Shield your money: an insider guide to investor protection in trading

Several countries operate so-called investor protection funds or investor compensation schemes designed to protect the capital and assets of retail traders and investors. These schemes are similar to deposit protection funds set up to guarantee bank deposits in case of a bank’s failure. But they protect securities and cash kept in brokerage accounts and greatly contribute to increasing the safety of your trading journey.

Investor protection funds are used to compensate investors for losses incurred due to specific circumstances, typically when their investments or assets held with a regulated entity become at risk or are compromised. Most often, these funds are used when a broker runs into financial difficulties or goes insolvent.

These funds are typically set up by the government of the country in question and financial firms (i.e. brokers) are required to pay a certain amount of money into the fund. This can be either a set amount or a percentage of their revenue or operating profit. Governments determine how much money needs to be in the fund, depending (among others) on the size of their financial market.

An investor protection fund is essentially a cash pool that can be tapped when a broker goes bust and its clients need to be compensated.

Regulators put in place limits on the amount of compensation provided to individual investors. The limits can vary widely depending on the jurisdiction and the type of financial instrument. We collected the data on coverage limits in the most important jurisdictions in the following table.

Authorities also regulate the what type of assets are included in the investor compensation scheme. In the US, for instance, the regulator published a detailed list of financial instruments excluded from investor protection coverage. In the UK or Canada, there are also rules in place regarding investment types covered by compensation schemes.

When it comes to investor protection, there are two crucial factors you need to keep in mind:

1. Investor compensation is not automatic: you will need to submit a claim and proof of your holdings to be compnesated.
2. If your broker is a member of an investor protection scheme, you will automatically be entitled to investor protection regardless of your citizenship or place of residence.

The latter means you should consider the availability of investor protection when choosing a broker. Also, you may want to open brokerage accounts at brokers that operate in countries with high investor protection.

Some brokers have their own insurance policies in place (taken out from insurance companies) to provide additional protection to their clients. This insurance comes on top of any existing investor protection schemes and this boosts their safety score to a big extent.

This is a valid question and the answer hinges on what type of problem you think you encountered with your broker.

Your broker is a scam

Despite regulatory efforts to root out fraudulent schemes in financial markets, scams remain an existing threat to traders. The bad news is that falling prey to scammers in most cases means your money is gone for good.

You should file reports with your national regulator and the police, however, chances are slim that the perpetrators will be apprehended and the swindled funds recovered. Even if you get “lucky” and the scammers are identified/arrested, it may take years for claims to be settled, provided the stolen money is also seized.

Your broker goes bankrupt

Bankruptcies in the brokerage industry are not common but definitely happen. As a trader or investor you need to be aware of the risk of brokerage failure and be well informed of your options, should such a situation arise.

Brokers are business entities and as such run the risk of hitting a wall (usually because of fraud or bad management). So what happens if your broker goes bust? The ensuing process is largely similar in all countries.

Once a brokerage company fails, a bankruptcy process will kick off and at some point the bankruptcy trustee will reach out to the clients of the broker, informing them how and by what deadline they should submit their claims.

This is a crucial point in the process: if you fail to submit your claim for cash and assets held with the bankrupt broker by the set deadline, your claim against the failed broker might not be enforceable.

Meanwhile the trustee will assess the bankrupt firm’s assets and liabilities to determine whether client funds have not been lost. If client funds are indeed available (i.e. the broker did not commit fraud, it simply ran into financial difficulties), your account (including your securities and cash) will be transferred to another broker and you will have access to them to do as you please. You will be notified about the transfer of your account.

If some (but not all) of client assets are missing, the trustee will use the bankrupt firm’s remaining assets to compensate clients in proportion to the funds they had in their brokerage account. In this case, you may see some of your funds recovered, but definitely not all of them.

If you are eligible for investor protection, you may get all your money back. For instance, if a US broker fails and you - as its client - had $400,000 in your brokerage account (in securities and cash), you will be fully compensated as the investor protection limit in the US is $500,000 (including $250,000 for cash).

As a UK citizen, you will get your money back up to the £85,000 if your UK broker fails. Citizens of most EU countries are only covered up to €20,000 but certain EU member states have higher compensation limits.

In order to qualify for investor protection, however, your broker needs to be regulated in a country that runs an investor protection scheme and it must be a member of that scheme. If you are a German citizen but your broker is regulated in Australia, you will not qualify for German investor protection and there is no investor protection scheme in Australia to protect you.

While there are rules in place to shield investors from scammers and fraudsters in most countries of the world, there are steps you can take to protect yourself.

1. Choose a reputable broker: Do your research and choose a broker that has a good reputation and a solid track record. Look for a broker that is regulated by a top-tier regulator and find out whether you are eligible for investor protection. Checking the website of the broker is a must. The quality of a broker’s website speaks volumes. Low overall quality, scant information should be treated as a red flag as these are typically signs of a scam broker.
2. Diversify your investments: By diversifying your investments, you spread your risk across different types of securities and industries. This can help protect your investments if one industry or security experiences a downturn.
3. Monitor your investments: Keep an eye on your account statements and check for any unauthorized transactions. If you notice any suspicious activity, contact your broker immediately.
4. Keep your contact information up to date: Make sure your broker has your current contact information, including your phone number and email address. This will ensure that you receive timely notifications about your account and any changes that may occur.

Does your broker, or any broker that you're considering using, offer investor protection? Find out by clicking on the broker names below.