A segregated account is a financial account that legally keeps money or assets belonging to clients separate from the operating funds of the institution holding them. Broker-dealers, futures firms, insurance companies, attorneys, and escrow agents all use segregated accounts so that if the institution fails or goes bankrupt, client assets stay protected and available for return rather than being pulled into the firm’s estate. The specific rules differ by industry, but the underlying principle is the same: the money is yours, and the firm’s creditors have no claim on it.
How the Protection Works
When a firm holds money that belongs to someone else, regulators prohibit “commingling,” which is the mixing of client funds with the firm’s own capital. The firm has to create a distinct account, keep separate records for it, and treat the assets as belonging to clients rather than to the company. Because those assets never belonged to the firm in the first place, general creditors can’t reach them in a bankruptcy.
The Securities Investor Protection Act, for example, defines “customer property” to include cash and securities held by a broker-dealer from customer accounts, along with any proceeds from transfers of that property.1Office of the Law Revision Counsel. 15 USC 78lll – Definitions In a broker-dealer liquidation, customer property is distributed to customers before anything goes to general creditors.2Office of the Law Revision Counsel. 15 USC 78fff-2 – Special Provisions of a Liquidation Proceeding The Commodity Futures Trading Commission applies a parallel rule to futures: customer segregated funds “may not be used to meet the obligations of the FCM or any other person, including another customer.”3Futures Industry Association. Protection of Customer Funds Frequently Asked Questions
Segregation is not insurance against bad investments. It doesn’t protect you if your stocks fall. What it protects against is the firm itself failing while holding assets that legally belong to you.
Where You’ll Encounter Segregated Accounts
Brokerage Accounts
The most detailed segregation rules in the United States apply to broker-dealers. SEC Rule 15c3-3, known as the Customer Protection Rule, requires broker-dealers to keep client cash and securities separate from the firm’s own trading and operating assets. For securities, the firm must promptly obtain and maintain physical possession or control of all fully paid securities and excess margin securities in customer accounts. “Control” means holding the securities in an approved location, such as a clearing corporation or a custodian bank that has acknowledged in writing that the securities are free of any lien, so that the firm can return them on demand.4eCFR. 17 CFR 240.15c3-3 – Reserves and Custody of Securities
Cash works differently. The firm calculates a “Customer Reserve Requirement” reflecting the net amount it owes all customers, then deposits cash or qualified securities in that amount into a Special Reserve Bank Account for the Exclusive Benefit of Customers, kept separate from the firm’s other bank accounts.4eCFR. 17 CFR 240.15c3-3 – Reserves and Custody of Securities
Futures and Commodities Accounts
Futures commission merchants must hold customer funds in separate accounts, clearly labeled to identify the money as belonging to customers. The firm must keep enough in those accounts to cover its total obligations to all customers at all times, and it can only deposit those funds with banks, trust companies, derivatives clearing organizations, or other registered futures commission merchants.5eCFR. 17 CFR 1.20 – Futures Customer Funds to Be Segregated and Separately Accounted For Money for foreign futures trading follows CFTC Regulation 30.7, with a broader list of allowable depositories that includes foreign banks with more than $1 billion in regulatory capital and clearing organizations of foreign exchanges.6eCFR. 17 CFR 30.7 – Treatment of Foreign Futures or Foreign Options Secured Amount Before opening a segregated account, the firm must obtain a written acknowledgment from the depository confirming the arrangement.
Insurance Separate Accounts
Life insurance companies use a version of segregation called a “separate account.” It records the assets and liabilities of specific products, most commonly variable annuities and variable life insurance policies, apart from the insurer’s general account.7NAIC. Separate Accounts The general account backs the insurer’s guaranteed obligations; the separate account holds assets whose investment risk the policyholder has chosen to bear.
The key question for a policyholder is whether the separate account is “insulated” under state law. If it is, those assets are legally protected from the claims of the insurer’s general account creditors, so an insolvent insurer’s other debts can’t be paid out of them.7NAIC. Separate Accounts Not every separate account product is insulated, and hybrid products that blend traditional insurance guarantees with separate account portfolios complicate the picture, because the general account may still be on the hook for guarantees allocated to the separate account.
Attorney Trust Accounts
Every state adopts some version of ABA Model Rule 1.15, which requires attorneys to hold client property separately from the lawyer’s own funds. Client money must go into a separate trust account, and the attorney must maintain complete records for at least five years after the representation ends.8American Bar Association. Rule 1.15 – Safekeeping Property Advance fee payments and expense deposits sit in the trust account and can be withdrawn only as fees are earned or expenses incurred.
Small or short-term client deposits that would not generate meaningful interest for any individual client are pooled into an Interest on Lawyers’ Trust Account. The interest earned on the pooled balance flows to state IOLTA programs, and over 90 percent of IOLTA grants go to legal aid offices and pro bono programs.9American Bar Association. Commission on Interest Lawyers’ Trust Accounts Overview
Escrow Accounts
In real estate and business transactions, escrow agents hold funds in segregated accounts pending completion of contractual conditions like a property closing or an asset purchase. The money isn’t the agent’s, and the agent can’t use it for operating expenses or anything other than the transaction it was deposited for. State licensing requirements typically require escrow agents to post a surety bond, adding another layer of protection beyond segregation itself.
What Happens If the Firm Fails
SIPC for Brokerage Accounts
When a broker-dealer becomes insolvent and customer assets are missing despite the segregation rules, the Securities Investor Protection Corporation steps in. SIPC does not cover losses from bad investment decisions; it covers missing customer property when a brokerage fails. Coverage runs up to $500,000 per customer, with a $250,000 sub-limit for cash.10SIPC. What SIPC Protects
SIPC coverage is calculated by “separate capacity,” meaning accounts held in different legal capacities are each protected up to the full limit. An individual account, a joint account, an IRA, and a trust account at the same brokerage would each receive separate coverage.11SIPC. Investors with Multiple Accounts Accounts held in the same capacity are combined for coverage purposes.
FDIC Pass-Through Insurance for Bank Deposits
When client funds sit in a segregated account at an FDIC-insured bank, coverage is not automatic. The FDIC offers “pass-through” insurance, under which each underlying beneficial owner can receive up to $250,000 in coverage, as if they had deposited the money directly. Three conditions must be satisfied: the funds must actually belong to the beneficial owners rather than the third party that set up the account; the bank’s records must indicate the fiduciary or custodial nature of the account; and records maintained by either the bank, the depositing institution, or another party in the normal course of business must identify each beneficial owner and their ownership interest.12FDIC. Pass-Through Deposit Insurance Coverage
If any of those requirements is not met, the coverage collapses. Instead of each client receiving separate coverage, the entire account is insured as a single deposit in the name of the institution that opened it, capped at $250,000 total.12FDIC. Pass-Through Deposit Insurance Coverage For a trust account holding funds for dozens of clients, that would be a serious gap. Proper account titling and recordkeeping are what make the insurance work.
Who Reports the Interest for Taxes
Segregation protects your assets from the firm’s creditors, but it doesn’t change your tax obligations on income those assets produce. The reporting question comes down to who actually owns the funds.
When an escrow agent holds money in a non-fiduciary capacity, the interest belongs to the depositor, and the depositor reports it. The bank will issue a Form 1099-INT to whoever is entitled to the interest if the amount exceeds $10 in a year.13Internal Revenue Service. About Form 1099-INT, Interest Income For IOLTA accounts, the pooled interest goes to the state program, so the individual client has nothing to report because they receive none of it. For brokerage accounts, interest and dividends earned on securities in a segregated account belong to the customer whose account generated them, and the broker-dealer reports those amounts to the IRS and to the customer.
The Limits: Segregation Depends on Compliance
Segregation only works if the firm actually follows the rules. The 2011 failure of MF Global, a major futures commission merchant, showed what happens when it doesn’t. During its final week of operations, MF Global used $1.212 billion in customer segregated funds to prop up its own proprietary trading and the operations of its affiliates. The firm also failed to notify the CFTC when it knew customer accounts were running deficits, and filed false reports concealing the shortfalls. A federal court ultimately ordered MF Global to pay full restitution of $1.212 billion plus a $100 million civil penalty, payable only after customers and priority creditors were made whole.14CFTC. Customers of MF Global Inc. to Begin Receiving Final Restitution Customers eventually recovered their funds, but many waited years.
The rules on paper are only part of the picture. For anyone with money held in a segregated account, the institution’s regulatory history and the strength of its internal controls matter alongside the legal framework itself.