Market fluctuations aside, the failure of Yamaichi Securities Co. in Japan underscores the ultimate risk of investing.
"There is no way to protect yourself from any eventuality," Madelynn Matlock, manager of Bartlett & Co.'s international fund, said Monday. "There is always something that can happen that has never happened before. People forget there is risk in investing."
As sober a reminder as Yamaichi's failure is, investors in the United States can take comfort in knowing that securities laws have been put into place to protect assets from unscrupulous or poorly managed brokerages.
"In this country, it's pretty clear what happens if a brokerage firm goes bust," Ms. Matlock said. "It's clear what the next step is. That's not the case with Japan."
Congress created the Securities Investor Protection Corp., or SIPC, in 1970 after the paper crunch of the late 1960s caused a financial crisis at almost 200 brokerage firms in the United States. SIPC, which covers almost all of the nation's 7,000 brokerages, will advance up to $500,000 a customer account, including $100,000 in cash, in case of bankruptcy.
"We try to place the customer in the exact position he would have been in had the bankruptcy not occurred," said Steve Harbeck, SIPC general counsel.
The SIPC program is a government-backed insurance program for investors comparable to that provided by the Federal Deposit Insurance Corp. for bank depositors.
But SIPC has never been tested on a large scale.
The largest brokerage failure in the United States was Bell & Beckwith in Toledo, Ohio, in 1983, Mr. Harbeck said. SIPC advanced $32 million to Bell & Beckwith investors who were defrauded by the firm's managing partner.
Since SIPC was created, it has forced the liquidation of 266 firms. Almost half of those failures occurred between 1971 and 1974. It averages seven to eight liquidations a year, with the majority of cases ranging in value between $1 million and $5 million.
Yamaichi is Japan's fourth-largest brokerage. Its debts total at least $24 billion.
"This would be like Smith Barney or Merrill Lynch going down," Ms. Matlock said, putting Yamaichi into the context of the U.S. securities business.
The Securities and Exchange Commission has two key rules that help limit brokerage failures in the United States, Mr. Harbeck said. They are the customer protection rule and net capital rule. The customer protection rule requires brokerages to segregate customer assets from those of the firm.
The net capital requirement exists to ensure that firms have substantial capital reserves. As such, a brokerage firm's liabilities - the amount it owes - may never be greater than 15 times the firm's capital.
"The failures we see today would almost always involve some sort of fraud," Mr. Harbeck said.
"In this country, there has been a concentrated effort to create rules to protect investors, but I would never say one of our big brokerages wouldn't go belly up," Ms. Matlock said.
"Barings Bank was a 250-year-old institution that went down (in 1995). I'm sure Barings never thought that a trader in Singapore would find a way to bring the whole institution down."
ING Group in the Netherlands bought Barings, Britain's oldest bank, for almost nothing but assumed responsibility for its massive debt.
