Protect Your Portfolio from Broker Fraud and Bankruptcy

Chad Creveling |

By Peggy Creveling, CFA, and Chad Creveling, CFA

Although it may not be common to have problems with a brokerage account, fraud and bankruptcies can and do happen.  These types of issues may occur most frequently in the offshore world where regulators may not have a handle on money being channeled through tax havens, but they can also happen in larger or better-regulated markets. For example, in January, several foreign exchange brokers went bust when the National Bank of Switzerland de-pegged the Swiss franc from the euro, and the franc appreciated rapidly against major currencies, resulting in mayhem in the forex trading community. The U.S. has had some recent high-profile brokerage bankruptcies, including the collapse of Lehman Brothers in 2008 and the fraud-related busts of firms like Bernie L. Madoff Investment Securities and MF Global. Fallout from the bursting of the Shanghai and Shenzhen market bubbles might normally lead to some broker bankruptcies, although in this case Chinese government intervention may stem the tide.

For expats concerned about the safety of investments held in brokerage accounts, you can take steps to help make sure that your investments are protected. Here's a checklist:

  • Choose to hold your investments at a custodian or broker-dealer that is regulated by a credible major regulator. Double-check with the regulator directly to make sure that the entity is indeed properly regulated. Find out if any complaints have been filed.
  • Avoid custodians that partake in risky activities, such as derivatives trading. If your custodian conducts proprietary trading for its own book, ensure that this is done in a legal entity separate from where client accounts are held.
  • Check with your custodian or broker-dealer as well as its regulator to see how your investment funds are protected from fraud or if the firm were to go bankrupt.
  • Check the financial strength of your custodian or broker. Look for a sizable equity base and strong credit rating.
  • Review and maintain a copy of your latest brokerage account statement showing the investments that the account contains. Make sure that the statement reflects all activity in your account and that holdings are correct. Any errors should be reported immediately to the broker in writing. If problems persist, contact the relevant regulator.
  • For investors using U.S. custodians or broker-dealers, read about the role of the Financial Industry Regulatory Authority (FINRA) and the Securities Investor Protection Corporation (SIPC), whose specific job is to restore funds to investors with assets in the hands of bankrupt or financially troubled registered broker-dealers.

The good news is that unless a broker-dealer engages in outside risky activities or outright fraud, the potential for bankruptcy is low. And even if a custodian goes bankrupt, as long as your broker kept client accounts separate, in most well-regulated jurisdictions your account should merely be transferred intact to a different, solvent broker.

Additional Resources
Five Questions Expats Should Ask Before Choosing an Offshore Custodian
FINRA: Avoiding Investment Scams