Nominee accounts, ISAs and SIPPs are not safe from the creditors of a bankrupt provider

4th Jun '18 by pka

41 comments 9723 reads

I urge anyone who has a share portfolio in nominee accounts or in an ISA or SIPP (which must by law be held in nominee accounts) to read this thread about the bankruptcy of Beaufort Securities:

https://www.stockopedia.com/content/beaufort-securities-client-campaign-365604/

Rather than being ring-fenced, it seems that such a portfolio is at risk of losing 40% of its value over £50,000 if the provider of the nominee accounts goes bankrupt through no fault of the portfolio owner.

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Pka

Premium Member

41 comments

unwise2

5th Jun '18

What, something like the FSCS?

No. I'm not suggesting a certain sterling amount of investments should be guaranteed, I simply think any client funds (of any size) that are ring fenced should be completely safe if a broker goes bust, isn't that what ring fenced should mean?

If there isn't sufficient assets to pay the liquidators bill the insurance scheme steps in and pays the difference. Investors assets get transferred to another broker with zero haircut.

peterg

5th Jun '18

OK, I admit, I was being slightly flippant. But, it does seem to me that while some sort of insurance of the sort you describe might be nice to have, I also think the situation for the vast majority of those with nominee accounts is not very different under FSCS.

Firstly, FSCS is NOT a guarantee on a "certain sterling amount of investments". It's a guarantee on a certain sterling amount of losses. In practice, with a "normal" broker, one that doesn't have complex holdings with many in unlisted securities that can't just be "transferred to another broker" (as Beaufort was) administration fees should be far lower, well under 5% - so you would need a portfolio of well over £1m to face a risk of loss - which would itself be significantly less again (in % terms) than the administration costs unless you had a multi £m account.

Hence my earlier statement, that you disagreed with, that the key here is that some form of independent control of administration costs should be in place. The initial "estimate" from PWC of 20% was clearly outrageous and intended to make the swinging figure they end up taking seem "reasonable". That sort of practice is outrageous, and needs some form of control (both in relation to nominee accounts, but in general).

A second point is that I am not of the view that investing money with a broker should be assumed to be completely riskless. That is what government bonds are for. We (mostly) accept that buying shares involves risk. Anyone who has considered and discussed nominee investments (as we did endlessly on TMF) will know that there have been exceptional circumstances where nominee holders have lost out when brokers have failed. In some case much worse than Beaufort customers seem likely to. Mostly those have involved some form of malpractice by the broker, or staff. They are rare, and I know of no case where what I would regard as a mainstream broker has been affected. And I choose my brokers on that basis, and would assume anyone else has a responsibility to do the same, just as they do in picking shares.

We also know that holding in certificated form is not risk free. There have been endless cases, for example of solicitors, or others, who have fraudulently misused certificates lodged with them, and I'm pretty sure I've heard of cases where people have persuaded registrars to reissue "lost" certificates to the wrong people. Any Crest holding has to be via a sponsor - who themselves forms another potentially risky link in the chain of ownership.

So yes, I do think the Beaufort case shows up potential for improvement, and I've suggested what I see as most important, but also think the special circumstances of the case and the FSCS mean the risk to the vast majority of nominee investors is very small, and I think anyone who is prepared to do due diligence on shares should not unreasonably be expected to take on a small amount of risk, and perform at least a small amount of due diligence on their brokers.

Peter

jonesj

5th Jun '18

The best answer is not ring fencing, but an electronic share register where consumers directly own the stock.

Then if your broker fails, you can seamlessly sell the stock via a different broker.

Singapore manages it, so why not the UK ?

I have so far written to my MP and the FCA. I urge everyone else to do so.
Also, as we seem to have shambolic regulation that merely prevents & does not protect, why not open a broker account in somewhere like Singapore ? If the UK system is not trustworthy, that is one backup solution.

Lordyjordy

5th Jun '18

I may not be understanding the full details here but my view is this.
I buy a share through a broker, I have paid with my money so the broker does not own it. I do.
They may hold the record/certificate of this transaction and run a website where i can facilitate my dealings which is why they collect the fee they charge. I don't see why I need to insure my holdings in case the broker goes bankrupt, as I said previously they haven't bought the share so any creditors against them should not be able to claim against me. No doubt there are many reasons why this is impossible/naive but if you think about it logically/ethically any deviation from this seems to me to be another attempt of the financial industry to take what is not theirs. It seems to me that all a modern day broker does is basic administration work. Or at least that is all that is necessary for many isa holders. Absolute disgrace!

MiserableJacktPotato

6th Jun '18

@LordyJordy. Spot on.

jonesj

6th Jun '18

As Ray Dalio says: Don't confuse how things should be with how they are. Recognise what is fact and deal with it.

Ring fencing has been shown to be a myth. We need direct ownership of stocks & a campaign is required.

In the meantime, the investor could consider actions to reduce risk, such splitting assets between several brokers & moving some assets to a country where shareholders rights are respected.

cig

6th Jun '18

- If the law is to be changed to guarantee the liquidation costs are not taken from the ring fenced assets, beyond the existing FSCS guarantee (which is pretty reasonable as peterg has explained), who's to pay for these costs?

- "Direct ownership" models are not foolproof either: as long as a broker exists who has authority to issue buy/sell orders on behalf of clients, they can fraudulently sell/trash your holdings before you can do something about it. Broker failures often involves rules being broken at the last minute (though it's apparently not the issue in Beaufort's case).

peterg

6th Jun '18

I don't see why I need to insure my holdings in case the broker goes bankrupt, as I said previously they haven't bought the share so any creditors against them should not be able to claim against me.

You own the shares held in the nominee account. But the broker is providing nominee service which allows you to do so. If the broker goes bust their creditors do not have access to your shares.

However, there will be costs involved in resolving the ownership of the shares in the nominee accounts and transferring them to new brokers. That is a different issue from a broker's creditors having a claim. The administrator is not a creditor, they are effectively working for the owners of the shares , unravelling the issues. Yes, I think those costs should be controlled, and of course the FSCS will cover them in most cases, but it's inevitable that if a broker goes bust there will be disruption and potentially some cost to those with holdings in sorting it out.

As has been said, direct ownership is not risk free either, and in the case of ISAs HMRC, quite rightly, is going to have a raft of regulations and controls to ensure that the system is not misused to avoid tax. I suspect it would be impossible to find a direct ownership solution that satisfied those requirements, quite clearly HMRC don't think so at the moment.

Peter

pka

6th Jun '18

Hi Cig, You wrote: "If the law is to be changed to guarantee the liquidation costs are not taken from the ring fenced assets, beyond the existing FSCS guarantee (which is pretty reasonable as peterg has explained), who's to pay for these costs?"

But is the existing FSCS guarantee reasonable? Most providers of nominee accounts claim in their literature that investments in nominee accounts are safe because they are held in the client's name and are ring-fenced from creditors. The investments do not belong to the provider of the nominee account, they belong to the client. So why should some of the client's investments be used to pay the administrator and creditors in the event that the provider goes bankrupt, through no fault of the client?

Some might argue that this situation is no different from client's money that has been deposited with a bank. In that case, if the bank goes bankrupt, FSCS limits do apply to client's deposits in theory (although in practice the government has always stepped whenever banks have failed in the past to protect the totality of client's deposits in order to maintain the public's faith in the banking system). After all, money in deposit belongs to the client, not the bank, but in theory the money above the FSCS limit could be used to pay the administrator and creditors of a failed bank.

However, there is a fundamental difference between bank deposits and investments in nominee accounts. When someone puts money in a bank or building society, interest is often paid on that money by the bank (although that's not the case with money in most current accounts in recent years as interest rates are so low at present). In order to pay interest on deposits, the bank has to put the client's money that is on deposit to work, either by lending it to other clients of the bank, in the form of mortgages and loans, or investing that money on the markets (in the case of investment banks). People who deposit money with banks implicitly accept that. So if the bank fails, it is not unreasonable for the bank's creditors to have some claim on client's deposits.

But that reasoning does not apply to client's investments held in nominee accounts. The provider of the nominee account does not pay interest on those investments - instead the client usually pays the provider a fee for administering the nominee account. Therefore, in my opinion, FSCS limits should not apply to nominee accounts, because they belong to the clients not to the provider, so no part of any client investments in nominee accounts should be available to pay the administrator or creditors of a provider that goes bankrupt.

cig

6th Jun '18

Nobody is talking about paying creditors to the broker, the ring fencing works for that.

The issue with Beaufort is about who pays for the liquidation, that is staff time for disentangling the records of who owns what within the nominee company's holdings, and executing transfers, which seems particularly tricky in this case but would not for a plain broker handling normal listed shares.

Who should pay for that? If not the punter, it's either the taxpayer at large (who one can argue has more worthy causes to fund) or an industry-wide fund, that is effectively a tax on all investors.

In my view neither solution is fair, because the status quo is adequate for normal brokerages. Maybe people who choose dodgy brokers should face (some) consequences for their failure to do due diligence.

An enhancement maybe is to explain more clearly in product literature that ring fencing is net of liquidation costs, and/or force brokers with unusually hard to liquidate nominee companies to disclose the fact or split listed vs. unlisted investments in separate nominee companies.

Lordyjordy

6th Jun '18

@PeterG
Ok it seems I misunderstood the finer details. I find your comment below interesting

"However, there will be costs involved in resolving the ownership of the shares in the nominee accounts and transferring them to new brokers. That is a different issue from a broker's creditors having a claim. The administrator is not a creditor, they are effectively working for the owners of the shares , unravelling the issues."

Should the ownership of the shares not be a simple administration exercise, surely it's a simple task to record the transaction and the name of the owner, is that not what a broker is paid for? How can this cost up to 40% of the value of the holding to find out who actually bought it?
I would like to point out this is a question and not an attempt to disagree with what you say.

xcity

6th Jun '18

The costs of dealing with the holdings after such a bankruptcy will be proportionate to the efficiency of the broker's admin systems. I take care to avoid (& move away from) brokers where their back office competence seems questionable. There have been previous problems with brokers with low quality systems going bust, and trying then to work out who the beneficial owners are of the holdings in the ring-fenced accounts. Sometimes there has been enough to go round, sometimes not.
The lesson I learned was about choice of broker, not about the need for insurance that would have to be paid by customers of all brokers. Don't see why I should have been paying anything towards the costs of people who chose to use Beaufort, although I have every sympathy with their plight and agree that something needs to be done about PWC and the behaviour of auditing companies in general.

pka

6th Jun '18

Hi Cig,

Thanks for your reply to my post, in which you wrote: "Nobody is talking about paying creditors to the broker, the ring fencing works for that. The issue with Beaufort is about who pays for the liquidation, that is staff time for disentangling the records of who owns what within the nominee company's holdings, and executing transfers, which seems particularly tricky in this case but would not for a plain broker handling normal listed shares."

If you're correct, that's reassuring. My wife and I have ISAs and SIPPs in nominee accounts with Alliance Trust Savings, which is a subsidiary of the large Alliance investment trust . Our ISA and SIPP investments are all in listed stocks, listed investment trusts and funds from large British providers. From what you wrote, in the event that Alliance Trust Savings goes bankrupt, our ISA and SIPP investments with them would probably be safe. That is not what I had understood from the Sunday Times article.

bwakem

6th Jun '18

Should the ownership of the shares not be a simple administration exercise, surely it's a simple task to record the transaction and the name of the owner, is that not what a broker is paid for? How can this cost up to 40% of the value of the holding to find out who actually bought it?

Obviously the charges are obscene (possibly criminal IMO) and the regulator doesn't care. One complication though may be that Beaufort most likely lent a lot of the stock out to shorters.

peterg

6th Jun '18

Well it can't! In fact PWC in their wildest wet dreams only came up with 20%, which they've now cut to 10%.

But it's also critical to realise that Beaufort was not a vanilla broker of the type most of us use. They had a lot of customers holding unlisted securities - I'm not exactly sure of the history, but my understanding is that it was something they offered to clients, rather than just having a few securities which they held onto after delisting. Those are very complex and expensive to deal with. You can't just reregister them, you basically have to sell them - which can be almost impossible, and will in many cases means they effectively have no value. So Beaufort will have exceptionally high administration costs. Most brokers that anyone here is likely to use won't hold unlisted stocks.

But that is no reason for costs to be plucked from the air, as PWC seem to have done. Which is why I've argued here that there needs to be some form of external verification of administration charges. I don't have a problem with investors having to pay a reasonable price to have their holdings sorted and reassigned after a broker collapse - that seems entirely reasonable. However, they should not end up covering the administration costs of the brokerage itself, in so far as those can be separated. Nominee holders should only be getting charged for the sorting out and reregistering of the holdings themsaelves.

For most vanilla brokerages those costs should be, as you suggest, small - much smaller than the 10% PWC are currently estimating for Beaufort.

Peter

Lordyjordy

6th Jun '18

Peter

Thanks for taking the time to reply

I got the 40% from PKA's main thread above.......

Maybe the brokers should be told to hold a certain amount in reserve so they can deal with the transfers in the event they go into liquidation?

cheers

pka

6th Jun '18

Hi Lordyjordy,

You wrote: "I got the 40% from PKA's main thread above......."

40% is the maximum amount that can be taken by an administrator from a client's investments in nominee accounts, according to the articles that I've read on this issue, such as:

https://www.thetimes.co.uk/edition/money/i-thought-my-cash-was-safe-i-feel-betrayed-t3bds3qdg

https://www.sharesoc.org/campaigns/beaufort-client-campaign/

pka

6th Jun '18

I have now watched this ShareSoc presentation on the Beaufort Client Campaign:

http://www.piworld.co.uk/2018/05/19/sharesoc-beaufort-securities-client-campaign/

I should have watched it before starting this thread, but never mind.

It seems from this presentation that assets in nominee accounts ARE protected by ring-fencing from the creditors of a bankrupt provider. However they are NOT protected from the administrators, due to an apparent loophole in British law that was introduced at the time of the Credit Crunch. The figure of 40% was the amount that PWC, the administrator of the failed broker, Beaufort Securities, had initially quoted as an upper limit on the amount that it might take from clients' assets in nominee accounts with Beaufort. That 40% figure has probably been revised downwards since the time that presentation was made, because PWC has reduced its estimate of its total fees down from £100 million to a still extortionate £55 million. My guess now is that there is no legal maximum to the percentage of clients' assets in nominee accounts that could be taken by an administrator.

cig

7th Jun '18

As far as I understand, the bankruptcy court ultimately approves the fees so there's some amount of check and balances. Presumably if it's really extortionate, the court can appoint another, less extortionate, liquidator.

At bankruptcy lawyer rates 55m is probably just 20 people for a year or two, which is not implausible to disentangle a bunch of presumably paper/scattered spreadsheets records, and have to chase each unlisted holding with lawyer-intensive processes.

Also if the accusations of illegal pump and dumps schemes and various money laundering schemes are true, it will get quite tricky: for example, how do you distinguish "proceeds of crime" holdings from regular ones?

As a reference the Madoff liquidation, which similarly involves disentangling a dodgy broker's records, cost US$ 1580m so far:

http://www.madofftrustee.com/recovery-chart-fees-34.html

All this would all be so much simpler with blockchain tech: you lose your key you lose your holdings simple no lawyers or accountant involved :-).

pka

9th Jun '18

ShareSoc has a suggested letter to your MP about this issue here:

https://www.sharesoc.org/sharesoc-news/act-now-to-protect-your-assets/

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Nominee accounts, ISAs and SIPPs are not safe from the creditors of a bankrupt provider

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Pka

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