That’s right. You think you own securities in your brokerage account, but you don’t.
A company you’ve probably never heard of, called Cede & Co., is the official owner of >99% of the securities outstanding in the U.S. What’s in your brokerage account is probably an I.O.U. See the fine print.
This is a feature of U.S. capital markets that arose for historical (not nefarious) reasons. But those reasons long ago faded, and yet this vestige of yesteryear’s market structure remains. Were we to create a new market structure from scratch, it would look nothing like it does today.
Main Street investors lose, folks! This is a consumer protection issue. Winners are the privileged few who are in a position to exploit leakages caused by this market structure, at the expense of Mom & Pop.
Podcast here (20 minutes long). Try here if it doesn’t load.
Slides available here: no you don’t really own securities_AS PRESENTED
Pension funds, mutual funds, insurance companies and other types of long-only investors unnecessarily bear (1) counterparty risk, (2) operational risk and (3) over-issue risk that can artificially suppress the value of securities. These 3 risks are inherent to today’s crazy market structure. Securities pass through a chain of leveraged intermediaries and are accounted for on an aggregate (not individual) basis—making it impossible to verify that securities accounting is 100% right 100% of the time. In the podcast and slides, I provide real examples of how investors lost because of this market structure.
An example: based on the IMF’s estimate of the length of collateral chains, only 1 of 3 investors who believe they own a U.S. Treasury security actually does. In the repo market, multiple investors report that they own the same asset at the same time (usually a Treasury security). Fails are a daily occurrence in the repo market.
Hey, here’s hoping the musical chairs never stop! Seriously. Hope!
The good news? Blockchains solve all of these problems!
Coming changes to corporate law will soon permit issuance of securities directly on a blockchain itself, which will give issuers the option to circumvent this risky market structure altogether—thus avoiding its layers of leveraged intermediaries and inherently opaque omnibus accounting. Delaware (the key state for corporate registrations) is leading the charge, and other states are likely to be very fast followers.
Among the winners from blockchain technology are:
- entrepreneurs, who will no longer be required to cede their ownership of the shares of the companies they built to Cede & Co. when they go public in an IPO. Folks, a better IPO alternative is coming soon!
- pension funds, mutual funds, insurance companies and other long-only investors, who will no longer bear unnecessary counterparty, operational and over-issue risks. I believe securities chain-of-custody will soon be standard due diligence for ERISA fiduciaries, fund company distribution platforms, independent fiduciaries in pension risk transfer transactions, and insurance company risk officers. Further, I believe long-only investors who have stronger chain-of-custody arrangements will gain a competitive advantage in gathering assets, not to mention absorb fewer costs for TMPG fails, glitches in posting collateral and other operational hiccups.
- issuers, who will have visibility into who owns their securities at all times, who can be confident of no leakage in close corporate votes, and who can reduce mistakes involved in shareholder records.
- Main Street, who will re-gain ownership rights in securities and benefit from FAIRER, safer and more transparent markets.
American Banker wrote a terrific article on the topic here.
Please read important disclaimer here.