Brokerage company bankruptcy: causes and consequences

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Brokerage company bankruptcy: causes and consequences

 

The bankruptcy of brokerage companies often becomes a real financial meltdown for their clients. It would seem that yesterday you were the owner of a solid amount of assets and felt almost Warren Buffett. And today you’re hurting the threshold of a brokerage firm in the hope of getting at least some of your money back. What is the reason for such financial collapse? And are there any signs that would allow us to identify future financial problems on the investment horizon?

The main reasons for the bankruptcy of brokerage companies

The only reason for the bankruptcy of a brokerage company may be the lack of funds of traders on its accounts. But how could that be? Actually, it’s pretty simple. The scheme of investing in Forex does not differ much from the principles of global investment. And the principle of “money should work” has killed more than one broker in this world. After all, withdrawal of funds from the accounts of their investors for the purchase of bonds or their circulation for other purposes (margin lending, repo, purchase of shares) “sin” not only unknown brokers, but also the largest companies and dealing centers operating around the world

What does such a borrowing scheme look like in practice? Let’s say there’s a million dollars in the broker’s clients’ accounts. And about 10% of them are actively used – this share is accounted for by operations of small investors – speculators. Large traders prefer to place their funds for a long term and with minimal risks – they account for about 20% of the total capital. As a result, deadweight assets are formed and there are many of them. Of course, the temptation for any broker will be too great sooner or later. And he will put his hand in this “mutual fund”, in most cases justifying his actions with good intentions. And for the time being, it’ll be quite safe and even profitable. And then there’s going to be an inevitable collapse

Learn more about the types of fraud brokers are involved in and how to avoid working with such companies in the article “Self-defense lessons: Forex fraud”

How is the bankruptcy process going?

It all starts with the fact that the clients give the broker requirements that he actually can not fulfill. There are many reasons for massive capital outflows of investors: a change of financial orientation, urgent cash needs, the impact of global financial risks (economic crises, defaults, etc.), and the sale of assets due to a change of activity. But the fact remains: sooner or later, a broker who manages clients’ funds without their knowledge will receive claims that he will not be able to meet due to lack of funds in his accounts

Of course, the broker can somehow solve the problem. For example, to urgently sell available securities, resell debt obligations, cancel the margin deal, withdraw borrowed funds from circulation. But, as practice shows, it is almost impossible to do it in the shortest possible time

And if such requests for urgent withdrawal of funds from accounts become avalanche-like, bankruptcy of the brokerage company becomes inevitable. And extremely dangerous for those investors who will be among the last to apply for reimbursement

Brokerage company bankruptcy: real-world examples

The most famous example of bankruptcy of a major brokerage organization is the collapse of MF Global, one of the largest brokerage holdings in the North American states. The news that the company has debts to investors in the amount of about $40,000,000,000,000 shocked the world community. And plunged into the stupor of those who managed to entrust their money to a bankrupt investment giant.

What was the cause of the disaster? According to some data, the brokerage holding has dragged European debt bonds into the debt hole, which have become cheaper literally in front of our eyes for a long time. But deeper market research shows that the company has had serious financial problems for a long time. And she was really trying to find a way out of the crisis. However, there were no investors willing to become a financial guarantor for MF Global, which is in distress. And the actions of the company became the reason for increasing the number of requests for withdrawal of funds. Which only accelerated the onset of bankruptcy.

The history of the PFGBest brokerage company is no less instructive. The bankruptcy announced in 2012 was preceded by two years of fraud, with accounts covering the obvious facts. Instead of the declared 220 million dollars in the accounts remained hardly more than five million. And the involvement of bank employees as well as representatives of regulatory organizations in the scam (for example, CTFC did not find any violations during the inspection). At the end of the scam, the NFA demanded that the company’s reports be submitted electronically rather than in paper format. After that, it was revealed that for two decades, the reporting of the brokerage company was not in accordance with reality

Read about the reasons for the deplorable situation of Forex MMCIS group, which at the time of publication of this material (October 15, 2014) was on the verge of bankruptcy, in the article “Financial problems of Forex MMCIS group: bankruptcy or collapse of another pyramid?

Brokerage company bankruptcy, why is that happening?

In fact, there is nothing unexpected about bankruptcy of brokerage companies. It is enough to study most of the financial crash stories to understand that they are all linked by one common factor – the availability of investor funds to engage a broker or other investors

Simply put, if you haven’t taken care to limit the movement of funds on your deposit only to your own operations, don’t be surprised that sooner or later you will get a refusal to withdraw them

Can we keep ourselves safe? Yes, you can, if you carefully study the brokerage reporting of the company you are interested in. Did you find out that the real volumes of assets are much less than the declared ones (for example, the funds of investors – by 10 million, but only one million is actually used)? This indicates that the broker can currently cover only 10% of its liabilities. And in order to declare it bankrupt, it will be enough to demand compensation in the amount exceeding the current deposit amount. Not ready to take the risk? Trust those companies that demonstrate the greatest financial responsibility and do not have debts that cannot be covered at the time the creditors apply

Learn more about the basic rules of choosing a brokerage company in the article “How to choose a broker?