Vital Information you need to consider TODAY

Last week yet another large clearing firm, Penson, shook the markets when its stock dropped in half in one day. One if its Board members had to resign and you can be sure there will be months of On The Records (OTR’s) trying to figure out exactly who knew what and when did they know it. Today the Wall Street Journal’s Josh Brown wrote an interesting column titled “Your Custodian and You”. He explored what is covered by FDIC and SIPC and why he likes to be covered but he never touched upon the effect on the actual brokerage firms and their brokers. As someone with over 15 years of clearing experience I thought I would share this with our loyal readers and advise them that your firm and your brokers could be in peril unless you are careful. I’ve decided to steal and reverse one of my favorite lines of the last ten years and state “Assertions and Facts”

ASSERTION: “My firm will be safe because my clearing firm has excess SIPC of 50 Million so I feel pretty safe”
FACT: That policy is worth about as much as the paper it’s printed on. In most cases it’s only for individual accounts and only for SECURITY positions not cash. One last thing to remember is that SIPC works about as efficiently as our US Postal service. SIPC came into Madoff in 2008…to date less then 2000 customers have received benefits.

ASSERTION: “I own all these accounts and if ABC Clearing fails I will just move all my accounts over to XYZ Clearing.”
FACT: Read your membership agreement with FINRA and your clearing agreement fine print again. The clearing firm in fact owns the accounts and allows you basically to work them. More importantly, if a firm goes into SIPC, the Trustee appointed has the right to accept bids from other clearing firms and force all the accounts to not only switch clearing firms but they usually have to agree to sign a three to five year agreement. I’ve heard many a client moan because they had to go back to a clearing firm they had already left and despised.

ASSERTION: “ SIPC will cover my settlement and Clearing Deposit account if the Clearing Firm goes under”
FACT: Your settlement account is not covered under SIPC and neither is your Deposit account. I have clients that lost any where from $50 to $350,000 in settlement account money because quite frankly the SIPC trustee needed the funds to help pay his legal bill. In another case the SIPC trustee paid out the clearing deposit account but put a 30% haircut on it. Remember this one fact: The SIPC trustee in the Madoff case has billed 2 million per week in legal fees to oversee the process. Your settlement account can be a prime source of legal fees in the event something happened.

ASSERTION: “ Even if I go to another clearing firm, I still have a contract and they have to honor my prices and services”
FACT: Not true. I’ve seen firms not only have to pay more but actually after a few months be told by the new clearing firm that they have 30 days to find a new home.

ASSERTION: “I’m a Broker so if my firm goes under I can just move my book to another firm”
FACT: Nothing can be further from the truth. If your firm goes under (say for argument sake Gunn Allen) the clearing firm receives a notice from a Regulator, SIPC or both that the firm is under. In order to make sure the clients keep getting served, the clearing firm will either re-assign the accounts to a firm in good standing or will force all of your clients to call in their orders directly to the clearing firm trade desk…oh yeah…and all your electronic access to your clients is taken away. You can of course manually ACAT the accounts though.

ASSERTION: “My clearing firm can’t just arbitrarily impose restrictions on my firm or take away access”
FACT: Oh hell yes they can! I have a client that was told to leave a prominent clearing firm because they didn’t like the type of business he was doing and felt it was a risk. They gave him 30 days to find a new clearing firm. When he wasn’t able to get a new deal by the deadline the clearing firm took away all his access and in order to ‘better serve” the needs of the clients, they reassigned over 600 accounts to their own brokerage arm. He began a lawsuit for breach and fraud and everything else but the suit was quickly dropped because the fine print in the clearing agreement not only allows for these actions but also indemnifies the clearing firm.

We do a lot of consulting at BD Exchange to firms and to OSJ’s of larger firms looking to move or form their firm. I won’t divulge the names of some of these firms , but I cannot begin to tell you how many times I’ve heard from owners that “ our clearing firm is working with us and told us to just buy a new firm and they will work with us”. Sure they will. As long as you do that before the notice comes from the regulators that you are net capped out of business. All of the sudden the clearing firm realizes it essentially owns 20,000 accounts and can do with them as they please. Often times, they will assign them to their best correspondent, usually in exchange for a 3 year extension on their current deal. Other times they will simply beef up their own private brokerage division and hand over all the accounts to their own brokers.

If you think I’m being hard on Clearing firms and casting them in a bad light, I am. Bare in mind however that I have done most, if not all of these same exact things. I once issued a 30 day notice to a firm out of NY that was driving me and my staff nuts. About a week later he came back and said he needed more time because he was having a hard time finding a new firm. I told him to take his time and find the right fit but in the meantime in 30 days the 4000 customer accounts were going to be reassigned to his rival b/d in the same neighborhood. Draconian for sure, but perfectly legal under all the terms of the clearing agreement. On a side note, I finally relented and he became much friendlier to the staff after that.

In closing I will leave you with some simple steps you should always have ready in your game plan:
• If your clearing firm appears to be having Financial trouble, DO NOT WAIT, start looking and see if you have permission to dual clear. I repeat: once SIPC comes in you are screwed and may have no control.
• If you are feeling uneasy about their financial situation, demand that all settlement monies be distributed weekly. Do not let large amounts accrue there for up to 45 days.
• Try to have your clearing deposit invested in a Treasury bond instead of sitting in cash. You may have to take a small haircut, however it’s a little dicier for a trustee to liquidate a bond and confiscate the cash then it is if there is just a cash balance to sweep over. He would have to fill out an order ticket and give specific trade instructions. Most will not do that.

For individual brokers and Branch offices remember these points and take these steps if you fear your firm will be closed:
• Once your firm is closed, the clearing firm now owns your accounts. Do not forget that or kid yourself into believing differently. If you are going to move to another firm or start/buy your own you must be ready to move quickly and be up and running and be transferring accounts over BEFORE the shut off notice hits the clearing firm. You may not be able to move all your accounts or all of your brokers but it sure beats sitting on the outside looking in while some other broker works your accounts.

We are not telling you to panic but to be prepared and to think outside the box. We welcome your comments and if we can help in any way please feel free to contact me directly at JOHN @BDexchange.com