Beware the Hidden Risks with Zero Brokerage Platforms

By Marketech Focus | More Articles by Marketech Focus

By Travis Clark

We have welcomed in the Year of the Ox, a time the Chinese believe bestows rewards on those who work hard. But, in preparation for this auspicious time, let’s first ensure that the investments that we shareholders have worked hard to build are as safe as we think they are. Even if we choose risky assets, like direct shares, to invest in.

One of the most critical issues for the growing army of individual share traders is to ensure that their trading platform works in their favour, not against them. Very surprisingly, many don’t. And here’s why.

With online share trading, it is still common for investor’s funds to be pooled, even though accounts may appear to be in the names of individual investors. Some cheaper online share brokers do this, as do many other investment types, as pooling does open up some beneficial investment options, such as ETFs and managed funds.

Opening an individual Holder Identification Number (HIN) account takes a little longer, and is commonly thought to be the safest way of controlling your investments as they are overseen by the RBA and ASIC on the Clearing House Electronic Sub-register System (CHESS). That means you can move your own shares from broker to broker, and independently check they are held safely and correctly through the company’s share register.

There are real risks in having pooled direct share accounts beyond the investment risk, as demonstrated by many high-profile examples in recent times, including the collapse of stockbroker BBY. And there are very good reasons why Marketech Focus does not. We feel these risks have been papered over, especially with the large number of new investors that were not around during the GFC.

Losing control of your assets is a serious risk that a new user may not consider when opening a trading account in a pooled trust, even if the pooled assets are held on the CHESS register.

Individual HIN accounts may be protected by the National Guarantee Fund (NGF), which, according to the ASX is a “compensation fund that covers losses in certain categories related to activities of ASX Market Participants, such as failure to complete a transaction, the unauthorised transfer of securities or failure to deal with property entrusted to the Market Participant where the Participant becomes insolvent”.

In most cases of pooled trust failures, it is due to that failure to deal with property entrusted by those that managed the pooled trust. Once an investor enters a pooled trust with a non-market participant, this NGF protection is not available. There is little recompense, and few ways of verifying your assets are more than just a number on an app.

The other standard practice for many mainstream stockbrokers is to protect the funds provided by each client by opening individual bank accounts. The money they are entrusted with is then deposited into cash management accounts opened in the name of each individual investor or entity, and it is accessible to the client, as well as for the authorised broker to settle trades.

In a similar manner to individual HIN’s, an individual bank account is likely to be protected by the Federal Government through the Financial Claims Scheme (FCS), which protects cash held by an authorised deposit-taking institution – banks, credit unions – up to $250,000 per account.

Once an investor enters a pooled cash account held under trust, this protection is not available as the trust is not an authorised deposit-taking institution in itself. And again, there is little recompense available and few ways of verifying that your cash holdings are more than just a number on an app.

Another layer to a pooled banking account is that interest earned, though currently nominal, is not often paid out of the pool to the individual clients, and is instead used to enhance the profitability of the online broker.

This is a grey area in fee disclosures, as they are an indirect cost that may vary each month. But even at 0.5% interest, a holder of $50,000 in cash will be missing out on $250 per year, which should be disclosable in the legislated Financial Services Guide (FSG) as a dollar amount. An authorised adviser is required by law to disclose the dollar amount or give examples of how trail fees can impact an investor, so should an online broker. The Hayne Royal Commission certainly shared that opinion.

Registering each individual shareholder via a HIN may take a little longer, as it is created for them alone, whereas pooling is an accounting entry. But that then affords the client the power to sell or transfer the shares to anyone they choose to. No-one else can do that without their explicit agreement, and again, there are government protections for individual holdings, but not pooled trusts.

It has been chilling reading of late that 12,500 clients of Halifax Financial Services have also been waiting since November 2018 for administrators to find and release the $211 million held in their trading accounts.

The time taken to fight for access to your own shares and money could cost you plenty as the markets may recover while you are locked out; or fall. And, add to that the legal cost of fighting for your assets, once the forensic accountants finally work out how much is left.

How do we know that? Well, recent figures published regarding the Halifax case show their clients had an estimated $265 million at risk. While recent share price gains would have added to the value of those holdings, the costs incurred by the administrators also have increased. The current shortfall is estimated to be around $50 million.

One argument says that these higher protections would increase the cost at ‘low-cost’ brokers, who currently keep your interest or pool your shares. But if tighter restrictions were imposed, it would mean that low-cost online brokers would have to disclose the true cost and true risk of their ‘low cost’ offering, meaning you would know exactly where you stand. You may still be ok with the risk and the cost, but you should at least be given the fullest opportunity to understand.

It’s reassuring to see that the controversy is now making headlines again. Perhaps share traders will learn from it this time around. But what investors really need is protection against such practices before the markets fall, or before a trustee proves to be fallible in the human way. In the meantime, it would be prudent for every single individual investor in Australia to check how they might or might not be exposed.

Travis Clark is the Managing Director of online broking platform, Marketech Focus, which provides institutional level functionality and security for retail share traders.