Personal Finance Strategies: Custodial risk

Since the headline-grabbing event of Bear Stearns in the US, the need for investor protection has been in the forefront of investors' minds.

By PHILIP BRAUDE
dollars 88 (photo credit: )
dollars 88
(photo credit: )
Since the recent headline-grabbing events of Northern Rock in the UK and Bear Stearns in the US, the need for investor protection has been in the forefront of investors' minds. Many investors are pondering what was once unthinkable, and wondering whether their savings and investments are safe. Custodial Risk is the risk associated with the financial institution that is holding one's investment portfolio. It is not the risk that an investment might lose value or not perform, but the risk that the financial institution might incur a fraud or go insolvent, and not be able to repay the account holder the value of the investment account. When asked by clients about this topic, I suggest the need for the investment account to be backed by a government-regulated guarantee arrangement. This is easier said than done; to the best of my knowledge, no Israeli financial institution carries such a government-regulated guarantee arrangement. Here are two international government-regulated guarantee arrangements that investors should be aware of: In the United States, assets held in accounts offered by brokerage firms are safe - if they are covered by Securities Investor Protection Corp. (SIPC) insurance. In the event of a financial crisis, SIPC will step in to make sure that customer accounts are transferred to a financially sound institution. That is what happened when Cincinnati-based Donahue Securities collapsed in 2001. SIPC also steps in to cover losses when assets disappear due to wrongful conduct, such as misappropriation by the broker. In such a case, SIPC covers losses up to $500,000 per account (only $100,000 may be in cash). Many US brokerage firms carry excess coverage for losses above this amount. Another arrangement is the one offered to investors using policies issued by Isle of Man-based life insurance companies. The Isle of Man's Policy Protection Act guarantees a payout of 90 percent of intended benefits in the event that a company is in default. These companies offer sophisticated open-architecture investment platforms, which enable the investor to personalize his investment portfolio and invest in any listed share, regulated mutual fund or corporate bank deposits. I would welcome the day that Israel-based investors were offered the same types of protection, and not have to hope that they will be rescued should their financial institution face an uncertain future, as has been very vividly demonstrated by the Northern Rock and Bear Stearns debacles. Sadly, the notion of big investment firms failing, no longer seems like alarmist fantasy. pbraude@anglocapital.com Philip Braude is an accountant, personal financial planner and licensed investment marketer. He is CEO of Anglo Capital Ltd.