Are customer accounts at brokerage firms safe?

[Ad Orientem]

A Risk Once Unthinkable
By JAMES B. STEWART
Published: December 9, 2011

Are customer accounts at brokerage firms safe?

Until the collapse of MF Global, that’s a question I thought I’d never have to ask.

Brokerage firms are required by law to maintain segregated accounts holding all client assets, including stocks, bonds, mutual funds, money market funds and cash. The law was passed after the 1929 crash, in the depths of the Depression, to make sure that customer assets were there at all times, ready to be disbursed even if everyone asked for their money at once.

This obligation to protect customer assets “is considered sacrosanct,”? Robert Cook, director of the division of trading and markets at the Securities and Exchange Commission, told me this week. “It’s considered a sacred obligation.”?

Lehman Brothers may have engaged in many foolhardy practices, but even in the firm’s last days, when officials were desperate for cash, no one dared touch customer assets, which remained safely segregated despite the firm’s collapse.

And then came the revelation that an estimated $1.2 billion in customer assets had vanished at MF Global, the large brokerage and futures trading firm headed by Jon S. Corzine, the former Goldman Sachs executive and Democratic politician, that collapsed in late October after a catastrophic bet on European sovereign debt.

How could such a thing happen? I had always assumed it was impossible and that strict internal controls existed at all brokerage firms so that firm officials couldn’t tap segregated customer funds even if they were willing to break the law. Thanks to MF Global, it’s now apparent that isn’t necessarily true. “If people are determined to misuse customer funds, they will misuse them,”? said Ananda Radhakrishnan, the director of the division of clearing and risk at the Commodities Futures Trading Commission.

Read the rest here.

[craigr]

Rule #10:

http://gyroscopicinvesting.com/forum/ht ... ic.php?t=1

Diversification

Rule #10: Don’t depend on any one investment, institution, or person for your safety.

Every investment has its time in the sun — and its moment of shame. Precious metals ruled the roost in the 1970s while stocks and bonds were in disgrace. But then gold and silver became the losers of the 1980s and 1990s, while stocks and bonds multiplied their value. No one investment is good for all times. Even Treasury bills can lose real value during times of inflation.

And you can’t rely on any single institution to protect your wealth for you. Old-line banks have failed and pension funds have folded. The company you think will keep your wealth safe might not be there when you’re ready to withdraw your life savings.

We live in an uncertain world, and surprises are the norm. You shouldn’t risk the chance that a single surprise will wipe out a large part of your holdings.

(emphasis added)

I strongly advocate not keeping all your investments at one investment company and to not use all the funds from a single provider. It's best to split the assets up in case something very bad were to happen with your brokerage or the company running the funds.

[melveyr]

Here is what I am going to be moving towards...

-Fidelity: Long Term Treasuries (they trade for "free")

-Vanguard: Total Market Stock Fund (pretty damn close to free)

-Treasury Direct: (I bonds, savings bonds, and T-bills)

-Physically held gold in various locations

What's great is that diversifying away some of the counter party risk actually helps reduce expenses. Vanguard is the cheapest option for stocks, Fidelity is the cheapest for bonds, and Treasury direct is the only place for juiced up risk free cash equivalents such as I-bonds and Savings bonds.

The PP can get pretty sophisticated once you get settled  8) We all get the urge to tinker, and I think tinkering to reduce counter-party risk is a very fruitful outlet for us.  ;D

[Tyler]

I understand the risk benefit of direct treasuries and physical gold, but hypothetically speaking, what would be the best combination of four ETFs to maximize diversity of the underlying companies?  Here's my first thought:

VTI - vanguard
TLT - ishares
SCHO - schwab
GLD - SPDR

Based on what I've read, I have the biggest problem with GLD as it seems to have more risk and higher costs than IAU.

Any other recommendations?

[l82start]

i switched from GLD to GTU when the premiums had a big dip and were in the investors favor.
GTU may be a little bit safer than the gold ETFs based on how they hold and count their gold, whether the extra safety is enough to justify "?" premium or the additional paperwork if held in taxable accounts could probably be debated, (i only hold a small amount in tax advantaged for re-balancing  purposes)

[Ad Orientem]

I understand the risk benefit of direct treasuries and physical gold, but hypothetically speaking, what would be the best combination of four ETFs to maximize diversity of the underlying companies?  Here's my first thought:

VTI - vanguard
TLT - ishares
SCHO - schwab
GLD - SPDR

Based on what I've read, I have the biggest problem with GLD as it seems to have more risk and higher costs than IAU.

Any other recommendations?

Tyler,
First a belated welcome to the forum.  I don't really have any major heartburn over your choice of funds.  That said I do agree with your observations regarding the shortcomings in GLD.  It's a tad expensive and their prospectus looks like it was written by lawyers with the intent of covering their clients ass rather than explaining in plain language how the fund works.  For those two reasons I would eschew it in favor of IAU or ideally physical.  I am not a fan of closed ended funds because the premium can bite in both directions.

SCHO is IMO OK for near cash.  But I notice that they are allowed up to 10% in non-Treasury securities.  SHY by contrast can only do that with 5%.  But then you are back to diversification among fund managers.  In the end you pays your money and takes your chances as the old Brooklyn bookie used to say. 

[Kel]

I added some posts under the variable portfolio on this subject and one of issues that is being brought up regarding MF Global is that since it is international there may be loopholes between what is legal in the UK and US and they even pointed out some interesting notes in the MF Global contractual agreement regarding how client assets could be used. So it may be worth revisting some of the fine print.... here is the article:

http://newsandinsight.thomsonreuters.co ... n_scandal/

Also somewhere i saw that there MAY be a 2005 bankruptcy "reform" law that placed derivative claims in front of depositors in a business failure - including a bank failure. Not sure about that one as yet.