June 17, 2008
Are Brokerage Assets Really Safe?
(c)
copyright, View from Silicon Valley, 2008. All rights reserved.
Are brokerage assets really safe?
This question was bouncing around in that dark cave I sometimes call a brain when I came across the an article in Barron's
last Christmas: "If Your Broker Goes Belly Up: Part II"
http://www.investorbrain.com/index.php/logicalblocks/C3/P9/
It took some time but the author eventually came back to me with a link to Part I:
http://www.investorbrain.com/index.php/logicalblocks/are_you_covered_if_your_broker_fails/
These articles laid out the process for recovering assets if your broker fails but there was precious
little detail on how or why a broker might actually fail. Most importantly, there was zero info how in the world a mainstream,
reputable broker could fail in the first place. How could my assets ever become "lost?"
We also recommend, by
the same author:
"What Online Brokers Are Doing To Keep Their Customers' Accounts Safe"
(http://www.investorbrain.com/index.php/logicalblocks/C3/P3/ ).
This is useful but not strictly on-point to my broker-safety question.
My questions remained,
1)
"How could a reputable, mainstream broker actually go bankrupt?"
2) How does a broker ever actually "lose" assets?
I
started asking around. I emphasized I was NOT looking for investment recommendations! Rather, I was
interested in the best /safest way to hold assets.
The e-mail went something like this:
* * * *
Most
folks understand FDIC /FSLIC ($100K limit) on their banks. They may soon start to learn more about SIPC ($500K assets,
including $100K cash, limit per person, not per account) and FINRA for their brokers. Since SIPC is not federally-guaranteed,
it seems to me that there should be some question about it's actual value in the event of a system-wide meltdown. Several
brokers carry supplemental insurance from firms such as Lloyd's of London but, again, what is the value of such coverage if
everything fails?
For those with assets >$500K, what is the real risk of a mainstream, reputable broker going under
AND "losing" your assets? Even when Bear Sterns was going under, it was widely claimed their customers' brokerage assets
were never in any danger. (Similar question, with safety not-so-widely-claimed, when E-Trade announced huge losses
on mortgages and there was a "run" on them for a few weeks.)
One solution is to break up holding's across different
brokerages. I've done some of this, but it is painful to maintain records & track portfolio diversification /performance
(no to the complexity of new ID/password combinations and tax reporting!) across multiple brokers. (Granted, accounting
for lost assets would be more painful.)
Another solution is to hold the actual stock certificates in a safety deposit
box. The risk of me losing papers seems higher than a brokerage going under, but I've seen several recommendations to
this effect.
Asking around seems to hint there is also some risk at brokers' clearing houses. Theoretically,
if you have funds in transit across a clearing house when it goes under, they may be "lost." Therefore, in addition
to breaking up your holdings across brokers, it may be appropriate to make sure your various brokers use different clearing
houses.
I've heard some suggest that if your broker goes under, the worst that happens is you may not have access to
your cash /stocks /mutual funds until the bankruptcy is discharged (or at least your accounts are assigned to a solvent broker).
Stated
in perhaps a catchier way, where does Warren Buffet hold his assets? Who does George Soros use? Or Carl Icahn?
Where does Larry Ellison keep his money?
* * * * *
A short list of who we asked this question (and their
response, if any) included:
+Theresa Carey (the Barrons author, basically said to read her article --duh!)
+Jim Sinclair
(his standard advise is "hold paper stock certificates" --my broker charges $50 /certificate)
+Bob Bronson ("we don't give
investment advice")
+Bob Hoye ("we can't recommend brokers")
+John Mauldin (no response)
+Martin Weiss ("we no longer
rate brokers for safety or solvency", sold biz in 2004 to theStreet.com)
+theStreet.com ("we do not rate the brokers any
longer")
+Motley Fool wrote, "Protect Yourself Against Financial Wipeouts" (no response)
There are dozens more well-known
pundits to ask, not to mention a couple-hundred finance folks' e-mails accumulated over the years. However, based on
the repeated non-responses, I decided to quit trying to perfect the "strategy" end of this issue and act based on what was
known.
I settled for opening new accounts at three different brokerages. The paperwork was annoying
but not terrible. (Note to Vanguard: A notarized signature should be enough. Asking for a "medallion" signature
is asking customers to put their funds elsewhere.)
Conclusion:
At the end of the day, we
decided assets stored at a reputable, mainstream brokerage house are "probably" safe. Do we know for sure? Not
really.
Our strategy based on this expectation was to shift assets so that no single account
exceeds the SIPC limit. We keep enough money in each of the brokerages so that the funds in any
one, if liquidated to cash, could carry us for something on the order of a year.
Only you can decide if something similar helps you sleep better at night. (Assuming you ever
wondered about this issue in the first place.
The mathematically-inclined among our readers might ask why we don't just go out and buy a house
with these funds? That's the point where we remind readers to discount total income by ~45% to account for
federal, state, social security and Medicare taxes. Then note the average house in our zip code sold for nearly
20x this net figure last month. Hmmm...
* * * *
Post-script:
BTW, shifting assets to different brokers
from where you bought them might come in handy some day if another new rule comes to pass:
"New Tools for New Cost-Basis Reports"
IT WON’T BE LONG BEFORE CONGRESS MANDATES
THAT YOUR BROKER tell the Internal Revenue Service the exact cost basis of securities you’ve sold.
http://www.investorbrain.com/index.php/logicalblocks/C3/P0/
We accurately account for our cost basis and pay all taxes on asset sales every year. We strongly
advocate everyone else do the same.
At the same time, we disapprove of giving the government access to more data than
is strictly needed. If you imagine the government will never start using this data to look over your shoulders and maybe
audit because they "think" there's a problem, then you trust government bureaucracy waaaaay more then we do.
