Security segregation
Security segregation or client funds, in the context of the securities industry, refers to regulatory rules requiring that customer assets held by a financial institution be held separate from assets of the brokerage firm itself in a segregated account and that there is no commingling.
Thus, for example, in the United States the law generally requires that a broker must take steps to hold separately, in separate to limit the broker's use of customer securities to support the broker's own business activities; and b) to facilitate the prompt return of customer securities in the event of the broker's insolvency. In many jurisdictions segregated accounts cannot be used to pay creditors during a broker's liquidation and must be returned to the customers directly.
This securities segregation requirement was developed due to problems in the U.S. stock markets towards the end of the 1960s. At the time, there was not any requirement that brokers segregate client securities from the firm's own assets on the firm's books and records. When brokers went bankrupt, therefore, they were unable to return securities to their clients, inasmuch as they had not maintained accurate books and records of their clients' holdings.
In the crisis of the late 1960s, a good portion of the net worth of brokerage houses was held in highly speculative common stocks which were owned by individual partners. When the bear market occurred, alongside contraction of these speculative common stock quotations, the net worth of these brokerage firms declined drastically hence leading to bankruptcy. The partners were speculating with clients' capital which was meant to protect them against financial hazards.