by elmads

Introduction

Due to the recent FTX exchange fiasco, the confidence in cryptocurrencies around the world have plummeted. People are now questioning the integrity of not just the remaining cryptocurrency exchanges such as Binance, Coinbase and Kraken and, but also the whole industry itself.

This is completely understandable, as a lot of individuals have lost substantial amounts of their life savings within a couple of days. Just imagine, your hard-earned money that you’ve placed in an exchange – which you thought was safe and legitimate, because a lot of people globally use it, and was even endorsed by popular athletes and celebrities – evaporated in thin air.

The damage has been done, and because of this law suits were filed against the management and founders of FTX, including the celebrities, athletes and “Financial social media Gurus/Experts” who endorsed the said exchange.

As sad and heart-breaking as it is, these events of financial and corporate fraud will always be a part of our world. Individuals or group of individuals who love and want money so bad that greed has always been their companion.

Financially misleading others and playing/gambling with other people’s money (in a nefarious way) are just fulfilling and thrilling for them. This is the world that we have, persons having these kinds of intent and frame of mind.

As ordinary citizens of this world, how could we still invest our hard-earned money – make our money work for us – if fraud and deceit are everywhere? how could we mitigate the risk of not losing our hard-earned money from such deception?

Do We Really Need Market Brokers?

The answer is yes. They’re an integral part of various markets around the world, whether it be in insurance, real estate, stocks, commodities, and even art. Brokers are and will always be part of the markets whether we like it or not.

In the marketable securities exchange, ordinary individuals cannot directly invest and access the exchange without having a brokerage account. Therefore, to be able for us to invest in stocks and bonds, we must register and open a brokerage account.

Brokers are the middle man between the market and the market participants.

In the stock market, brokers act as an intermediary between an investor (Retail & Institutional Investors) and the stock market exchange (e.g., New York Stock Exchange, London Stock Exchange and Philippine Stock Exchange) with the purpose is to execute financial transactions based on the decision of their customers. By doing this, brokers get a commission fee for every transaction they execute (Buy & Sell orders).

Before someone can be a broker, a qualification and a license must be secured first. Individuals need an undergraduate degree in finance, business, mathematics, economics, or accounting related degrees. While, for starting a broker company, the founders would need tons of license and authorization first. And, one of the most important authorizations they need to have is with the Securities and Exchange Commission (SEC) of the country where they operate.

Marketable Securities (Stocks, Bonds & Money Market) investment broker firms have two common services that they offer, the Full Service and Discount.

1. Full Service Broker – As the name implies, this type of broker gives all of the services that a broker can offer to anyone such as basic trade execution, investment and tax advices, market research, wealth management, portfolio management, and retirement planning.
2. Discount Broker – These types of brokers are the popular no-commission fee brokers of today. They only execute orders from their clients. They don’t offer any investment, market research and portfolio advisory services, hence the lower fees.

There are other types of brokerages out there like the Forex Brokers, where they only execute their clients’ buy and sell orders relating to foreign exchange rates.

How Investment Brokers Make Money

In the recent paragraph, I shared how brokers make money through fees, but I didn’t specify what are those fees.

1.) Transactions/Commission fees – usually it is the difference between the buy and sell spread price of an asset that their client trades.

2.) Holding costs – Not all brokers have this. Basically, it is a custodian like services. It is like with banks, where you need to pay them money for keeping safe your deposited capital within their account.

3.) Research fees – these fees are for the advisory services they provide to their clients. Only applicable for Fully Service Brokers, and only if you availed such service.

4.) Risk-Management costs – some brokers will have “Stop and buy order limits”, where they’ll automatically buy or sell an asset depending on the instruction you have set. Let’s say you’ve bought Apple Inc. shares at $140/share, then you set a sell order at $200, this means that when the stock price of Apple reaches $200/share, your broker will automatically sell your Apple shares. The same applies for the Buy limit order.

5.) Foreign Exchange fees – Some global brokers handle foreign exchange rates. For example, you live in France where your local currency is Euros. You then invested in a global broker that has access in different stocks around the world. You then placed your Euros in the exchange and purchased a stock in Japan that only accepts Japanese Yen. The broker in this case will also handle the Euro to Japanese Yen foreign exchange rate, and with that they’ll get a forex fee on top of the transaction fee.

Brokers are somehow like banks, where we deposit money with them in exchange for a small interest. Subsequently, banks will utilize our deposited money to make more money through a mix of lending, investments in different market securities, use it with leverage and others more.

It doesn’t concern us what banks do with our deposited money in our savings account as long as they’ll be able to return it fully once withdrawn.

With brokerage firms, we place money in an account for investment purposes (buying and selling marketable securities or assets). We trust our brokers to keep safe our money that has not been invested yet (cash not yet used to purchase stocks, bonds and money market funds, instead stored in a broker account as cash), and honour our investment decisions.

That being said, how will we know if we can actually trust a certain investment broker? how will we reduce the risk of losing our hard-earned money, not directly because of volatility or our own investment decisions, but from an investment brokerage fraud?

Simple Ways to Know if an Investment Brokerage Firm is Legal or Not

1.) It is by understanding and accepting that there will always be fraud everywhere. It’s not just in the financial industry, but in other industries as well. We have to accept this fact, and this will never go away as deceit and fraud have always been a part of the world since human beings learned to record history.

You see, by acknowledging this, we are be able to take actions to further reduce the risk of getting connected and/or take fraudulent investment brokers. It’s through finding ways to get familiarized with the red flags that could differentiate the fraud from the legitimate ones. By taking this path we get to learn more and understand some of the things we didn’t even know existed before.

• https://elmads.com/?p=3272 – Popular Financial Scams
• https://elmads.com/?p=3309 – The Pyramid Scheme

2.) Check if the investment brokerage firm is registered under Securities and Exchange Commission (SEC) of your country.

The SEC oversees securities exchanges, securities brokers and dealers, investment advisors, and mutual funds in an effort to promote fair dealing, the disclosure of important market information, and to prevent fraud.

For instance, the investment brokerage I use for my Philippine equity investment is Col Financial Philippines. It is a brokerage firm registered in the Philippine Securities Exchange Commission. (See photo and link provided below)

3.) Check if the brokerage firm has any released company reports and financial statements (Annually, Interim or Quarterly). Not all brokerage firms publicly share this information, most especially if it is a privately owned brokerage company.

In Col Financial Philippine’s case, it is a publicly listed company in the Philippine Stock Exchange. This means that anyone can access its corporate and financial reports through its website. By doing so, we can further understand what the company does and how they make money, which could help us decide if it is a trustworthy brokerage firm.

If a brokerage firm is a publicly listed company, then its shares are listed in a certain market exchange where it is being bought and sold by both investors and traders. With Col Financial, the shares of the company is listed and traded in the Philippines Stock Exchange. (See photo and link provided below)

The following below are my blogs where I share how I research a public company from scratch.

• https://elmads.com/?p=7348 – How to Understand a Public Company from Scratch
• https://elmads.com/?p=7407 – Understanding a Public Company from Scratch – MD&A & Financials
• https://elmads.com/?p=8918 – My Simple Investment Checklist
• https://elmads.com/?p=8992 – My Simple Investment Checklist with Greggs PLC

What if the Brokerage Firm is not a Publicly Listed Company?

As what I’ve written previously, not all brokerage firms share publicly their corporate and financial reports.

This is where you need to make your own risk assessment and ultimately your own decision. Will it be okay for you to not have any sufficient information regarding the brokerage firm where you’ll place your hard-earned money in order to buy and sell marketable securities?

If you do really want to use a specific broker because it has “zero-commission”, then try to keep on searching for further information and proof of its legitimacy and trustworthiness.

NOTE: Some private brokerage firms are start-ups that are funded by Venture Capitalists. These young start-up brokerage businesses release and share their company information online.

Here in the UK we have Trading212 and Freetrade who share their reports publicly despite not being a publicly traded company. Why? start-up companies tend to need funding from institutional investors in order to grow. Making business and financial reports could help potential institutional investors to know more about their small start-up and increase the chances of attaining more funding.

https://find-and-update.company-information.service.gov.uk/company/09797821/filing-history – Freetrade reports

https://find-and-update.company-information.service.gov.uk/company/08590005/filing-history – Trading212 reports

4.) Check if your chosen brokerage firm is registered or part of any scheme that protects your cash held in your brokerage firm account.

As an example:

In the Philippines they have The Securities Investors Protection Fund Inc (SIPF). It was created to protect investors against losses in case of fraud, failure or insolvency of a member broker/dealer. Col Financial Philippines is a member of SIPF. This means that The cash balance that you have with COL is insured through the SIPF up to 100,000 pesos only. Please note that this limit only applies to the cash balance in your account and not your mutual funds, stocks and bonds holdings.

In the UK we have the Financial Services Compensation Scheme (FSCS). It is the UK’s statutory deposit insurance and investors compensation scheme for customers of authorised financial services firms. This means that FSCS can pay compensation if a firm is unable, or likely to be unable, to pay claims against it.

Both Freetrade and Trading212 online brokerage companies are FSCS protected.

Below is the statement from Freetrade regarding their FSCS protection for their client.

In the unlikely event of our bankruptcy, our clients’ assets are protected in a few ways. Firstly, our client asset arrangements mean that any client assets should not be available for administrators to cover Freetrade’s outstanding debts. 

And as a regulated UK financial business, all deposits and investments with us are covered by the Financial Services Compensation Scheme (“FSCS”).

The FSCS can award up to £85,000 in compensation to any one investor where they decide that an investment business is in default and is unable to satisfy any claims against it. You can find out full details on the FSCS by visiting their website here.

You can contact them on 020 7741 4100 or 0800 678 1100 or write to them at FSCS, 10th Floor, Beaufort House, 15 St Botolph Street, London EC3A 7QU.

https://freetrade.io/blog/keeping-client-money-safe

ADDITIONAL INFORMATION: What happens to your stock holdings if your chosen brokerage firm undergoes bankruptcy?

5.) Check if there is a protection placed for your marketable securities holdings (stocks & bonds) in the event of a bankruptcy of your chosen brokerage firm.

In the Philippines: “Let’s say that you have 1 million pesos worth of PLDT stocks with COL and COL closes down, all of your PLDT stocks are safe. Remember that COL is only a broker (or an agent) and they don’t physically hold in their possession the stocks purchased by their clients. Stock brokers in the Philippines are required by law to lodge or deposit the shares purchased on behalf of clients with the Philippine Depository & Trust Corporation (PDTC) as custodian.”

https://allicanhandle.blogspot.com/2014/02/what-happens-if-your-stock-broker-in.html

In the UK. Using Freetrade broker as our example. See their statement below taken from https://freetrade.io/legal/keeping-your-money-safe.

Your stocks are protected in nominee accounts or at approved third-party custodians. When you invest with Freetrade, any UK-listed stocks or ETFs that you buy are held by Freetrade Nominees Limited, which holds stocks and ETFs, with you as the beneficial owner. The stocks and ETFs are held in CREST, which is the UK’s central security depository.

Freetrade Nominees Limited is a non-trading company. That means it can’t run up liabilities of its own and can be shielded from any liabilities that Freetrade Limited accrues.

All of this is done so that, in the unlikely event of Freetrade failing, the company’s creditors will not be permitted to use your investments to cover Freetrade’s liabilities.

When you invest in US-listed stocks, we hold them in custody at a third-party SEC-registered broker (the Security and Exchange Commission, which regulates US securities markets). Our customers’ stocks are held in a designated customer account at the broker, and cannot be mixed with Freetrade’s own assets or used to settle our debts. Similar to the UK securities being held in CREST, your US stocks are ultimately held in DTCC (Depository Trust & Clearing Corporation). Currently, some customers’ US stocks are still held by Freetrade Nominees Limited in CREST, but we are in the process of fully migrating US stocks to our third-party broker.

To Sum It Up

Protect your hard-earned money from possible fraudulent investment brokers by

1. Understanding and acknowledging that there will always be fraudulent brokerage firms.
2. Check if the brokerage firm is registered under your country’s Securities and Exchange Commission and other government agencies.
3. Check if the brokerage firm has any corporate and financial reports (Annually, Interim or Quarterly)
4. Check if your chosen brokerage firm is registered or a part of any scheme that protects your cash held in your brokerage firm account if ever they undergo bankruptcy.
5. Check if there is a protection placed for your marketable securities holdings (stocks & bonds) in the event of a bankruptcy of your chosen brokerage firm.

This is for investing in marketable securities (stocks and bonds). But how about with cryptocurrencies? how do we protect our hard-earned money in an emerging asset class that doesn’t have any multiple and strong government regulations yet in place?

Next week Monday the 19th of December, I’ll be posting the continuation of this blog titled “How to Protect our Digital Assets as a Cryptocurrency Investor”.

Knowledge is my Sword and Patience is my Shield,

elmads

This blog is for informational purposes only and not a Financial Recommendation. Not all information will be accurate. Consult an independent financial professional before making any major financial decisions.