How does investor protection work, and what does it not cover?

#What does investor protection actually mean?

When you put money into shares or funds through an app, two very different things can go wrong. The investments can fall in value because markets move. Or the firm holding them can fail, make mistakes or behave badly. Investor protection is about the second problem. It is a set of rules and schemes that try to make sure your assets are still there, and still yours, whatever happens to the company in the middle. It does not promise any return, and no scheme makes investing free of risk.

#Which rules control how firms treat you?

In the US, an investment adviser, including a robo-advisor, owes clients a fiduciary duty. The SEC explains that this duty "comprises a duty of care and a duty of loyalty" and applies to the entire adviser-client relationship⁠^[1]. Brokers who recommend investments to retail customers must, under Regulation Best Interest, act in the customer's best interest at the time of the recommendation without putting their own interest ahead of the customer's⁠^[2]. Our comparison of robo-advisors and financial advisors explains what these duties mean in practice.

#Where are your shares and cash actually kept?

Your investments are not supposed to sit in the firm's own pot. US broker-dealers must "promptly obtain and shall thereafter maintain the physical possession or control of all fully-paid securities and excess margin securities" carried for customers, and must keep a special reserve bank account for the exclusive benefit of customers, topped up according to a set formula⁠^[3]. Investment advisers with custody of client assets must generally use a qualified custodian, such as a bank or registered broker-dealer, which sends account statements at least quarterly, and the adviser faces a surprise examination by an independent accountant at least once a year⁠^[4]. The glossary entry on custodian explains the role in one page.

The point of separation is simple. If a firm goes bust, its creditors should not be able to take customers' assets to pay its debts. Separation is the main protection; compensation schemes are the backstop when separation fails, for example because records are wrong or assets have gone missing.

#What happens if a brokerage firm fails?

In the US, the Securities Investor Protection Corporation (SIPC) steps in when a member brokerage fails. SIPC describes itself as "a non-profit corporation created by Congress" and says it works "to restore investors' cash and securities if their brokerage firm fails"⁠^[5]. In SIPC's words, "The limit of SIPC protection is $500,000, which includes a $250,000 limit for cash"⁠^[6].

Other countries have similar schemes with different limits. The UK's Financial Services Compensation Scheme (FSCS) covers up to £85,000 per eligible person, per firm, for investment firms that failed after 1 April 2019. It can also cover money lost through bad advice, but only where the adviser or provider has gone out of business⁠^[7]. In the EU, the Investor Compensation Schemes Directive sets a minimum of €20,000 per investor when an investment firm fails to return investors' assets⁠^[8].

#What does investor protection never cover?

This is the most misunderstood part. SIPC says plainly that it "does not protect against the decline in value of your securities", and it also excludes items such as commodity futures, foreign exchange trades and crypto assets that are not registered securities⁠^[6]. The FSCS says it cannot accept claims for poor investment performance because investments "can go down as well as up"⁠^[7]. The European Commission notes that the EU directive "does not cover investment risk, such as when an investor has bought stocks which then fall in value"⁠^[8].

#How can you check a firm before you invest?

In the US, the SEC's investor site lets you search a professional's name and directs you to the Investment Adviser Public Disclosure (IAPD) site or FINRA's BrokerCheck, where you can see whether the person and firm are registered and any disciplinary history⁠^[9]. Firms serving retail investors must also give you a short relationship summary, Form CRS, covering services, fees, conflicts of interest, the standard of conduct and disciplinary history, in no more than two pages for a single type of firm⁠^[10].