The plumbing: brokers, custody and what actually protects you

After this lesson you'll know what happens after you press Buy, who really holds your shares, and which disasters you're protected from — with an honest list of the ones you aren't.

After the button

Press Buy and four parties do their jobs in sequence. Your broker takes the order and routes it to a market. The exchange matches it against a seller (courses 1 and 2). A clearing house then steps into the middle of the trade, becoming the buyer to every seller and the seller to every buyer, so that if the party on the other side of your trade went bankrupt an hour after your fill, you would never even hear about it. Finally a custodian records the change of ownership.

The legal exchange of shares-for-money is called settlement, and it takes a moment: in the US, the next business day ("T+1", since 2024). Much of Europe still takes two days and is scheduled to move to one in 2027. For your everyday trading this is invisible. It starts to matter when you're moving money in and out, and your broker's cash screens make more sense once you know the word.

Whose shares are they?

Your broker holds your shares in custody. The word to know is segregated: properly held client assets are kept legally separate from the broker's own money. If the broker goes bankrupt, your shares sit outside its estate, so they get transferred to another broker rather than being used to pay the broker's creditors. When Lehman Brothers collapsed in 2008, the customers of its US brokerage had their accounts moved to another firm within weeks.

For the gaps, meaning fraud and failed record-keeping, there are investor compensation schemes, and they come with limits worth knowing before you fund an account. In the US, SIPC covers up to $500,000 of securities per customer. The Dutch scheme covers up to €20,000, and other countries differ. Cash sitting at a broker is often covered differently from securities (bank deposit guarantees are a separate system with separate limits). Those numbers are public, so look your broker's up before you wire anything.

What nothing protects

A compensation scheme pays out when the broker's back office fails. No scheme pays out when your trade goes against you. Market losses are yours in full. All the machinery in this lesson protects your ownership of what you hold, and it says nothing about whether holding it was a good idea. Money borrowed from the broker sits outside the fence as well, because that's a debt, and no protection scheme touches debts. The decisions are the unprotected part, and they're what School II is for.

Check yourself

1. Your broker goes bankrupt on a Tuesday. What happens to your 300 shares? (They're segregated client assets outside the broker's estate, and get transferred to another broker. The compensation scheme exists for fraud and record-keeping gaps, up to its limit.)
2. What does T+1 mean? (Trade today; the legal exchange of shares for money completes the next business day.)
3. Which of these is covered by any protection scheme: (a) broker fraud, (b) a 40% loss from bad trades? ((a), up to the scheme's limit. (b) is covered by nothing, which is what School II is about.)

The idea this lesson installs

Know your custody chain and its numbers before you fund the account.

Next: Course 6 — "Sessions and auctions: the shape of a trading day."