fluctuations, only missing assets.

## Insurance That Is Rarely Invoked

Why is SIPC insurance so rarely called upon? Because an elaborate set of guardrails around a broker-dealer’s financial operations makes SIPC an absolute last resort.

There is a vast framework of regulatory safety checks and audits that custodian broker-dealers undergo on a daily, weekly, monthly, and annual basis. For example, the requirement to segregate client assets from those of the broker greatly increases the likelihood that account holders can be made whole without having to use SIPC funds. If this segregation is properly maintained, account holders should be made whole in case of firm insolvency, no matter the account size. Close monitoring of a broker’s net capital cushion serves a similar purpose.

Again, adherence to these safeguards is a foremost focus of a custodian broker-dealer—every single day a custodian broker-dealer is required to perform applicable safety-checks and immediately report problems to its regulators.

Of course, there are outliers when an institution fails under more nefarious circumstances. In the most notorious example, the Bernard Madoff Ponzi scheme, some investors could not be compensated when it turned out they didn’t own the securities they thought they did. Madoff just lied and said that they owned them. (Additional rules were enacted post-Madoff, which are discussed in more detail below.)

Betterment Securities holds only publicly traded ETFs in client portfolios, allowing for complete transparency. All of our clients can track their assets and returns on a daily basis.

High-profile cases such as Madoff are exceptions, overshadowing the fact that SIPC proceedings are very rare. As shown in the chart below, there have been just 328 proceedings since the organization was set up in 1971, out of more than 39,600 brokers who have been SIPC members over that period. There were 109 proceedings initiated in the first four years, and since then, no year has had more than 13.

In fact, in the 10 years through 2013, a tumultuous time for the financial markets and the financial-service industry, no year has seen more than five proceedings initiated. In 2014, there were none.

## Be Proactive: How to Protect Your Investments

SIPC is important when it comes to protecting your investments, but it’s also necessary for you to consider these key safety points when choosing a brokerage firm:

• Your assets are never commingled with the brokerage’s operational funds.
• Your holdings are completely transparent at all times.
• You should be able to review publicly available audits of your firm.
• If you are being promised something “too good to be true,” there is reason to be cautious.

### Never Allow Your Assets to Be Commingled

With any brokerage you use, your money and the firm’s operational funds (e.g., what the firm uses to pay its bills) should never be mixed.

With Betterment Securities, operational funds and customer funds live not only in different accounts, but in separate universes—separated by numerous digital (and human-supervised) firewalls. Regulators require us to file our detailed financials on a monthly basis; we must report both firm capital and any customer cash that we hold.

As Betterment Securities is the custodian of our customers’ assets, we must also maintain substantially higher levels of net capital than an introducing firm, which is a broker that delegates custody to a third party.

Another guideline is to avoid brokers that engage in proprietary trading for their own account, while also handling yours. On occasion, such a broker might “blow up” over some failed exotic trade made in the house account. As a result, the need to cover a shortfall can create the temptation to “temporarily” borrow funds that are off limits, such as those from customer accounts.

Betterment Securities never does any proprietary trading for its own account. That is not our business, and never will be.

### Always Be Able to Verify Your Assets

One of the great pitfalls for Madoff investors was that they could not verify their assets—in fact, Madoff lied about their existence.

With Betterment, you have full visibility into your exact positions at any time. You can follow your performance over any time period, directly from your account (on mobile or on the Web).

We believe in complete transparency—on any day, after every trade, we disclose the precise number of shares of every ETF in which you’re invested. That differentiates us from many portfolio and fund managers who do not openly share this information with their clients.

### Look at the Public Record

You don’t need to take your broker’s word at face value—you can and should verify regulatory audits to ensure you’re in good hands.

The U.S. Securities and Exchange Commission (SEC) issued an amendment in 2010 (post-Madoff) that applies to investment advisors who custody their clients’ assets, or who use a related party to do so. We are the latter case. Betterment LLC, the investment advisor, is an affiliate of Betterment Securities, the custodian.

Under rule 206(4)-2 of the Investment Advisers Act of 1940, the investment advisor must be subject to an annual surprise exam from an independent public accountant. We don’t know when the surprise exam will happen. The accountants just show up in the office one day.

The auditors verify the internal books and records of the affiliate custodian. They reconcile every share, and every dollar we say we have, against our actual holdings. They spot check several hundred random customer accounts. They contact customers directly, and verify that the account statements we issue to them match our internal records for these accounts. They ask questions if something doesn’t add up by even a penny.

Friedman LLP, founded in 1924, performs our annual surprise exam. It then issues a report to summarize its findings, and this report must be filed with the SEC. You can see our most recent report here, and past reports on file at the SEC in our ADV filing (click through to the ADV, and then click “Accountant Surprise Examination Report” on the bottom of the left side, under Form ADV-E).

### Trust Your Instincts: There Are No Shortcuts to Investing

Not all brokers deserve your caution in equal measure. It is not a coincidence that Madoff’s fund handily beat the market year after year after year. If something seems “too good to be true,” it probably is.

Similarly, be wary of overly complex, exotic strategies that you cannot understand. At best, such complexity creates circumstances for you to be overcharged, on account of perceived sophistication. At worst, it’s a red flag for smoke and mirrors.

Betterment is designed for market returns over time, and we make no promises we cannot keep. We buy global index fund ETFs on your behalf, and charge you a small management fee. It’s that simple, and when it comes to assessing risk, simplicity is your friend.

While SIPC insurance and regulatory oversight can help protect you from mismanagement by all but the most devious frauds, it can’t save you from yourself. President Richard Nixon, of all people, made that clear when he signed into law the Securities Investor Protection Act, the bill that created the SIPC.

“Just as the [FDIC] protects the user of banking services from the danger of bank failure, so will the [SIPC] protect the user of investment services from the danger of brokerage firm failure, he said. “It does not cover the equity risk that is always present in stock market investment.”

Of course, all investing comes with risk, but that risk is the price you pay for return.

Fortunately, you can take only the risk necessary to achieve your goals, by staying properly diversified to smooth out volatility and cushion the impact of bear markets as you invest for the long haul. That is what Betterment is designed for.

All blog posts and investment advice are produced by Betterment LLC.

1SIPC insurance does not cover commodity futures, fixed annuities, foreign currency—none of which are part of the Betterment portfolio. SIPC also does not cover losses associated with market fluctuations. You can learn more at www.sipc.org.

2SIPC Annual Report 2014, page 8

3SIPC Annual Report 2014, page 30

4SIPC Annual Report 2014, page 9

5SIPC Annual Report 2014, page 30

6SIPC Annual Report 2014, page 9

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