What to do if your stockbroker goes bust

What happens to your money and your shareholdings if your stockbroker goes bust? The question is far from academic. One of the highest-profile casualties of the eurozone crisis so far was brokerage MF Global, which went bust after its $6.3bn bet on troubled European bonds backfired. The firms' commodity-trading customers now face a shortfall of about $593m, says Bloomberg Businessweek. So what safeguards are there for your own trading account, and how do you reduce your risks?

Segregation is supposed to save you

Under UK financial market rules set down by the Financial Services Authority (FSA), a broking firm that holds and manages assets such as shares on your behalf, or takes your money, is supposed to keep it all safe by segregating it. By recording your assets in a segregated account (so for cash, that means a separate account at say a third-party bank), you are protected should the broker go bust. In effect, your assets are ring-fenced because they are in someone else's name. So in the event of bankruptcy, your broker's creditors the people it owes money to should only have a claim against the assets registered and held in your broker's name, not the ones being kept for you.

With a UK share, which is a registered asset, the way this works is a broker will enter a special account name on the relevant share register. It might say something like XYZ brokers nominee account' rather than just XYZ brokers'. As long as shares held on your behalf are recorded under the nominee account name, they should be safe. However, you can still make your life easier should the broker go bust.

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The pooled nominee problem

To save time and effort many brokers will, unless instructed otherwise, lump your shares together with lots of other clients' shares, and hold them under a single nominee name. After all, one share is the same as another, so if five clients buy 1,000 Tesco shares each, there is no need to set up and run five separate accounts on the share register showing 1,000 shares per client. Instead, a broker will create a pooled nominee account and register all 5,000. If you then decide to sell half of your holding, any 500 shares can be taken from the nominee account quickly and easily. All individual savings accounts (Isas) are run this way.

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However, there is a potential problem. If a broker goes bust it may take the administrator some time to work out what shares are being held on behalf of which clients. Firms that go bust are often disorganised, so client records may not be up to date. So while you'll hopefully get your assets back, you could face quite a wait. There is a solution, but it costs extra (and unfortunately, doesn't apply if you want to have your assets wrapped in an Isa). It's called CREST personal membership. CREST runs the UK's share settlement system (which updates share registers among other things) and you can join as an individual. That way your individual share holdings are separately recorded in a designated account, making tracing them faster.

What if the worst happens?

In a worst-case scenario, due to fraud or negligence, client and firm assets and cash may not have been segregated at all. If your assets cannot be recovered, there is some help available from the Financial Services Compensation Scheme (FSCS). However, be aware of its limitations.

Firstly, it will pay you nothing if an unauthorised (or rogue' in plain English) firm goes bust. You can check if a firm is FSA-authorised at the FSA website or by phoning them (0845-606 1234). Never, ever commit to deal with a firm if you are unsure, and don't take their word for it. FSA-authorised firms are banned from cold calling you to sell single products such as shares and derivatives, so any firm that does is probably a rogue operator.

Secondly, be aware that you are not eligible to use the FSCS until you have been unsuccessful in claiming from the firm in question, or its liquidators. The liquidator is the firm responsible for managing the insolvent broker and settling its outstanding obligations. They may choose to notify the FSCS that the firm's customers are unlikely to be repaid before a full liquidation has been carried out, but until they do your claim will not be processed. This means that getting your money back can take some time.

Thirdly, the amount you can claim is capped depending on what you are claiming for. For deposits held at a bank or building society, the maximum payout is £85,000 per person per firm for firms declared in default from 31 December 2010. Under FSA rules a broker is supposed to segregate money held on your behalf and hold it with a separate custodian (typically a bank). However, if a broker holds your funds solely "for investment purposes", it will be covered by the investment compensation rules instead. This matters, because for investments (shares for example being held on your behalf) the maximum payout is £50,000 per person per firm for firms declared in default from 1 January this year. So it is worth checking with your broker on the exact status of cash held on your behalf.