How Broker Bankruptcy Can Affect Investor Funds

When newcomers come to the stock market, they often ask: “Will my funds be safe? If the broker goes bankrupt, will my securities and money in the brokerage account disappear?” Usually, more experienced investors respond that there is nothing to worry about: client funds (both paper and money) are kept separate from the broker’s assets, and, in case of a problem, client funds cannot be levied.

How Broker Bankruptcy Can Affect Investor Funds

For the most part, this is true. Clients’ securities are held in a depository, not with a broker. The broker can make transactions with them only on behalf and with the consent of the client. In general, the paper storage system looks quite reliable. However, scandals related to the financial problems of brokers sometimes arise. And in March 2022, an extraordinary event occurred that affected clients.

What happened?

In the first half of March, clients of one of the brokers received a letter stating that, due to force majeure, the broker had problems with settlements on clients’ margin positions. In other words, the broker found himself in a margin call situation, but he himself was not able to deal with the difficulties that arose. For this reason, the clearing center began to close the broker’s margin positions on its own, blocking the broker’s ability to make transactions.

In this situation, we are talking about the stock market, and not about the urgent one, and securities belonging to clients were sold on the margin call of the broker. Moreover, according to the margin call of the broker, securities of clients that were not margined were sold. It turned out that conscientious clients who trade only long and without borrowing funds had to pay off the broker’s debts with their own property.

The clearing house, in turn, issued a press release in which it indicated that it acted in strict accordance with the regulations. The blame for what happened (the sale of securities of bona fide clients) was completely assigned to the broker. Allegedly, all the securities of the clients of this broker in the clearing center were accounted for on one account in the form of a single pool, and in a margin call situation, the center had no way to find out whether the securities being sold belong to the margin client or not – this information is available only to the broker.

Understanding the situation

The situation is very unpleasant, and most importantly, outrageous – because it undermines the credibility of one of the main “pillars” of investing in the stock market: “in the event of a broker’s bankruptcy, the client’s funds are safe.” And the inviolability of the client’s assets is not affected by whether he is margined or not, whether he gave the broker permission to use his assets or not. The sale of assets of non-margin clients to cover the obligations of the broker was not massive – only a little-known broker suffered, this organization has only about 2 thousand clients.

How Broker Bankruptcy Can Affect Investor Funds

Thus, the risk that a novice private investor will find himself in a situation where his assets are sold off due to the debts of speculators is quite low. However, this is no reason to relax, and some security measures are worth taking.