Wealthfront maximizes the protection of your assets by doing the following:

Third party custodian: Your assets are held in an account at a third-party custodian named Apex Clearing. Wealthfront only has the right to issue trading instructions against your account. It cannot access your cash other than to receive its monthly advisory fee. You are the only one who can deposit to or withdraw from your account.
SIPC Insurance: Your brokerage account is protected by SIPC insurance. This insurance covers up to $500,000 in securities for each type of account you hold with Wealthfront. An IRA is considered a different type of account than a taxable account for this purpose, but different types of IRA accounts are considered one account for this purpose. SIPC insurance also covers up to $250,000 in cash – which almost always exceeds the minimal cash balance we maintain to pay your fees.
Additional coverage: Apex Clearing has secured excess SIPC insurance that provides an additional $150 million of coverage across all its clients. This insurance should be more than enough given that over the past 42 years 98.7% of client assets were recovered in failed brokerages even before SIPC insurance was employed.
Everything is held in street name: Wealthfront only invests in SIPC covered securities registered in street name at the Depository Trust Company (DTC). That means the securities purchased on your behalf by Wealthfront are held separately from other Wealthfront assets and other assets of our brokerage partner (Apex Clearing) and are fully insured as described above.
No proprietary trading: Our brokerage partner, Apex Clearing, performs no proprietary trading, the cause of the failure of MF Global. Even the failure of MF Global did not result in a loss to investors’ capital.
No rehypothecation: Wealthfront clients only have cash accounts (vs. “margin accounts”) at Apex Clearing. That means at no time can the cash or securities held in your account be loaned out or borrowed by Wealthfront or Apex.
Third party custodian

In accordance with SEC rules (particularly 15c3-3, the “Client Protection Rule”), our brokerage partner Apex Clearing protects client assets by segregating them and ensuring that they are not used for any other purpose, including loans to investors or institutions, corporate investment purposes, or corporate spending. Regulators and independent auditors periodically review Apex’s financial records to ensure clients’ assets are accurately tracked and held separately from the firm’s own holdings. It could be a civil and/or criminal violation if an investor’s assets were inappropriately commingled.

SIPC Insurance

When a brokerage firm is closed due to bankruptcy or other financial difficulties and client assets are missing, the Securities Investor Protection Corporation (“SIPC”) steps in as quickly as possible and works to return clients’ cash, stock and other securities. SIPC provides up to $500,000 of protection on securities held per legal entity and up to $250,000 in cash in excess of what is not recovered per legal entity. The following would qualify as separate legal entities, each subject to the $500,000 limit: your individual account, your trust, your IRA, your spouse’s individual account, trust and IRA, your joint account, as well as a custodial account for a child. Two IRA accounts held by the same client would be considered one legal entity and thus are combined for purposes of insurance coverage. The same combination occurs when a single client holds two individual taxable accounts.

Not all asset types are covered by SIPC. Among the assets typically not eligible for SIPC protection are commodity futures contracts, precious metals, as well as investment contracts (such as limited partnerships) and some fixed annuity contracts. However, Wealthfront does not purchase non eligible assets for its clients and thus all of your Wealthfront assets are protected. See http://wwww.sipc.org for more information about SIPC.

If a broker fails, most (if not all) of the securities (stocks, bonds, ETFs, etc.) will be returned to the clients. After the broker’s client assets have been distributed, SIPC steps in to replace only eligible securities and cash that are missing. Wealthfront typically only keeps enough cash on hand in your account to pay your advisory fees for one year (approximately 0.25%). Even on a $5 million account, that translates to only $12,500, which is well under the $250,000 cash protection provided by the SIPC.

To illustrate a typical SIPC liquidation on a $5 million dollar client account:

Assume a brokerage firm fails, resulting in $5 billion of client claims on assets.
Assume $500 million in client assets are missing.
Assume a historically low recovery rate of assets in liquidation of 90 percent (the actual historical recovery rate is 98.7%) or $4.5 billion.
In a client proceeding, a client holding $5 million in SIPC eligible assets would receive $4.5 million from recovered assets and $500,000 from SIPC. The loss on a $5 million client account would be zero.
SIPC reports that 99.7 percent of eligible investors have been made whole in the 324 cases of failed brokerage firms that it has handled since its founding 42 years ago. Of the more than 625,200 individual entity claims completed or substantially completed cases as of December 31, 2011, 351 remained unsatisfied for claims of cash and securities whose value was greater than the limits of protection afforded by SIPC. These claims total $47.2 million and represent less than 0.06% of all claims made. The remaining claims in excess of SIPC limits are understood to be claims that were filed by clients of broker-dealers that did not carry excess coverage.

Over its history, SIPC has paid out a total $1.47 billon to settle client claims that exceeded assets recovered during a liquidation proceeding. This represents only 1.3% of all assets claimed during such liquidations. In other words, 98.7% of client assets have been recovered historically through the SIPC liquidation proceedings. (Source: 2011 SIPC Annual Report)

Additional coverage

Because of the limits on SIPC, many large brokerage firms purchase so-called “excess of SIPC” insurance products, which insure their clients for any losses in client property above and beyond the distributions they would receive in a liquidation proceeding, including advances from SIPC. In other words, this insurance is only paid out when all distributions from the SIPC liquidation are insufficient to satisfy a client’s claim in full. Claims for excess of SIPC insurance have been extremely rare. In fact, to our knowledge there are only 2 such known cases, put together both cases totaled less than $1 million in claimed assets.

Wealthfront provides its brokerage clients with additional “excess of SIPC” coverage from Lloyd’s of London offered through Apex Clearing. The policy provides in aggregate up to $150 million in excess of SIPC coverage, subject to maximum limits of $37.5 million for any one customer’s securities and $900,000 for any one customer’s cash. This excess of SIPC coverage would only be used if SIPC coverage were exhausted.

To illustrate how excess of SIPC works on a $6 million client account:

As per our previous example, assume a historically low recovery rate of 90 percent (again, the actual historical recovery rate is 98.7%) on client assets in an SIPC liquidation.
A client with a $6 million account would receive $5.4 million from recovered assets and $500,000 from SIPC. The $100,000 balance would be covered by excess SIPC.
Everything is held in ‘Street Name’

Both SIPC and Excess of SIPC coverage are limited to securities held in street name in a brokerage account. Securities held by clients in “street name” are kept securely with the Depository Trust Company (DTC), separate and distinct from the assets of the securities firms. Regulated by the SEC and the Federal Reserve, the depository is a national clearinghouse for settling trades and a custodian of securities. All ETFs purchased by Wealthfront are held in street name at DTC. Neither SIPC nor the additional coverage protects against loss of market value of the securities.

No Proprietary Trading

Proprietary trading is the practice of a brokerage firm trading in the marketplace using its own capital. When a firm makes a bad bet in the market and doesn’t have the capital to pay for the losses, the firm either must declare bankruptcy or commit fraud and use client assets that were supposed to be segregated. MF Global, the eighth largest bankruptcy in U.S. history, was such an example. Fortunately even the clients of MF Global did not lose any capital.

Our clearing partner, Apex Clearing, does not participate in proprietary trading for its own account, which we view as a significant risk mitigator.

No rehypothecation

When you invest with Wealthfront, your assets are held in a cash account. A cash account assures you that your assets are fully paid for and may not be rehypothecated (loaned out to other clients). This is in contrast to opening a margin account. In a margin account you agree to loan out the securities you hold in the account as collateral to other broker/dealers. The securities are usually loaned to other broker/dealers for delivery by their customer accounts to settle a short sale. A short sale is when you sell what you don’t own at one price, with the hope of buying it back at a lower price and pocketing the difference. Your broker/dealer will borrow shares you’ve sold short from another broker/dealer’s margin account and deliver those shares to the buyer. When you cover the short and buy the shares back, those shares are delivered to the original lending broker and placed back in the customer’s margin account.

Problems can arise for margin account clients when their stock leaves the broker/dealers custody. That’s because, if the lending broker/dealer fails, the borrowing broker/dealer may be unwilling to return the shares (even when the short is covered) until its own counter-claims against the failed broker/dealer are settled. Margin account customers whose shares have been lent out become unsecured creditors of the failed firm. If the margin account client must sell those shares to meet a margin call, it can’t be done—the securities aren’t in the account. The only way to avoid this scenario is to limit the number of securities in your margin account or to not have a margin account altogether. Doing so makes those securities unavailable to the broker/dealers stock loan department to loan out.