Find the right trading environment for you

The recent collapse of brokerage firm Sonray Capital Markets raises a number of issues and questions that are important to all investors – not only those trading Australian shares and CFDs, but traders in all markets and all instruments. Reports from the appointed administrators suggest that SONRAY has lost around $46 million of client’s funds out of a total of around $76 million through a combination of illegal and inappropriate trading activities and poor business management. Apparently, client’s funds were being used to fund the illegal trading activities being carried out by SONRAY. It is suggested that a trader or traders within the SONRAY organisation had access to client funds and used this money to fund the illegal trading activities and prop up the business. These trades have gone horribly wrong leaving clients facing losses of their trading capital and perhaps even shares they believed they owned, through no fault or action of their doing. These clients may well be asking how was this allowed to happen and what are the regulators intending to do to prevent this occurring again?

Cash at risk

Many of the Sonray clients may well have believed that their Funds were held safely in ‘a client segregated account’ that was separate from the brokers ‘house’ account. This appears to not be the case. This may well raise a number of questions, including:-

1. Why and how was access gained to this pool of client’s funds?
2. Who has access to this pool of client’s funds?
3. Are client’s funds really as ‘safe’ as we would like to think?

I’m sure you can think of many more.

After researching the security of cash injected into accounts for trading we found that there is no alternative more secure than having your capital deposited in an Australian bank account, whether linked to your online broker or not. Many Australian brokers provide their clients with CMA (Cash Management Account) or CMT (Cash Management Trust) accounts which are typically linked to client online trading accounts or are the linked account to the online broker. Accounts under $1 million are also secured under the Australian Government’s Financial Claims Scheme (FSC).

In the case of Sonray, it has been reported that client cash, that is the deposited monies in their online trading accounts that were not invested in shares, is allegedly not secured and therefore is at risk of being used by the appointed liquidators to pay outstanding creditors. This remains to be confirmed by the currently ongoing Sonray liquidation process. I’d urge investors to familiarise themselves with the Sonray situation, and to thoroughly research your current broker to determine if they deposits monies in a similar way to the method that Sonray did or in a more secure manner that cannot be used to pay creditors in the event of a broker default.

If an ASX broker provides an online linked CMA or CMT account with an Australian Bank in the client’s name, the clients’ funds are protected in the event of a default by the broking arm of the business. This means that your funds are held at the bank in your name and not within the brokerage firm. In the event that the broker was to default, your cash would be secure within the banking structure. The risk is significantly reduced but it is not eliminated.

If a broker deposits their client’s funds into any other account other than an account with a recognised Australian bank in the client’s name then the client’s cash that is not invested in the market may be at risk of being used by the broker in the event that the broker defaults or a client of the broker defaults with a large loss. This is a general statement as the level of risk varies depending on the details provided in the broker’s PDS and any back-to-back contractual agreements that the broker may have in place with third parties.

I urge you to thoroughly research and understand the way your broker holds your funds so that you are fully aware of any extra layer of risk that you may be exposed to in the markets. This starts with your brokers Product Discloser Statements. You should start by reading your brokers Product Discloser Statement in detail and assess what are the potential risks you are exposed to. Don’t treat your broker Product Discloser Statements or your broker client agreement forms the same as you would treat your general banking or general insurance Product Discloser Statements. Be diligent and ask your broker specific questions that concern you and your money.

As traders and active investors we CHOOSE to participate in the financial markets. We know and understand individual trade risk, we understand market risk, and we also need to understand the potential for broker default risk as the Sonray example shows. This is a layer of risk over which we have little if any control when things go wrong. We can take steps to limit this risk but we must still be aware that it can occur.

We also need to be aware of the fact that ‘cheap’ brokerage is not always the ‘best’. Whilst at first blush it may appear that a brokerage rate of $10 per trade is cheaper than $25 per trade, this is of little consequence if our trading capital disappears into a black hole if our cheap broker defaults and collapses, and leaves us thousands of dollars worse off. As always, do your research, know your risks, and understand fully the whole environment in which you are trading.

Next week I will discuss how shares are ‘held’ and what happens when trading other instruments such as futures and FX.