When the canary quit singing, the coal miners knew toxic gases were high, and it was time to vacate. Today, in our world of high speed communication, the canary has awakened and begun to chirp. We should be paying attention.

Our canary is a quasi-governmental agency – the Securities Investor Protection Corporation, or SIPC. I found this hard to believe. However, SPIC is running radio and TV ads touting the amount of money that it has paid to investors. Presumably, that will make investors feel good in the midst of all the more disconcerting economic news.

THE ONLY REASON SIPC PAYS OUT ANY MONEY is due to the failure of a brokerage firm to remain financially viable and stay in business. As an insurer, you only have to pay when there are losses.

SIPC’s ads are a defacto announcement of brokerage firms failing. Apparently, the firms were not as large and noticeable as the collapse of Bear-Stearns because the failures did not receive attention in the national press. At this writing, there are fourteen brokerage firms being settled by SIPC.

SIPC guarantees investors’ funds held in brokerage accounts. The guaranty is limited to $100,000 of cash and a maximum of $500,000 of total value in securities and cash per account. Typically, brokerages buy additional insurance for excess coverage in the event of their default.

We do not know the details of the failures that have resulted in SIPC reimbursing investors for their loss of securities or cash. We do know recent history. The collapse of the savings and loan industry and settling of accounts by FSLIC took up to two years. We do know that major brokerage firms have collapsed in the past quarter century during the greatest bull market of the last 100 years.

Our concern is what lies ahead as the Boomer generation prepares for retirement. Boomers will reduce their consumer spending to focus on debt reduction and asset accumulation for retirement. The demographic change in our country will be much greater than the corresponding change in Japan during the 1990s. We expect a protracted bear market in US stocks beginning in 2009, or 2010, at the latest.

Since SIPC is already settling accounts on failed brokerage firms in a bull market environment, we are very concerned about what happens in a bear market. In a good market there are other firms willing to take over the trading of investor accounts as we recently witnessed with JP Morgan’s acquisition of Bear-Stearns. In a bear market, ready buyers may be more difficult to find since their financial conditions may be compromised.

The worst case scenario is that SIPC has to actually settle investor accounts in a failed brokerage firm. With the firm closed, SIPC must audit the accounts before delivering cash or securities. Will that take two weeks or two years? We do not know. However, it is the “government here to help you.” FSLIC had to go to Congress for a special appropriation (read that tax assessment on us) to pay off the depositors of the S&Ls. Everyone received their insured account balances, eventually.

Internally, we have been receiving invitations from brokerage firms to attend meetings explaining how financially secure they are and why our clients should not worry about keeping their accounts with the broker. Paraphrasing the Queen in Hamlet, “…the (firm) doth protest too much, methinks.”

Brokerage firms get into financial trouble and violate net capital requirements because of bad decisions, bad market bets or excessive leverage. Legally allowed to use client assets for collateral, brokerage firms are often very highly leveraged. I have seen more than one national firm collapse during my career. Remember EF Hutton? Lehman Brothers? Integrated Resources?

There is a solution. Do not custody assets with your brokerage firm. Insist on using a trust company for custody and safe keeping. Your brokers will likely object due to the greater administrative task in placing trades. Tough!

Trust companies cannot use client assets as collateral for their borrowing purposes. The whole concept of trust custody is the separation and safe keeping of assets for another party.

Trust company financial regulations are much more stringent than required for brokerage firms. After all, trust companies do not have the task of creating new and enticing investments to attract your investment dollars. The trust companies’ responsibility is to guard your assets and account for everything that is due you, kept separate from others and their own accounts.

Tough markets have always resulted in brokerage firm failures. With an Economic Tsunami just ahead, expect more Bear-Stearns like events. They will probably be less visible and more slowly resolved. If you are caught in one, your account is frozen until a resolution is determined. No trading. No redemptions. No cash withdrawals. If you are on margin, you will get your loan called but be unable to sell your stocks for settlement. Be certain to have a back up line of credit equal to or greater than your margin limit.

Alternatively, move your accounts to a trust company. Your broker does have one to work with. You give up your ability to margin your assets. You may have to give up check writing against your investments (a different form of margin, but margin, nonetheless). You gain increased security and control of your assets through all market conditions. You remove an unnecessary risk from your personal finances. With that, you should have greater peace of mind.