This bizarre rule in the US is a huge risk to your investments
By Simon Black, republished from SovereignMan.com - March 10, 2016

Human beings have come up with some crazy ideas for money and finance over the years.

Conch shells. Beads. Animal skins. Salt. Rice. All of these were used as a form of money at one time or another.

But the strangest by far has got to be the Rai Stones of Yap Island.

Yap is a tiny speck in the western Pacific, a few hours by plane from the Philippines and Guam.

Long ago, islanders began using gigantic limestone discs called Rai Stones as a form of money.

Rai Stones were large– the size of a mid-sized car– so they were seldom moved.

And they could be anywhere… at the bottom of the ocean, in the middle of the jungle.

So rather than roll your Rai Stones down to a local bank, or pile them up in the back yard, everyone on the island just sort of knew who owned which Rai Stones.

And whenever there was a transaction, word got around that ownership of a particular Rai Stone had changed hands.

It was crude, but it worked.

This is the hallmark of any well-functioning financial system: the ability to properly account for private property ownership.

Think about it– when you buy a house, there’s a deed that’s recorded in the local clerk’s office. When you buy a car, a certificate of title is issued.

This makes the chain of ownership very clear and unmistakable. You know with 100% certainty that whatever you buy is exclusively yours.

But strangely enough, this isn’t the way it works when you buy stocks in the Land of the Free.

There’s a concept in the US financial system called “Street Name Registration”.

This means that when you open a brokerage account and buy shares of Apple, your broker registers those shares in THEIR name, not yours.

In other words, your broker officially owns the shares.

On their internal books, the broker maintains a liability that they owe you the shares. But the Apple stock isn’t your asset. It’s the broker’s.

The reason they do this is convenience. It’s easier for them to buy and sell stock on your behalf if the shares are held in their name.

This strikes me as totally ludicrous.

Imagine if when you buy a new car the dealer registered the title in HIS name instead of yours; or if your home was held in the name of your real estate broker.

This makes no sense. Financial securities should work like any other asset: when you buy it, it’s yours. Simple.

That’s how it works here in Australia, where they have a system of direct ownership; it’s called the Clearing House Electronic Sub-register System, or CHESS.

That’s a fancy way of saying that, in Australia, when you buy or sell stocks, ownership of the shares passes to you directly.

The database is maintained electronically, and brokers have no control over these records.

This ensures there is no feckless intermediary standing between you and your assets.

It’s such an easy concept– to actually own the stocks that you buy. But that’s not the way the financial system is set up in the US.

The even bigger issue is that Street Name Registration in the US leads to serious problems whenever there’s financial turmoil.

Banks and brokers have a bad habit of ‘borrowing’ from their customers. They call it ‘hypothecation’ and ‘re-hypothecation’.

Essentially, brokers routinely take the shares that they’ve purchased on your behalf (and registered in their own name) and pledge them as collateral in other deals over and over again to boost their profits.

Assuming everything else goes OK, problems seldom arise.

But as soon as the financial system hits a speed bump (like it did in 2008), it can get very bloody for the original investor who put up the money.

Bottom line, you might not own what you think you own.

And given all the serious challenges facing the financial system, it makes sense to pay attention to how your investments are registered.

It may be worth checking with your broker to see if you can do ‘direct name registration’, whereby they re-title the investments in your own name.

This would help ensure that if your broker ever ran into trouble down the road, you would still have control of your assets.

You might also want to consider investing in better jurisdictions like Australia where you can have a lot more certainty over the assets that you own.

Besides, there are plenty of great investment opportunities down here.

The Australian dollar is at a multi-year low against the absurdly overvalued US dollar. So assets are already quite cheap.

Besides, the commodity recession has pushed valuations so low that many Australian companies are trading for less than the amount of cash they have in the bank.

This has been a winning investment strategy for us (and premium members), with returns in excess of 30%. More on this another time.

You don’t have to play by the rules of the corrupt politicians, manipulative media, and brainwashed peers.

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  • tom

    “On their internal books, the broker maintains a liability that they owe
    you the shares. But the Apple stock isn’t your asset. It’s the broker’s”.

    Isn’t this exactly analogous to the situation with regard to bank accounts? As I understand it, the moment you make a deposit, that money belongs to the bank. It merely owes you the money as a debt – but that debt can come a long way down the list if the bank goes out of business.

    It seems to me simple enough. The financial industry – all of it, from top to bottom – is run entirely in the interests of those who own it. What security there is, accrues to them – not the client. What profits are made, accrue to them. If there is a surplus left over, the client may get it. If there is a deficit after the financial corporations get their profit, then that’s what the client gets instead.

    It’s all good when you have a state-imposed oligopoly.

  • rmp

    It’s ridiculous and why some talk of revolution. The very idea that we don’t own anything gives one pause about anything. It’s all nonsense and why so many are upset.

  • WinChll

    DB –
    are you familiar with CEDE & Co.? Even the broker does not have physical ownership.
    Gone are the days of actual stock certificates.

    • Sarah Bailey

      what? I have a stock certificate in my file drawer right now. Is it not valid?

  • Wow

    I had no idea

  • richo345

    Holding Your Securities—


    Get the Facts

    As an individual investor, you have up to three choices when it comes to holding your securities:

    Physical Certificate — The security is registered in your name on the issuer’s books, and you receive an actual, hard copy stock or bond certificate representing your ownership of the security.

    “Street Name” Registration — The security is registered in the name of your brokerage firm on the issuer’s books, and your brokerage firm holds the security for you in “book-entry” form. “Book-entry” simply means that you do not receive a certificate. Instead, your broker keeps a record in its books that you own that particular security.

    “Direct” Registration — The security is registered in your name on the issuer’s books, and either the company or its transfer agent holds the security for you in book-entry form. The “Direct Registration System” (also known as “DRS”) allows investors to transfer securities held this way. For more information about DRS, please see our Frequently Asked Questions below.

    Direct Registration

    If a company offers direct registration for its securities, you can choose to be registered directly on the books of the company regardless of whether you bought your securities through your broker or directly from the company or its transfer agent through a direct investment plan. Direct registration allows you to have your security registered in your name on the books of the issuer without the need for a physical certificate to serve as evidence of your ownership. While you will not receive a certificate, you will receive a statement of ownership and periodic account statements, dividends, annual reports, proxies, and other mailings directly from the issuer.

    The advantages of direct registration include:

    • Since you are “registered” on the books of the company as the shareholder, you will receive annual and other reports, dividends, proxies, and other communications directly from the company.

    • If you want to sell your securities through your broker, you can instruct your broker to electronically move your securities via DRS from the books of the company and then to sell your securities. Your broker should be able to do this quickly without the need for you filling out complicated and time-consuming forms.

    • You do not have to worry about safekeeping or losing certificates, or having them stolen.

    The disadvantages include:

    • If you choose to buy or sell registered securities through a company’s direct investment plan, you usually will not be able to buy or sell at a specific market price or at a specific time. Instead, the company will purchase or sell shares for the plan at established times — for example, on a daily, weekly, or monthly basis — and at an average market price.

    While it is solely your decision how to hold your securities, you should carefully review each of the alternative forms of security registration and should consult with your financial advisor or broker-dealer to determine which form is best for you.

    • Thanks.

    • while these are your legal options is it not the case that the vast majority of brokerages work on a street name basis, and are not really all that interested in educating their clients on the details of this issue? For obvious self interest reasons. So most people wind up in an arrangement that they are not even aware of? I may be wrong but I think this is Standard Operating Procedure these days.

  • martae

    I own most of my non IRA shares by direct registration.