Wednesday, December 14, 2011

Rehypothecation: Broker's License to Steal Your Money

After going through account agreements I have discovered some troubling language.  In light of the MF Global meltdown and the resulting losses suffered by their clients I have started to evaluate the risks that I face as a retail investor.  If you read the excerpts below, you will find that all of the brokers require the authority to repledge or re-hypothecate your assets and use them for whatever they want.  They also require, with the exception of TD Ameritrade, that you accept any losses that may result from their bad management of those assets, a la MF Global.  I even found an old account agreement from Charles Schwab that contains language, that has since been modified, that protects the individual account holder.  So, take a look and see what kind of authority you have given your broker.  I hope that these brokers will respond to this issue and give us all some assurance that our money is truly as safe as they say it is.

I must note that the fact that brokers have the authority to engage in this kind of behavior does not necessarily mean that they are engaging in MF Global type behavior.  I am simply showing you the language that we all have to agree to in order to trade securities in the markets.  Make your own judgments!

Here are excerpts from account agreements with some of the more popular retail brokerages.

optionsXpress Account Agreement (Printed 10/27/11)

32. Consent to Loan or Pledge of Securities in Margin Accounts
Within the limits of applicable law and regulations, you hereby authorize optionsXpress to lend, either to us or to others, any securities held by optionsXpress for your account, together with all rights of ownership, and to use all such property as collateral for our general loans.  Any such property, together with all attendant rights of ownership, may be pledged, repledged, hypothecated or rehypothecated either separately or in common with other such property for any amounts due to us thereon or for greater sum, and we shall have no obligation to retain a like amount of similar property in our possession and control.  In connection with such securities loans, we may receive and retain certain benefits to which you will no be entitled.  You understand that, in certain circumstances, such loans could limit your ability to exercise voting rights, in whole or part, with respect to the securities lent.

Charles Schwab Account Agreement (01/09)

10. Pledge of Securities and Other Property
We may pledge,  re-pledge, hypothecate or re-hypothecate, either separately or together with Securities or other customers, all Securities and Other Property that you, now or in the future, carry, hold or maintain in your Margin and Short Account.  The value of the Securities and Other Property we pledge or re-pledge may be greater than the amount you owe us, and we are not obligated to retain in our possession and control for delivery the same amount of similar Securities and other Property.
11.  Loan Consent
You agree that Securities and Other Property held in you Margin Account, now or in the future, may be borrowed (either separately or together with the property of others) by us (acting as principal) or by others.  Schwab may place any security held in your Account into the Margin Account portion of your Account.  You agree that Schwab may receive and retain certain benefits (including, but not limited to, interest on collateral posted for such loans) to which you will not be entitled. ....

Now read the same paragraph from a December 1995 Agreement (underline added by me for emphasis)

12. Loan Consent
You agree that Securities and Other Property held on margin, now or in the future, may be borrowed (either separately or together with the property of others) by us (acting as principal) or by others.  No compensation will be payable to you in connection with such borrowings, and any losses or other detriments or gains or other benefits arising from such borrowings won't accrue to your Schwab One Account.

Why did Schwab remove the language that protects account holders from "losses or other detriments"?

TD Ameritrade Agreement dated 11/11.  This applies to Think or Swim Accounts as Well:

g. Pledge of Securities and Other Property.  You may pledge, repledge, hypothecate, or re-hypothecate, without notice to me, all securities and other property that you hold, carry, or maintain or for any of my margin or short Accounts.  You may do so without retaining in your possession or under your control for delivery the same amount of similar securities or other property.  The value of the securities and other property that you may pledge, repledge, hypothecate, or re-hypothecate may be greater than the amount I owe to you, and any losses, gains, or compensation that result from these activities will not accrue to my account.

h. Loan of Securities.  You are authorized to lend to yourself or others any securities you hold in my Account and to carry all securities lent as general loans.  In connection with such loans, you may receive compensation and retain certain benefits that I will not be entitled to, such as interest on Collateral posted for such loans.  In certain circumstances, such loans may limit my ability to exercise voting rights with respect to the securities lent.  I may request that fully paid securities not be used in connection with short sales.  I understand that in certain situations in which you have borrowed my securities, I may receive a "payment in lieu" of the dividend issued (see Margin Handbook for more details).  

Interactive Brokers LLC


14.  IB's Right to Loan/Pledge Customer Assets: As allowed by  law, IB is authorized by Customer to lend  to itself or others Customer securities or assets. IB may, without notice, pledge, re-pledge, hypothecate or re-hypothecate Customer's securities and assets, separately or together with those of other customers, for any amount due in any IB account in which Customer has an interest, without retaining in IB's possession or control a like amount of assets. For loans of securities, IB may receive financial and other benefits to which Customer is not entitled.  Such loans could limit Customer's ability to exercise securities' voting rights.