During the crisis of 2002 (in the southern cone of South America) several banks and other financial entities faced liquidation. For different reasons, the crisis involved entities from several countries, including Brazil, Paraguay, Argentina and Cayman Islands.
The referred liquidations helped to identify important loopholes regarding investments in securities done through the private banking divisions of said entities.
We will not review them all; however, we will go through some general aspects, common to all of them, to try to find an answer to the heading question: "Easy to invest, as easy to recover?"
Of course, you already know part of the story. You work, you save some monies and sooner or later you want your own portfolio. That is for sure. The pros and cons, including the benefits, should be brought by the broker, usually your bank through the private banking division.
Governmental bonds, shares, commercial papers, participations in funds, hedge funds, etc; some look attractive, some conservative but, at the end of the day, the debtor’s risk or the company’s performance is all that matters. Higher risks, higher earnings, this seems to summarize it all.
But, is this all you need to know? Surely, not.
Have you ever thought how you will recover your securities in case the bank faces liquidation? You do not hold your securities, your bank does. And, who knows your securities are yours and not assets of the bank? Of course, you do. But, are creditors of the bank ready to accept that the securities are yours and not assets of the liquidated company? Why should they do that?
Let’s think about a more complex, and at the same time, everyday scenario.
You instruct your bank to invest in bonds. The broker acquires them for you at your risk and furnishes you with a document which acknowledges the investment was accounted in your custody account.
However, said document does not necessarily prove your title to the security. It only evidences the bank acknowledges holding said security on your behalf.
The reason for this is that, in between the debtor and you -the security holder-, there might be several banks/brokers operating, each of them having registered the same securities on behalf of others, until the last one, who has it registered in your name. This last is your bank/broker.
By way of example, suppose now that, as part of the referred structure, your bank/broker (bank A) has registered your securities in his custody account with a correspondent bank (bank B).
Suppose now, that bank A faces bankruptcy. Surely, you will then claim bank A to return back your securities.
In principle, there should be no problem in obtaining back your securities. Custodies held for third parties are neutral transactions; consequently they are neither assets nor liabilities of the bank, and therefore they should be returned back to its real owners, disregarding whatever occurs with the liquidation.
But, what happens if creditors for bank A attach the custody account held by bank A with bank B?
Should judges require further evidence before granting an attachment over a custody account, or should they assume that all and any securities registered within that account pertain to the custody account holder (bank A)?
Under regular circumstances these questions would not require any answers. However, as expressed, bank liquidations have caused important conflicts in this area.
On one side, custody account holders appeared claiming back their securities and stating that they were not creditors for the liquidated entities, just custody holders, and consequently, they were not supposed to take any risk of the bank. This was, and still is, theoretically true.
On the other side, creditors of the liquidated entities claimed that those securities were assets of the liquidation and therefore they should be sold to pay depositors.
As a consequence, liquidated banks holding said securities in the interest of custody account holders were forced to disclose full name of its clients (the real owners); otherwise, they could not defend the securities from the attachments requested by its creditors.
A doubt arises immediately, is this a legitimate exception to bank secrecy?
It seems, at least, that most custody owners should be glad the liquidated bank has tried to protect their securities from being attached or confused with the assets subject to liquidation. But, what is protected at the end of the day with bank secrecy? Is it acceptable an infringement of said secrecy to defend securities?
On a simplified perspective, the whole situation may be clarified by means of analyzing the accounting statements of the liquidated bank, since this should reflect not only the assets and the liabilities, but also the neutral transactions, such as the securities hold in custody for third parties.
Then, this could be reconciled with information of securities in custody accounts held with other entities and provided by these other entities, thus enabling to identify where each security is allocated.
This may arise quite easily when the situation deals with a liquidated bank with updated accounting statements, audited and/or controlled by a regulatory agency, usually the Central Bank. On the contrary, it is not that easy when liquidation is faced after complicated processes of fraud and asset diversion from the liquidated company. If so, those accounting statements will probably not be of much help.
Suppose the accounting statements are regular and fortunately, you are able to evidence that your assets were acknowledged by the bank to be held in trust in your interest, thus not being assets of the bank. If the assets are yours, then creditors of the liquidated bank cannot attach them or pretend to recover from them. This would surely be a very important step, but unfortunately, still not enough.
Just think about it. Your custodies are, for example, US treasury bonds, but, who else holds US treasury bonds? Maybe ten more clients do. If your bank - now in liquidation - has held those bonds with several correspondent banks, which are yours and which are those of other custody account holders? If only some of them are attached by third parties, are those yours or the ones pertaining to other clients?
Let’s think it the other way round. You are now a creditor of the liquidated bank and you have attached securities held by the bank with a correspondent bank. The liquidated bank – your debtor- states then that the securities attached pertain to clients and that, consequently, they should not be attached. Maybe the bank can even provide affidavits from its clients claiming title to those securities, in support of his response.
If so, surely you will be ready to release the securities since you want to recover from the bank and not from other clients. However, if the bank has a position on US Treasury bonds, how do you know the securities attached are those of other clients and not an investment of the bank? Can those securities of the clients be held on other accounts of the bank with other correspondent banks?
The universe of possible situations is really very wide. It is strange how something apparently that simple can suddenly become so complex.
Dealing with securities has become familiar and apparently clear to all players involved. However, as expressed, the liquidation of several entities that had actively operated in the private banking area has demonstrated there were plenty of situations not easy to address.
In facing all the above described problems and similar others, the only way out has always been to gather all possible information and above all, to explain and further explain how the system works, which is the role played by each of the participants, etc.
It was, and of course is, the job of attorneys to explain these issues, mainly to judges, authorities, and other decision makers, to come up with, usually case-to-case solutions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
