Many eons ago, I wrote a post wondering why the Government bothers to sell Canada Savings Bonds when so many competing options are available. The post elicited this interesting comment:

Canada Savings Bonds are definitely attractive. In the last 6 months we have discovered that banks and brokerages can easily collapse. Government bonds held for you at a brokerage still depend on the broker in several ways: you trust that there is no fraud and the broker actually holds a bond for YOU; you trust that the bond is not being loaned out in securities lending; you trust that if the bank/broker collapses, CIPF will speedily process an insurance claim and get your bond back to you. With Canada Savings Bonds you aren’t exposed to any of this middleman risk. In most cases with CSB, you are the certified owner of the bond and you directly hold the bond. This is worth something. I am an expert in bond markets and I still hold CSB (mostly because I don’t trust the banks, brokerages, or CIPF).

Subsequently, another reader suggested checking out the Bankruptcy and Insolvency Act (BIA) and the Marlow case. A quick search brought up this excellent article titled When Securities Firms Fail: An Inside Look at the Marlow Group Bankruptcy. The article points out that when a broker goes bankrupt, only securities registered in customers’ names will be returned to customers and all other securities will be put in a common pool to be distributed pro rata to customers. Since it is common for brokerage assets to be held in street name, it is worth asking: how do we protect our investments if our broker goes bankrupt?

This article has 17 comments

  1. Transparency is a huge issue regardless, but no investment is completely without investment risk – including Canada Savings Bonds. I mean, what if a bank says it’s CDIC insured and then doesn’t pay the premiums and goes bankrupt? Did you actually check to see if the bank paid their CDIC premiums this month and every single month? What if they sell you a GIC and then they invest that money in something that CDIC doesn’t like, such as a hedge fund, or crude oil futures. Is it still “guaranteed”? What if there is a run on all of the Big 5 banks all on the same day? What if the Canadian Federal Government suddenly decides one day that they can wipe out the national debt by simply canceling all government bonds and refusing to pay anybody? Is it likely to happen? No. But is it POSSIBLE that it might happen? Yes. Look at Iceland, Dubai or Greece – they can’t honor their national debts.

    Canada Savings Bonds mainly suck because interest rates are negligible (0.4%) and is probably going to underperform inflation. US Savings Bonds have the benefit that it is a tax deferral vehicle as you don’t pay taxes on the interest until the bonds are cashed in. Not so with the Canada Savings Bonds – if you make a measly $4 per yr interest on every $1K you invest, you have to pay full taxes on it every year you hold it until maturity.

  2. In the Marlow case discussed in the article the assets were (mostly) not CIPF-protected. I agree with most of the points made by the commenter you quote, but I value the risk differently. I’m not willing to pay the price of lower bond yields to own CSBs. A better solution to me is to divide my assets between two big bank discount brokerages and count on CIPF.

  3. Stuff all of our money in our matresses!

  4. Canadian Capitalist

    @Phil, @Michael: I’m not thinking of dumping all stocks and buying CSBs at all. Instead, I’m wondering if it will make sense to get the securities registered in our name. It costs $50 or so and I’m wondering if it will be worth the expense. I’m not all that confident that CIPF will be able to make whole investors in the event of a major bankruptcy due to, say, massive fraud.

  5. CC: I don’t know much about the process of getting securities registered in one’s own name. Are you still able to sell the security through your broker, or would you have to send them some sort of authorization? Would you have to pay the $50 each time you buy more of that security? Depending on whether these costs are recurring or one-time, it may make sense to register a core of your portfolio and leave the part that may get involved in rebalancing, etc. in street name.

  6. I only wish we could buy other treasuries directly from the Government of Canada, and not just just savings bonds. Why can’t we do this? Why do they force us to use a broker for other bond issues?

  7. investnoob,
    Distribution of securities is a difficult and risky business. Basically in any transaction there are transaction costs, which include the cost of finding customers. While it may be the case that the government could be capable of pulling a feat like universal distribution of government securities off, the government can do it much more cheaply by distributing to a small number of broker/dealers, who will be incentivised to do a good job at distribution by the possibility of profit. Plus, they already have lists of clients. Why should the government waste taxpayers’ money building its own list when it can benefit from ones that are already prepared?

  8. Hi
    I remember owning some securities in my own name (it was BNS – common). The certificate was stored in my safety deposit box. Purchasing more was easy; you were able to purchase directly from the transfer agent, though the shares were then held in the transfer agent’s hands. And, it also made taking part in the dividend reinvestment plan easier. Selling, of course, meant transferring the certificate(s) to your brokerage acct. But, all of this seems to depend on the company that you are investing in. (ie, do they have a DRIP? do they allow additional purchases through the transfer agent?)
    CC raises a good point, though…I have thought about this as well. At this time, I don’t have enough (non-rsp) investments to warrant worrying too much about my non-rsp brokerage acct, which I use as a place to park only a portion of my emergency funds, and as a place to sell shares that I buy at a discount from an employee share purchase plan at work. But, in the future, I can indeed forsee a situation where I may need to worry about this. Indeed, if I do accumulate a large enough amount to worry about this, I may indeed pay the $50/certificate to get the certificates registered in my name, for my long-term “buy-and-hold”-type investments.
    Intersting post, CC. thanks!

  9. How does this work if you have $100,000+ with a transfer agent?
    I’m assuming since the stocks/securities are held in your name, and not in-trust with the bank, you’re OK??

    Certainly a mix of both (securities registered in your own name) and some held with a CIPF member bank should do the trick.

    Heck, what did Derek Foster do with all his DRIPs? Does somebody have a line on him to email him that question?

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  11. MK, I’m a little confused by your comments.

    Are you saying that assets held in an RSP are treated differently than those held in taxable accounts in the event that one’s broker goes bankrupt?

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  13. sorry for the confusion….my personal experience on this was only with my non-RSP brokerage acct. Perhaps CC would know about the RSP-based brokerage acct. And, I suppose a tax lawyer would know about how assets would be treated, for non-rsp vs. rsp brokerage accounts.

  14. Change of Heart

    I pointed CC to the Marlow case. Not sure if anyone will read this, but, fwiw, other client name options exist: anything held directly through a bank (such as a GIC), including online banks (such as Ally, ING, etc.). Mutual funds purchased directly through banks are often held in client name. However, mutual funds and ETFs practice securities lending (Google this if you’re not aware of it) — so “your” holdings may be exposed to some counterparty risk. The problem here is not dissimiliar to the one of brokerage failure: intermediary risk. Also, RRSPs are, by definition, “in trust,” so you’ll never completely get away from an intermediary with an RRSP. As a test, I put a small amount of money in a CSB RRSP. Sure enough, when I received the legal paperwork in the mail, I was informed that CSB RRSP funds are held in trust by TD.

    My strategy is to continue to hold equities (all types) in my discount brokerage. I also have no choice but to hold RRBs and long bonds through the brokerage. These instruments cannot be purchased directly in Canada. However, short and mid-term bonds can be easily replaced by client name GICs — often at better rates and including a CDIC guarantee. (But if you have more than $100K, you need to be careful of the CDIC limits, which can be confusing. Limits are based on issuer, but the GIC issuer may overlap with a bank account. For example, my TD Savings Account is actually TD Mortgage, while TD Chequing is actually TD Bank.)

    Eliminating risk is not possible, so I just try to mitigate it where possible. For example, a very few exceptions exist to the securities lending practice I mentioned above: four early ETFs, such as SPY, are actually Unit Investment Trusts. Understanding the inner-workings of any ETF is a difficult task; however, there may be somewhat less counterparty risk due to securities lending restrictions on UITs. Of course, they could restructure at any time. Caveat emptor.

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  17. Change of Heart

    Another option for residents of Ontario is Ontario Savings Bonds. Rates tend to be more competitive: Other provinces have similar programs. Credit risk is higher than holding a CDIC-backed GIC or CSB, but it’s another option for those interested in direct ownership.