One of my standing recommendations to clients is that they hold investments traded on a securities exchange, rather than on the balance sheet of a financial institution. This strategy largely avoids the possibility of loss if the financial institution becomes insolvent, although it does not eliminate the market risk for the securities investment.
Basically, the reasoning here is that you don't want your investments to be a hostage to the safety (or lack thereof) of your bank or brokerage. So, for instance, instead of holding short-term investments in a brokerage's money market fund, consider holding them in a short-term Treasury bill fund traded on the NYSE or other exchange.
This strategy paid off big-time for investors who maintained brokerage accounts with Stanford Private Wealth Management. This company is now under investigation in an alleged US$8 billion Ponzi scheme masterminded by its founder, R. Allen Stanford.
Last month, a U.S. court froze 32,000 investor brokerage accounts with Stanford when the SEC sued Stanford, two associates and three affiliated companies. Most of these accounts (more than 28,000) were quickly unfrozen. However, on March 12, a federal judge in Dallas indefinitely extended the freeze on more than US$1 billion in about 4,000 remaining Stanford accounts. To recover these monies, the receiver (i.e., the official appointed by the court to recover assets to repay victims of the Ponzi scheme) may require investors to submit proof that their funds aren't tainted by fraudulent activity.
Since many of these 4,000 accounts belong to Stanford employees, this proposal is not unreasonable. However, not all the account-holders are Stanford employees. Many of them merely purchased high-yield certificates of deposit throughAntigua-based Stanford International Bank. These CDs aren't traded on any exchange and appear to be part of the bank's balance sheet. Although we don't know how things will shake out in court, the account-holders who purchased these CDs may well be considered unsecured creditors of the bank. They'll need to wait in line with all other unsecured creditors to divvy up whatever proceeds the receiver can recover. It's entirely possible they'll lose close to 100% of their investment.
The lesson should be clear. Particularly in these times of extreme financial uncertainty, avoid keeping significant investments on the balance sheet of any financial institution, unless you're very confident of long-term solvency.
Copyright © 2009 by Mark Nestmann
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