January 31, 2012
BY: Robert Hallberg, Topics: Direct Registration
In todays highly leveraged system the threat of systemic risk is higher than ever before, and with the recent collapse of MF global many investors have become more and more worried about the stability of the system; questioning whether their shares and wealth is really safe or not.
You may or may not be aware that most brokerage firms automatically put your securities into a street name registration, unless you give them specific instructions to the contrary. Street name registration in short means that you are not registered as the owner or beneficiary on the issuer's books. Instead, your brokerage firm will appear as the owner of your shares, and they will then keep a record of the shares that belongs to you.
The Securities Investor Protection Corporation (SIPC) does insure your equities of up to $500,000, and up to $250,000 in cash in your brokerage account. However, the bigger questions if whether the SIPC have enough capital of cover a major bust, fraud or even theft.
The SIPC keeps a billion dollars in reserves to cover losses, and they also have a credit line of $2.5 billion from the US treasury to backstop a bust. This kind of capital was perhaps respectable a decade ago but it is miniscule by todays standards. All it would take is 2000 accounts of $500,000 or more to go bust for the SIPC to have to tap into its emergency credit line. To put this in context, Scottrade alone have more than 1.5 million active accounts with roughly $51 billion in customer assets.
Furthermore, an underreported fact is that the MF Global collapse did not only affect futures contracts. MF Global was also a clearing house for stock securities and the SIPC is currently in the process of refunding 800 some equities accounts that lost their assets.
All this is very worrisome but there are steps that investors can take to mitigate risk and make sure that they will not be affected by the next MF Global disaster. Risk mitigation starts with transferring the title of the stock certificate from your brokerage firms name into your own name. As an individual investor, you have three different choices when it comes to holding your securities and all of them have its advantages and disadvantages.
Your options are:
Physical Certificate The security is registered in your name on the issuer's books, and you receive an actual paper certificate.
Street Name Registration The security is registered in the name of your brokerage firm on the issuer's books, and your brokerage firm keeps a record of the shares that belongs to you.
Direct Registration The security is registered in your name on the issuer's books, and either the company or its transfer agent holds the security for you in a book-entry form.
A physical paper certificate is the old and traditional method for holding shares. With this method, the security is registered in your name on the issuers books, and the issuer will send you an actual certificate. Some brokers may charge a small fee for issuing the paper certificate.
This approach mitigates the risk against your broker going bust and you also have the added benefit of receiving company reports and other information directly from the issuer. The disadvantage includes a more cumbersome process of buying and selling shares. For one, you will need to send the certificate to your broker or the company's transfer agent to execute the sale. This may make it harder for you to sell quickly. If you lose your certificate, you may also be charged a fee for a replacement certificate. In addition, if you move you will need to contact the issuer and update your address so than you wont miss any important filings.
Street Name Registration
This is the default option for virtually all brokers and chances are that your shares are registered in the in the street name. Most brokerage firms will automatically put your securities into street name registration unless you tell them otherwise. With street name registration, the shares are issued to your brokerage firm, but they will keep records showing you as the real owner.
This approach does not leave you fully protect against bankruptcy, fraud and theft. The SIPC insures your account up to $500,000, but as we discussed earlier, this organization is undercapitalized and may not have enough capital to ensure against a widespread collapse.
However, street name registration does give you the advantage of placing limit orders since your securities are already with your broker. It is also easier to setup a margin account if you use street name registration.
This is a digital book-entry system that registers you as the actual owner of the shares. With this system your shares are recorded and transferred electronically without issuing a physical certificate. Instead of receiving a physical paper certificate your shares are recorded and maintained by the Securities Transfer Corporation (STC). This book-entry form of ownership is a relatively new way of holding and transferring shares and it grants you all the rights and privileges as a shareholder without actually having a physical paper certificate.
If you currently hold your security in street name registration, you can instruct your broker or the issuer to move your security position to the issuer for direct registration. You will then receive a statement of ownership from the issuer acknowledging your direct registration system (DRS) book-entry position once the change has been made.
When you want to sell your securities through your broker, you can instruct your broker to electronically transfer your securities via DRS from the books of the company and to sell your securities. Your broker should be able to do this quickly without the need for you filling out complicated and time-consuming forms.
Direct registration is a good way of safekeeping your shares. It gives you protection against loss, theft and bankruptcy while also giving you more flexibility than physical paper certificates offers. However, not all issuers (stocks) offer this method and you will need to check with your issuer or broker to find out if the issuer offers direct registration.
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