As if it's not enough to be worried about the state of your portfolio, the economic crisis is making investors worried about what happens if a stockbroker goes bust. In particular, customers of stockbrokers place great trust in the broker when depositing their cash or their portfolio in one of the broker's accounts. But there is also the question of what happens to your investments in nominee accounts if the broker goes bust.
Investors' Chronicle readers, particularly those who have sold shares and retreated to cash, are becoming increasingly worried that their trading accounts are safe.
One IC reader writes: "I am a small shareholder having about half of our life savings in individual savings account (Isa) share accounts. In view of the current banking situation, where do I stand if any of these nominee accounts' trustees fail? Are the underlying shares element still mine and what about any cash in the account? I understand share values fluctuate and we could lose money but I do not expect to lose if the nominee fails?"
"Relax, your savings should be fine," says Jason Butler, a chartered financial planner at Bloomsbury Financial Planning. This is because assets held by a nominee account are legally separate from those of the trading company which administers the nominee account, and as such cannot be taken into account as an asset of the company if it goes bust or into administration.
"The nominee is usually a limited company which has been formed solely for the purposes of owning the assets on behalf of investors," he explains. "You still own the assets, but they are 'beneficially held' for you by the nominee company. In the event of the failure of the management company, the nominee company would be transferred to the control of another administrator and your assets would remain in place."
There are also very strict controls and procedures which nominee accounts must operate within. "For retail investors using nominee accounts your assets cannot be pledged or used as collateral by the management company in its own trading activities, without your express consent," says Mr Butler.
Bureaucratic hurdles
This doesn't, however, mean retrieving your assets would be a smooth process if your stockbroker went bust. The UK Shareholders' Association has often raised the dangers of holding shares in nominee accounts as opposed to having the shares registered in your own name.
When Pacific Continental Securities (PCS), a firm which specialised in promoting smaller companies, went into administration in June 2007, customers with shares in the nominee account found themselves at the mercy of the administrators' bureaucratic process. The administrator had to establish that they were the rightful owners of the assets and reconcile the total claims of all the former PCS clients to the holdings on the share registers of the companies in which PCS has invested on their behalf. In effect, shareholders could not obtain full title to the shares or sell them for several months.
But it is often difficult to find a broker who allows direct registration, and if you are investing in tax wrapper such as an Isa or self-invested personal pension (Sipp), then the nominee account is your only option.
Faced with this economic crisis, it makes sense to double check your broker is authorised by the Financial Services Authority (FSA) and also to check where your broker holds cash on your behalf.
The official position on nominees
Here is what the Financial Services Compensation Scheme (FSCS) has to say about investments held by nominee companies:
"Nominee companies are covered if an authorised investment firm has accepted responsibility for their losses. If not, we will pay compensation only if the nominee firm is authorised by the Financial Services Authority. You can check this be using the FSA's Firm Check service at www.fsa.gov.uk or by phoning the FSA Consumer helpline on 0845 606 1234."
The FSCS covers deposits (which it defines as "money placed in a bank or similar institution to earn interest of for safe-keeping") up to £50,000 per person. It also covers investments, which it defines as "a financial product in which money can be invested to earn interest or profit (although the value of investments can go down as well as up)" up to £48,000 per person (100 per cent of the first £30,000 and 90 per cent of the next £20,000). The investment compensation is mainly intended to pay out if consumers suffer detriment as a result of bad financial advice. However, if an authorised firm is declared in default and you lose money as a result, this could be a useful safeguard.
For investors who hold cash in their shares Isa, the FSCS says that cash will be treated as if it were held in a deposit account, and that the wrapper is not important. Francesca Pattison of the FSCS says: "Any cash held as part of such an ISA would be covered by the deposit limit of £50,000, unless the money was only being held temporarily pending investment into an investment product. In that situation, the investment limit of £48,000 would apply." However, she added that, in practice, any cash held in a shares Isa at the time of the bank going bust would simply be made under the deposit scheme (£50,000 limit) while the portion invested in shares would be claimed under the investment scheme (£48,000 limit).
Soothing noises
Stockbrokers are lining up to reassure their customers that their money is safe. TD Waterhouse chief executive officer Angus Rigby says: "In the case of TD Waterhouse, our customers should remain confident that their assets and bank deposits with us are safe and secure. We are backed by the financial strength of the TD Bank Financial Group (TDBFG), one of the largest financial institutions in North America with an employee base of 74,000 in offices around the world.
"TDBFG is very well capitalised with assets of C$509bn. Crucially, it is one of the only banks in the world to avoid write-downs due to the US sub-prime mortgage market and has an AAA rating from Moody's, the highest rating available. Although the impact of developments in the US are being felt to some extent all over the world, the Canadian financial services sector, and TDBFG in particular, remains well positioned."
Hargreaves Lansdown states: "Except where clients have chosen specific fixed-rate deals, client money within the Vantage Service is currently held across the five major clearing banks - Barclays, HBOS, HSBC, Lloyds and RBS. Our current policy confines us to the five main British clearing banks because we believe that it is highly unlikely that the British government will allow any of the key clearing banks to fail and default on depositors. We currently hold no cash with foreign banks or their British subsidiaries."
Hargreaves Lansdown says its policy of spreading cash between five institutions means clients can receive up to five times the normal level of protection.
But the bottom line is that if you are holding more than £50,000 on deposit with a stockbroker, you are not covered for the surplus if the organisation (bank or broker) with which this money is deposited goes bust.
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