Liars & Margin & Banks, Oh My!
Smoke, Mirrors, Lies, and Distractions
One of the Uniform Law Commission’s (ULC) primary objections to amending Article 8 of the Uniform Commercial Code (UCC) is that the amendment would eliminate margin accounts and securities lending. This is not true; it is at best a distraction.
Our team recently testified at an Oklahoma legislative hearing on this issue and the ‘margin account’ argument was the main issue in the written statements provided to the committee by the ULC and SIFMA (Securities Industry and Financial markets Association). We will post a link to the Oklahoma hearing on this Substack.
Margin accounts and securities lending have been around for over 100 years, margin accounts were not created by the 1994 Amendment to UCC Article 8, in fact the terms ‘margin account’ and ‘securities lending’ do not appear in this statute. Margin accounts will survive with or without UCC Article 8.
Margin Account
So, what is a margin account anyway? If you have an investment account with your stockbroker, you may be able to borrow money from your broker using the stocks and bonds in your account as collateral – this is a margin account. There will be a separate written (loan) agreement between you and your broker that sets out the terms of the loan. This loan agreement will cover what happens to your investments if you do not pay back the margin loan. But what happens if your broker or your broker’s custodian becomes insolvent? Will you get your investments back? Stay tuned.
Interestingly, an earlier draft of the 1994 UCC Article 8 Amendment included the term ‘margin account’ in Section 8-511(b), but this wording was removed in the final version that was presented to the states for ratification. Why was that term removed?
Here is the wording of section 8-511(b) the earlier draft:
(b) "a secured party has priority over claims of the securities intermediary's entitlement holders if (1) the secured party has control over the security or securities entitlement; or (2) the entitlement holders' claims are for securities carried in a margin account.” (emphasis added)
And here is the wording that appears in your state’s UCC Article 8-511(b) today:
(b) A claim of a creditor of a securities intermediary who has a security interest in a financial asset held by a securities intermediary has priority over claims of the securities intermediary's entitlement holders who have security entitlements with respect to that financial asset if the creditor has control over the financial asset.
Clear Wording
The clear wording of the current law in your state does not mention ‘margin accounts’ and it certainly does not limit the risk of loss you face to a margin account. The earlier version of this section shown above includes the word ‘or’ and then refers to a margin account. If margin account were the only type of account that is at risk, why not just say that? The current law puts all of your accounts at risk. And this was understood by the drafting committee for the Article 8 revision.
This is from the official Code Comment in the Oklahoma Statute referring to this section in 8-511:
“Thus, unless they acted in collusion with the dealer, persons who provide secured financing to securities dealers and obtain control of the particular financial asset are not subject to the risk that the dealer was acting wrongfully as against its customers. See UCC § 8-503(e). In this situation, the customers may have rights under the Securities Investor Protection Act.” (emphasis added)
Comforting, no?
Also, it is important to stress that not all accounts are eligible for a margin loan. Your IRA or 401(k) is not eligible for margin loans and these two vehicles hold the vast majority of investments for us ordinary folks. A very small minority of investors with investment accounts actually utilize margin loans. Yet this threat is at the top of the list for those who are fighting our efforts to protect your property.
But, since the ULC brought up margin accounts we should point out how they work. Investors may not be aware that the common margin account agreement that you sign gives the broker the right to repledge your shares when the broker borrows money from a bank. So, what happens if the broker can’t pay back the loan? The broker’s bank takes the shares. Even if you then pay back the loan from your broker you will not get your shares back because they are gone. You have a contract claim against your broker under your margin loan agreement, but if the broker is bankrupt, you will be lucky to collect pennies on the dollar. SIPC insurance coverage may not be available in this situation because there are no shares in your account to for the insurance to cover. (I will address the concerns about SIPC insurance coverage in a later post.)
Every Account is a ‘Margin Account’
A main point of The Great Taking is that under our financial system today every investment account is treated like a ‘margin account’ in that the shares in your account are used as collateral by your broker or one of the financial service providers that your broker works with. If the next financial crisis takes out these financial service providers your shares will be gone, just like the example of a margin account.
Securities Lending
The securities lending argument also lacks legs, but the backers of the current law use it to confuse and deflect. Securities lending is when one investor loans their stock to another investor, usually for a short term. Again, this requires a separate written ‘loan’ agreement between the parties and that agreement will control the transaction whether UCC Article 8 exists or not. This primarily affects large institutional investors and, again, your IRA and 401(k) is not eligible for securities lending. Another red herring.
Call the Bluff
If legislators want to protect margin accounts and securities lending the proposed amendment to UCC Article 8 can easily carve out these two exceptions. It was done in an earlier draft of the 1994 UCC Article 8 Amendment and we can do it again.
In fact, it may be a good idea to do that because when the ULC and bank lobby continue to oppose amending UCC Article 8 to protect investors it will reveal that something else is at stake. Removing the fig leaf will expose the true agenda.
Armageddon Planning
Again, as pointed out in an earlier post, the stated purpose of the 1994 UCC Article 8 revision was ‘Armageddon Planning’ for the financial sector. Nothing about margin accounts or securities lending has anything to do with Armageddon planning – it is smoke and mirrors. If anyone deserves Armageddon Planning it’s you, the investor.
It is 2030 2024 and you will own nothing, and you will (not) be happy.