How to "Own" Securities

Do you own the securities in your stock brokerage account?  Probably not.


If you read your stock brokerage account agreement closely you know that you do not really own the stocks in your account.  Stocks are held in 'street name'.  What you own is essentially a claim for a specific number of shares in the pool of those shares administered by your brokerage.  The brokerage has title to all the shares in the pool in their 'street name'.  This facilitates trading by enabling quick transfer of stocks from one account to another at the same broker and bundling of shares for purchase and sale.

Say, for example you have an account at ABC Broker with 100 shares of Chevron (CVX).  ABC broker has all CVX shares in all its customers accounts pooled together and registered with Chevron as one in street name of ABC.  In that way all the CVX shares in all the accounts at ABC are registered with Chevron in the name of ABC and not in your name.  Your shares are allocated by ABC to your account from the pool of all CVX shares at ABC.  The allocating of CVX shares at ABC to each customers' account is called book entry form. 

There is risk that ABC Broker makes a mistake or defrauds its clients in the allocation or book entry process.  This risk up to $500,000 is presumably covered by the Securities Investor Protection Corporation (SIPC).  From the SIPC webiste:
The Securities Investor Protection Corporation either acts as trustee or works with an independent court-appointed trustee in a missing asset case to recover funds. The statute that created SIPC provides that customers of a failed brokerage firm receive all non-negotiable securities that are already registered in their names or in the process of being registered. All other so-called "street name" securities are distributed on a pro rata basis. At the same time, funds from the SIPC reserve are available to satisfy the remaining claims of each customer up to a maximum of $500,000. This figure includes a maximum of $250,000 on claims for cash. Recovered funds are used to pay investors whose claims exceed SIPC's protection limit of $500,000. SIPC often draws down its reserve to aid investors.  http://www.sipc.org/Who.aspx
Though created by the Securities Investor Protection Act (15 U.S.C. §78aaa et seq., as amended), SIPC is neither a government agency nor a regulatory authority. It is a nonprofit, membership corporation, funded by its member securities broker-dealers.  http://www.sipc.org/Who/Statute.aspx 

At the end of 2012, the SIPC had about $1.6B in assets to cover claims and about $1.1B in liabilities which includes former account holders at Lehman Brothers, Bernad L. Madoff Investments, and MF Global.  http://www.sipc.org/Portals/0/PDF/2012AnnualReport.pdf 

Interestingly, the SIPC brochure clarifies that some investments are not eligible for SIPC protection including commodity future contracts.  It is not clear if ETPs such as GLD are eligible.

Investments protected by SIPC. The cash and securities – such as stocks and bonds – held by a customer at a financially troubled brokerage firm are protected by SIPC. Among the investments that are ineligible for SIPC protections are commodity futures contracts (unless in portfolio margining accounts and defined as customer property under the Securities Investor Protection Act), fixed annuity contracts, and currency, as well as investment contracts (such as limited partnerships) that are not registered with the U.S. Securities and Exchange Commission under the Securities Act of 1933.  http://www.sipc.org/Portals/0/PDF/HSPY_2012_English.pdf 
There are two alternatives to holding your securities in book entry form at a brokerage:
An individual investor can hold a physical, paper certificate issued by the investee.  The investee registers the investors ownership directly on its books and in the name of the investor.  Unfortunately, most companies stopped providing this service many years ago.  Chevron, for example stopped issuing stock certificates in 2005.  http://www.chevron.com/investors/stockholderservices/investorqa/#b3


The other alternative is direct registration.  In direct registration the security is registered in your name and the company or its transfer agent holds the security for you in your account and on the company register.  Investees typically contract transfer agents to administer direct registered shares on their behalf.  Chevron, for example uses Computershare.  Transfer agents typically perform other share administration tasks for their customers, such as stock purchase programs, dividend reinvestment programs, dividend payments, and proxies.


An excerpt from Computershare's CIP Plan Summary is below, as an example: 

"Computershare will hold, in the name of its nominee, all shares of stock purchased or deposited for Participants and will establish and maintain CIP account records that reflect each Participants separate interest." Page 8 of the Computershare CIP plan summary.
"CIP accounts, the securities held therein and any cash temporarily held on behalf of a Participant are not deposits of Computershare and are not insured by the Securities Investor Protection Corporation (SIPC), Federal Deposit Insurance Corporation (FDIC) or any other federal or state agency.  Page 14 of the Computershare CIP plan summary.  
https://www-us.computershare.com/Content/Download.asp?docId={37158B0F-D8F0-4EDF-854B-CC1AA1F4C22D}&cc=US&lang=en&bhjs=1&fla=1&theme=cpu
http://www.cis.computershare.com/pdf/TA_Overview_WhitePaper.pdf 

The way I read it, and I am not experienced in securities law, Computershare keeps the share owners names and amounts, which is similar to book entry, on the investees register of shareowners.  Computershare is contracted by Chevron to perform this bookkeeping task.  Presumably, Chevron would fully compensate shareowners if Computershare made mistakes or committed fraud.  Clearly, the SIPC and the FDIC provide no insurance to Computershare account holders.  

In summary, the relative advantages of holding securities at a brokerage in street name or direct registration:
Ownership Model
Street Name
(Brokerage)
Direct Registration
(Transfer Agent)
Insurance
SIPC up to $500k
No SIPC.  No FDIC.  Investee’s discretion
Fungibility
High: ownership transferred by broker
Medium:  must instruct broker to use Direct Registration System (DRS)
Investee-Investor communication
Administered by broker
Direct
Pledging securities as collateral
Medium
High
Creating a margin account
Easy
Not available
Receiving interest and dividend payments
Broker is added step in payment chain - delays possible
No delays
Administration regulated by
SEC
SEC
Record keeping
Book entry.  No paper.
Investee's Register.  No paper.
Corporate governance
Easier for investee to go dark with fewer registered owners.
More difficult to avoid mandatory disclosures.


Physical certificates are no longer an alternative since most companies no longer offer paper certificates.

You may wonder, as I do why the street name method is necessary in today's computerized and networked world.   It would seem pretty straight forward to attach an owner to each share that is traded and automatically generate a register of all owners at anytime.  Well, we are not alone.  Here are some thoughts on that topic http://blogs.law.harvard.edu/corpgov/2010/01/30/street-name-registration-an-antiquated-idea/

Now, what to do with my Chevron shares?  Direct registration is more secure since share ownership would be in my name on the companies register.  However, no insurance is concerning.  But then how much confidence can one put in the SIPC's insurance.  The SIPC reportedly has $0.5B of net assets to cover a crisis.  This amount might cover only my broker.  It would be a pittance in a systematic crisis.  Both alternatives are equally unattractive.  So I will direct register half my shares now while I learn more. 

Am I being too alarmist by focusing on 'ownership' and securities law.  I don't think so.  Ask a former account owner at MF Global.  Although it is naive to think that any of the current laws would survive a crisis.  The oligarchy is adept and changing the rules during the game.  Ask a former Cypriot bank account holder.  



Other Information: 

A quick overview of securities ownership models by the SEC:
http://www.sec.gov/investor/pubs/holdsec.htm

http://corpgov.net/2010/02/firms-gone-dark-another-reason-to-abolish-street-name/
moving to a system of direct registration would also represent a significant step in ending the abuses that often occur at Firms Gone Dark, which he explored in a paper by that name.

During my research for securities ownership I came across some very interesting information.

No FDIC insurance for deposits at foreign branches of US banks, even if the account is dually in the US and abroad.  Is the FDIC protecting itself from coming confiscations of account holders assets in foreign countries?  





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