Ask HN: Can I trust brokers with my stocks? | Hacker News Reader

Ask HN: Can I trust brokers with my stocks?

52 pointsanticristi63 comments

Dear all,

As result of the GameStop "upset", I came to realise that retail brokers not only make money by charging commission, but also by untransparently borrowing my stocks for shorting.

At this point, I want to know:

1. How can I find out if my broker borrows my stocks for shorting?

2. How big is the risk for me? Can I lose part of my stocks due to reckless shorting?

I asked the same two questions to my broker (Avanza in Sweden), and they haven't replied after 4 weeks.

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Interactive Brokers has a stock lending program and shares half the profits with their customers who opt-in. They are transparent about how it works. (Basically they deposit cash collateral to your account to cover the stocks they’ve lent out).

https://ibkr.info/article/1839

I think many other brokers do basically same, but aren’t transparent and don’t share the profits.

Seconding IBKR. I've always viewed them as the most ethical broker and also the one with the highest skill ceiling. They do not sell order flow, they offer programs like the above so you can earn interest when they loan your shares out to other individuals or institutions, and let you get very granular about things like your exchange routing.

You should watch their CEO Thomas Peterffy's interview during the gamestop situation - he basically said "shorting is illegal" and a lot of other such nonsense .. completely lost respect for IB after that, even though I still maintain an account.

https://streamable.com/ycdec9

That's a long video. Can you link directly to the nonsensical statement you're referring to?

He says "so short squeezes are illegal" at about 3:30

Thomas says a lot of nonsensical things during those 4 minutes. He keeps on continually referring to the trading prices of GameStop, basically belittling the market price of $100~200 and continually insisting that it is a company worth a lot less (somewhere below $50, I forget). Even though he runs a brokerage firm, his personal opinion is very non-neutral and he wants to dictate a market direction.

Naked shorting is illegal

>Ask HN: Can I trust brokers with my stocks?

I'm not so sure I would be able to trust most of them with my laundry as much as the average dry cleaning professional.

Which one would be most likely to be wearing your best suit more often than you do while it is not in your possession?

>Naked shorting is illegal

Probably less obvious when wearing someone elses' outfit instead of nothing at all.

Where do you put your money?

Best place I've found is into a company where I own the majority of shares.

Give this woman an award: 03:00 "But, but, can I, if I, Thomas, if I can break in - and we should point out that Interactive Brokers is a sponsor of Bloomberg Radio and Bloomberg TV. So it's not the case that traders were doing anything wrong or illegal. It's just a case of logistically, there were going to be problems, right, in terms of clearinghouses. So that's more an operational problem versus a market problem or traders doing something wrong, correct?"

And Thomas responds: "No, no, no, not correct. So, so short squeezes are illegal. ..."

That's some inside baseball observation by her. See NSCC Procedure XV, on (virtual) page 294/385:

> Each Member of the Corporation, except as otherwise provided in this Procedure, is required to contribute to the Clearing Fund maintained by the Corporation an amount calculated by the Corporation equal to:

* https://www.dtcc.com/~/media/Files/Downloads/legal/rules/nsc...

Agree. If the OP's concern is the Gamestop fiasco, then IB is just as bad as Robinhood.

AFAIK, IB restricted only option trading, while RH also restricted buying actual stock.

My mistake, you're absolutely correct.

correction - i meant he said "short squeezing is illegal" which is why they stopped the trade. For those asking for timestamp, he says that around 3:30

They don't sell 100% of their order flow, but their firm 606 disclosure says they send significant amounts to Citadel and Virtu.

Even if they don't receive payment for it, one would certainly hope they're sending their orders to wholesalers and not an exchange. They'd be screwing their customers otherwise.

There's no point in hoping, because the 606 forms on their website clearly say they send lots of orders to exchanges too.

I wonder if that is just limited to IBKR Lite, their commission free platform https://www.interactivebrokers.com/en/index.php?f=45196

During one of the interviews, I think he says that payment for order from is like 1-2% of their revenue.

CEO of IBKR openly admitted that they halted GME trading "because stock was too expensive" and will open it again once "it would cost 17$". And laughs in between.

In what world this is "ethical"?

How is it not ethical? They're stopping people from losing money buying something that is overpriced.

But causing people to lose money who already bought it and couldn't sell, presumably

Isn't the whole purpose of a free market with stock trading that people make those decisions themselves? I've certainly made bad trades in the past, but no one stopped me. Shouldn't I have been stopped as well then?

And if everyone is protected from losing money, we should just disable buying stocks at all for everyone, because you can always lose money.

What kind of interest does that pay? It seems like a good way to use shares on which you are going long and plan to hold for a while.

It depends on the stock and the current demand for that stock. If you had GME shared during the recent frenzy, you could have earned a lot in interest. But, say you have Google, you won't earn much since there is a lot of shares and lot of people willing to lend.

Do you have a sense of at least order of magnitude for the interest rates? Like, is this a "up to 0.25% annually" situation or is it something more substantial?

Disclaimer: IANAL or a financial expert. This information is relevant in the US, but Swedish brokerages may do something similar.

In the US, brokers cannot lend out your shares without your knowledge. Brokerage customers can opt into a program called Fully Paid [Securities] Lending, in which the broker pays you a monthly fee to lend your shares out to short sellers. The fee you're paid is higher for securities that are harder to come by; shares of an up and coming marijuana company will be much more rare than large-cap stocks in the S&P 500. (Brokerages often own their own shares of popular stocks that they can lend out, so there's no need to pay customers for access to them.) You can recall the shares at any time, so they're still considered liquid. The only "catch" is that you can't vote as a shareholder without first recalling them.

Here are some product pages for FPL programs run by Schwab[1] and Fidelity[2]. Most (all?) large US-based brokerages seem to offer this in some form.

[1] https://client.schwab.com/secure/file/P-5182696/MKT33373-05.... [2] https://www.fidelity.com/trading/fully-paid-lending

My understanding is that this ability to lend out shares is broadly the default option for services like Robin Hood and TD Ameritrade.

I believe you need to upgrade to the premium Robinhood Gold before they can lend shares. It isn't the default, AFAIK. But a lot of people who post online about trading (selection bias) use Robinhood Gold.

Ahhh thanks. I had heard so many times about this. Everyone on WSB telling everyone to call up and get it disabled.

If you lend out shares, any dividends are taxed differently too I think.

Here is an idea of how much you'll need invested into a rarer stock or your typical retail brokerage account:

Fidelity: "*You must have at least $250,000 in your Fidelity brokerage account(s) to apply."

Schwab depends on the stock, but it seems many people get an email when they have over $100k of an eligible, especially rarer, security.

TDAmeritrade does not offer it, but they were bought out by Schwab so that will likely change as your account is transferred over.

"Interactive Brokers earns 15% annualized income from lending shares with a value of $10,000 and it posts $10,000 cash collateral to a participant's account"

Avanza supports loaning out stocks depending on the account type, it is only available on Kapitalförsäkring because otherwise the stock is in your name (on Depå / ISK). Also you get paid a premium if they loan your stocks. It is described on https://www.avanza.se/konton-lan-prislista/konton/kapitalfor... and includes a section about the risk.

Can you use ISK when living outside of Sweden, and still enjoy the low tax and no capital gains tax?

This depends on your country's tax code, but assume by default not. For example, in France, interest on savings (Livret A) is tax exempt, whereas in Sweden it's not. When living in Sweden, I had to pay taxes on French interest.

No, I'm a swede living in Germany

Awesome answer and good to know they are so transparent about this. Wish their customer service had given me the same answer.

The answer varies depending on brokerage, legal jurisdiction, and your account status(es). I wasn't able to find good English-language information on Swedish consumer financial regulation, and I suspect this particular concern is not one that is asked regularly.

That said, the following rules of thumb for American brokerages might be of interest:

* Securities held in cash accounts are not loaned out without the customer's approval. Brokers may offer a revenue-sharing agreement, for example IBKR's "Stock Yield Enhancement Program" at <https://www.interactivebrokers.com/en/index.php?f=46942>.

* Margin account agreements usually have wording allowing the broker to loan out securities held on margin. This is important for holders of dividend-producing equities in a margin account, because taxation of "payments in lieu" is different from that of qualified dividends.

* In both cases, loaned securities are covered by cash collateral. The exact percentage varies between brokers; as one data point, IBKR collateralizes the loan at 102% [0].

* Retail brokerages have insurance on the first $500k USD of assets per account, including $250k of cash, through the SIPC[1]. This is designed to protect customer assets if your brokerage enters liquidation, and although it doesn't protect loaned shares, it does protect your retail account from being impaired by another customer's short going wrong.

[0] https://gdcdyn.interactivebrokers.com/Universal/servlet/Regi...

[1] https://en.wikipedia.org/wiki/Securities_Investor_Protection...

Let’s say I have a margin account and own 100 shares of GME. My broker then lends out those shares of GME to a hedge fund. What would have to happen for me to never get my shares back? I assume if the hedge fund goes bankrupt, it’s clearing firm would be on the hook? If the clearing firm also goes bankrupt (which has happened before), then what?

They are regulated related by their local authorities US,EU etc... Each country has their own retail protection law, as far as I remember the amount changes from 100k$ up to 800k$. So if I am correct it is not based on transaction but the value of your account.

Stick to large, well known firms. In the US, that's Fidelity, Vanguard, Schwab, eTrade, ... There are few 'fintech' players that have the weighty balance sheet you'd want when major market events occur. Trades are pretty cheap, even $0 for most standard trades on Schwab[0].

[0] https://www.schwab.com/pricing

I think almost every platform made trades free in December 2019. In any case Bank of America/Merrill Edge also has free trades.

Seems like Avanza competitor Nordnet is fairly transparent about loaning out your stocks. On by default for some account types (when the stocks are not in your name, e.g. KF account type). They will give you a cut of the gains. You can chose to opt out.

https://www.nordnet.se/se/marknad/aktier/aktielaneprogrammet

In the US, even reputable shops such as Vanguard lend shares out for short sellers. It’s one way to keep the fee low for consumers. I never heard of anyone losing their shares due to short sellers.

If you are worried about that wait until you learn about Cede & Co.

On US listed stocks there is a very good chance you don’t own them at all. You just have certain contractual rights to them.

(Note: I believe the counter party risk with lending for shorts or Cede & Co custody is extremely far down the list when talking about risks in the equities market)

You can order physical delivery of certificates from them if you want, but absolutely nobody actually wants this, not least because you'll have to pay for all the silly labour involved, and pay for it all over again if you ever intend to sell what you own. It's exactly like worrying about Visa/Mastercard trying to fuck you when paying for gas in a foreign currency, while ignoring the massive convenience and cost efficiencies you receive in return. Failure of the depository system is no more likely than failure of the bond market -- and even if it did fail, the paper trail means you'd have extremely strong and obvious claims to whatever it is you happen to own. If you're worried about such critical infrastructure failing, just go live in a cave or renovated nuclear bunker, because that means cash is dead to you too.

Cede & Co conspiracy theories are a non-issue, and absolutely nobody wants the alternative, which involved fleets of bicycle couriers carrying actual physical certificates between brokers, and caused so much overhead that the US market system reached the point of total collapse prior to introduction of the depository, resulting at one point in the stock exchanges closing for one business day per week simply to allow brokers time catch up on all the paper mess.

>I asked the same two questions to my broker (Avanza in Sweden), and they haven't replied after 4 weeks.

Get a new broker. I've had some fairly complex securities questions in the past and my broker (Fidelity) always had someone on the phone to talk it out with or inquire further and get back to me.

1. Nordnet and Avanza both do this, but they let you opt out. Specifically to Avanza, if you have stocks in a kapitalförsäkring then you are automatically included and if you don't like this, you need to opt out.

2. Yes, looks like it. Have a look at https://www.avanza.se/konton-lan-prislista/konton/kapitalfor....

(Quick translation from the Avanza link: they have a security worth 105% of the value of the borrowed stocks, so if Morgan Stanley goes bankrupt, Avanza tries to buy the stocks back. If trading is stopped, or stocks cannot be bought back for other reasons, you'd be compensated monetarily.)

Other countries may of course do things differently.

My Swedish isn’t great, but is avanza saying that if you have a capital insurance then they are lending out your stocks ... that doesn’t sound like insurance at all.

I don't know what you define as insurance, but in this case it's basically something which contains things you can invest or save money to, and you get to name a beneficiary (e.g. your child/grandchild/wife/husband/etc.) who gets the money in case of your death. Plus some other details.

Otherwise it like a "normal" brokerage account, except the tax rules are a bit different, no capital tax on profit but you pay a certain percentage based on the size of the insurance (which has details like in which quartal you moved money in). Dividends are not capital taxed, there's a "template tax". Losses cannot be deducted. Etc.

Anyway, with the lending of your stocks the chance of everything going bad is very, very low, but of course it's still non-zero. I guess some people opt out not because of the inherent risk but because they don't like short selling as a concept.

IANAL

Technically you could lose shares loaned to short sellers, but it would happen under some pretty extreme circumstances. Basically, the short seller would have to go into default and be unable to return the shares; then, your brokerage would have to also be in default and be unable to buy the shares needed to return them to your account. I have never been in this situation but I think most brokerages would try to offer a cash settlement for the lost shares. If the brokerage is bankrupt and was unable to transfer your account to a solvent brokerage, then, as far as I know, you would be a creditor during the bankruptcy proceeding and would be "first in line" i.e. you would have to be paid before the bond- or stockholders of the company.

To compensate for this sort of risk short sellers must make interest payments, and usually brokers will share the interest payments with the client that they borrowed shares from (and thus the client must know the shares are being loaned).

[EDIT: Looked it up, should have done this beforehand; if your brokerage is in default, you would be entitled to withdraw the collateral the brokerage had deposited for the loaned shared.]

If you really care about this you must also pay attention to funds you hold, as (AFAIK) the vast majority of providers earn extra yield by lending out their holdings

https://www.investopedia.com/investing/role-securities-lendi...

> BlackRock, Inc. (BLK) managing director for securities lending Jason Strofs indicates that this is a significant business: "about $3 trillion of our assets we consider lendable, which consists of iShares ETFs, mutual funds, collective trusts, and separate accounts," he says. "Across that $3 trillion, roughly 9% of those securities are out on loan on any given day."

SLB is a double-edged sword, for example since it increases float it may also work to reduce spread, reducing transaction costs for everyone

It's a common practice for big brokers to have a custody option where your securities are held separately (as far as you are concerned), but usually it comes with more fees. If you don't want to take the risk of brokerage lending, then you have to enable custody and agree to have some extra fees.

Whether the benefits will outweight or not depends on your investment habits and which brokerage you use.

I'm not sure, but I think Degiro offers several account types, and at least one of them (custody) doesn't allow that type of behavior.

https://www.degiro.co.uk/helpcenter/faq/profiles/1068

You can opt out/opt in of stock borrowing on Avanza, there’s a setting.

1. You can’t easily.

2. All of the money you invest.

There's only one thing that grows in someone else's hand, and it's not money...

I’m not a lawyer but own a number of shares in a number of companies through IG in the UK.

Since you don’t really own the shares, the broker (in my case IG) hold them on my behalf in a ledger that simply allocates the shares to me then I imagine they can do what they like with the shares. So long as the money is there when you want to liquidate it then it’s irrelevant to some degree.

In the UK the value of the shares I believe is fenced off in a separate entity so that should the broker go bankrupt the money is still there for shareholders (ie shares bought in the platform, not shareholders in the brokerage) and inaccessible to creditors, this was tested in the high court in the UK recently when the administrators tried to use this ring fenced money to pay their fees as the broker couldn’t pay it themselves and the ring fence was upheld by the court.

Not sure if any of this helps but it’s good to remember you don’t actually own the shares, they are held by someone else and they can probably do what they like with it.

I have evidence that in Sweden you actually own the shares. I actually got a personal letter (read "paper delivered to my mailbox") from the CEO of SAS AB (the Scandinavian airlines).

Cool, then yes you should definitely care what your brokerage is doing

In EU there are strict financial regulations about custody. Brokers are not allowed to do anything to your shares without your instruction. So, for example, if the broker goes bankrupt, the custody account with your shares is still there for you.

I assume it is still the same in the UK post-brexit, but I have not looked it up.

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