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Investment dealer bankruptcy- part 2- which investors should most worry? Print
worryimages.jpgMost retail investors use an investment dealer or broker to invest. Any investor should realize that the collapse (very unlikely, but possible) of their dealer may, depending on the sufficiency and terms of the local financial industry protection fund, expose you to serious financial loss. In a previous commentary we looked at the existing dealer bankruptcy protection regime. In this part 2 we look at the 4 types of investors who should be most concerned by the risk of dealer bankruptcy. Read-on to see if you fall into any of those categories. In a future part 3 we will look at what preventive steps can be taken to address this risk.


In a previous commentary we looked generally at the existing dealer bankruptcy protection regime. In this part we look at the types of investors who may or should be more concerned by the risk of their dealer bankruptcy.

There are basically four investor-types who are likely to be more concerned by the potential bankruptcy of their investment dealer:

  • Those for whom a government credit or guarantee is essential (Government Credit Seekers)
  • Investors with large sums invested (Mr. Big investors)
  • Investors who use a major bank broker subsidiary client and are concerned by the strength of the Canadian financial system (Doom and Gloom’ers)
  • Investors who deal with marginal operators and other exclusions (Below the radar shops)

We will now look in turn at each.

Government-credit seekers

Many investors deliberately decide to allocate a significant portion of their investments to securities that carry a government direct credit (in Canada, federal, provincial or municipal governments) or a government guarantee. Such investors would tend to hold bonds issued directly by, or guaranteed by, a government, and to hold deposits and GIC’s covered by a government deposit insurance scheme, such as CIDC   (or its Quebec equivalent ) in Canada.

Unfortunately most investors purchase and hold their government bonds in an account with their investment dealer in which the bonds are held in so-called street form i.e. not registered in the customer’s name (see Wikipedia ). In the event of a dealer bankruptcy the investor’s claim falls from one against a government body to one against a private industry fund.

We shall look in the third commentary in this series at how to protect such an investor, but one alternative, which should be available, is not. In the US, investors can purchase and have their US government bonds held directly with the US Treasury, and so avoid any intermediation risk. Regrettably, as a result of lobbying by the Canadian banking system, the Canadian government has declined to  set up a similar system in Canada; for more on this deplorable situation, see Government of Canada bonds and Minister Flaherty .

Does the same intermediation risk apply to the purchase through a financial intermediary of GIC’s issued by issuers who are covered by a government deposit insurance scheme? We have exchanged correspondence with both CIDC and CIPF. What we learnt is twofold:

i)             if a dealer goes bankrupt a typical investor with GIC’s bought and held though that  dealer has no claim under the government CDIC deposit insurance scheme (that  scheme only applies if it is the issuer of the GIC which  goes bankrupt)- PDF doc.2149; and

ii)            instead, the investor’s claim becomes one against the trustee of the bankrupt dealer, and if not entirely compensated, the investor has a claim against CIPF, a private (i.e. non-government) financial industry indemnity fund- PDF doc.2150.

Mr. Big investors

A limit has been placed by CIPF on the coverage it provides equal to $1 million for losses.  Therefore, in a routine bankruptcy (one not involving an investment dealer so large as to put in doubt the sufficiency of the CIPF Fund),  it is the big investors, not the small ones, who should be most concerned.

Fortunately  the $1 million limit is actually more generous than it might appear because certain types of accounts are treated separately, and in addition it is the net losses to which the limit applies i.e. after  the trustee returns available assets to the dealer’s customers; see CIPF Policy or as a PDF doc.2152 and an example of the net loss calculation or as a PDF doc.2153

However, if your account is significantly larger than the average account with your investment dealer, CIPF computation rules may in effect penalize you when coverage is calculated in the event of a bankruptcy:

Losses are shared among customers in proportion to their net assets at the Member, so unless your account is very large in relation to the Member’s other clients, your share of the loss will likely be below the coverage limit. Source: CIPF web site   or as a PDF doc.2151.

Last Updated ( Monday, 10 September 2012 )
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