After the Beaufort affair, is the money you entrust to your stockbroker really safe?

The collapse of a small broker has exposed a loophole in the rules designed to ring-fence investors’ assets

WE won’t tip a stock this week but will look at a question that has been weighing on the minds of many investors: if a stockbroker goes bust, can the administrators help themselves to customers’ assets to meet the cost of winding the firm up?

Many of us, Questor included, had long assumed the answer to be no, thanks to strict laws and supervision concerning financial firms and, in particular, to mandatory “ring-fencing” of clients’ assets, keeping them separate from the firm’s own.

But the recent insolvency of one small broker, Beaufort Securities, has shattered that belief. When it went under in March, administrators from PWC, the accountancy giant, were appointed to manage its affairs and reunite customers with their assets.

PWC initially put the cost of this work at £100m, although it later revised the figure to £55m. As that sum exceeded the value of Beaufort’s own assets, the accountancy firm said it would have to use money belonging to clients to make up the shortfall.

Losses for customers that arise this way, rather than from the normal risks that come with any investment, are counted as a failure on the part of a regulated firm to meet its obligations to clients and are therefore eligible for recompense from the statutory safety net, the Financial Services Compensation Scheme. The FSCS has agreed with PWC that it will pay up to £50,000, the current limit where investments are concerned, to each customer affected.

The upshot is that very few customers, perhaps fewer than 10, will suffer a loss once the FSCS has met its share of the costs.

But the affair has caused many investors to wonder how safe their money is with stockbrokers and “investment shops”.

PWC is within its rights as the law stands to act as it has at Beaufort and the same could, in theory, happen if any other broker or similar firm were wound up, no matter how big or reputable, Questor has established.

But there are several reasons why, in practice, losses for customers would be far less likely if a big player such as Hargreaves Lansdown or Fidelity went bust. This is because Beaufort was a very different animal from the mainstream investment shops used by millions to run their Isas and pensions. Beaufort was partly a “discretionary” broker. This means it took investors’ money and decided for itself how to invest it – a very different business model from the one used by Fidelity, Hargreaves, Barclays Smart Investor and the other large shops, which operate on an “execution-only” basis.

Execution-only means that clients can put their money only into funds, shares or bonds that the broker has allowed on to its system. As a result, customers end up with funds run by large, reputable asset managers or shares listed on established exchanges.

Beaufort, by contrast, used its discretionary model to put some of its clients’ money into esoteric and unregulated assets, some of which could not be quickly sold. The work involved in reuniting these assets with their owners is therefore vastly more complicated than would be the case with one of the big execution-only houses.

These companies hold assets in “nominee” accounts with fund managers or share registrars, supported by an internal database that matches individual holdings to customers. In the event of an insolvency it should be straightforward to transfer the assets in the nominee accounts en masse to another broker, along with the database, allowing the correct allocations to be made to individual clients.

This would involve some expense for administrators, but the brokers are required to hold considerable sums in reserve to meet this contingency. It seems unlikely that these reserves would be insufficient – and almost inconceivable that any costs charged to customers would exceed the £50,000 available from the FSCS (soon to be increased to £85,000).

A change in the rules looks unlikely. If you want absolute security you could hold paper certificates or set up a “Crest” electronic account with a broker that offers the service. Your correspondent, however, holds assets with Hargreaves Lansdown and AJ Bell and is happy to keep them there. The same would apply to any of their household-name rivals.