Thursday, June 24, 2010

Sonray Capital – another Australian broker failure

Sonray Capital failed a couple of days ago and the clients are likely to incur nasty losses.  Strangely I first found out about this from US news sources.  Only three weeks ago I wrote a letter to a blog reader who knew someone who worked at Sonray expressing my doubts about the organization.

For my global audience I should specify that Sonray commanded four-fifths of five-eights of not very much of the market.  In no way is the failure of this broker a reflection of the economy.  It is a failure – as if another one was needed – of Australian broker-dealer rules – or more precisely the lack of broker dealer rules.

The United States has strict rules which segregate client assets from broker assets.  The broker can’t use client assets to fund their own business and there are limits on the extent to which client assets can be rehypothecated.  In the UK those limits are thinner – and in Australia non-existent.  That means that if you pledge your securities to a broker (for a margin loan or even as collateral against a bill as low as $100) you can lose the lot in the event of a broker failure because the broker can repledge them to cover their own borrowings.

When Lehman failed the US broker-dealer sailed through unharmed.  The UK broker dealer failed causing huge client losses and a huge panic.  I blogged about that here and here

Opes Prime was smaller than Lehman London but the characters were just as unsavory.  I blogged about that here

I have no problem with a broker-dealer using their own capital to run their business or to trade.  I have a big problem with a broker dealer using their client capital to run their business.  I suggested a fix to the Australian Government in a submission to the Cooper review – but alas this has disappeared into the do-nothing basket. 

How long is it that Australia needs to hold itself up as a place where you can come, open a broker dealer, fund it with client money – and – in at least one case disappear with client money before the Australian Government will do something?





PS.  There is a reflexive no-government-regulation thing amongst some of my readers.  But the question here is not whether we should allow brokers such as Goldman to speculate.  The question is whether we should allow them to speculate for their own profit with the clients’ money.  Lehman US speculated itself into oblivion but it did not do it with client money and the clients of the broker dealer were made whole.  Lehman UK speculated with client money speculating their clients into oblivion.  In the Sonray case the clients were mostly retail.


Anonymous said...

I am worried about
1)the cash I have with this broker
Is it not true that as per ASIC rules the broker has to keep client money in segregated account?
Although it might be possible that each client does not get separate segregated account and all clients money is pulled in to one segregated account. SO in that sense the clients are not creditors and this money should be clearly visible?
Is there any insurance coverage?
2) All the positions were closed by force so can we take legal action because we have been denied the opportunity. and forced to close a position
Can anybody please elaborate along these lines

Anonymous said...

John, what do you expect from politicians? The toppling of the democratically elected Prime Minister Rudd has just demonstrated who really holds power in Australia. So much for democracy then. Surely the lack of regulation for brokers in Australia also works in favour of somebody who does not like to concede his advantage.

John Hempton said...

1. No insurance policy in Australia.. US has SIPC 500 thousand limit for securities 100 thosand - now 250 thousand for cash.
2. No client segregation of securities but there is a segregated client account for cash... so you should get your cash back provided that there is no shortfall in the client segregated account.
3. Liquidator will close all positions - those are not client segregated - so closure makes sense. Makes no difference - you cannot collect anyway as the positions are in the name of the broker.
4. You can sue - but there is no capital left to sue so you will not recover.

My guess is that you are toast on positions and have some chance on the cash...

Why didn't you understand the message of Opes Prime, Chimera, et al...?

There is NO Australian broker I would ever pledge my shares to - none at all - and that includes JBWere/Goldman Sachs.

I would happily pledge to the US domiciled broker.

Here is the disclosure re segregated cash...

All money deposited into your account by you or by a person acting on your behalf, or which is received by Sonray on
your behalf, will be held by Sonray in one or more segregated accounts it must maintain pursuant to the Corporations
Act. Please note that individual client accounts are not separated from each other, but may be co-mingled into one
segregated account (which is separate to Sonray’s monies/assets). It is important to note that holding your money in
such segregated account may not afford you absolute protection, and the purpose of the segregated account is to
separate Client monies from Sonray monies. All Client monies are pooled together within the segregated account,
therefore an individual Client’s balance may not be protected if there is a default by another Client that causes a loss
to the overall segregated account balance. In order to minimise this risk, Sonray may use its own company funds to
cover any Client balance shortfall that may be caused by a Client default in the short term. If there is a deficit in the
segregated account and in the unlikely event that Sonray becomes insolvent before it makes up the deficit in the
segregated account, then you will be an unsecured creditor of Sonray in relation to the balance of any monies owing
to you from the segregated account.


John Hempton said...

Here is the disclosure re open positions:

Whilst the Client’s money and
property is segregated from Sonray’s
money and property, it may be comingled
with the money and
property of other Sonray clients, and
utilised as free and clear collateral by
Sonray from time to time in respect
of open positions. Such monies and
property shall accordingly be treated
as the legal and beneficial property
of Sonray, subject to an obligation by
Sonray to transfer equivalent back to
Client in accordance with their
transaction rights under these Terms
and Conditions;


Your collateral is treated as the beneficial property of Sonray - so to the extent you have property as collateral you look to be stuffed.


It does not seem to suggest that it can use your property when it is not collateral...

I will report as things become clearer here...

Good luck. Hope it is all cash and hope the cash is good.


John Hempton said...

Just to make it clear you lose collateral rights on positions there is this disclosure:

Sonray may use the funds in the
client segregated account to manage
Sonray’s dealings with its
counterparties with respect to client
positions. The Client acknowledges
that this serves as sufficient written
authorisation for Sonray to withdraw
without notice to, or further
authorisation from, the Client any
money or property deposited into
the segregated account to be used
by Sonray for this purpose. The
Client has no interest in or claim over
Sonray’s contracts (if any) with any
other person or in the accounts into
which Sonray lodges or pays the
funds which were withdrawn from
the segregated accounts. The Client
acknowledges that the balance of
the Client’s account may not be
protected if there is a default in the
dealings with counterparties or in
the overall segregated account

Unknown said...

Hi john, your reply is most informative. Thanks.

One question.

Liquidator will close all positions - those are not client segregated - so closure makes sense. Makes no difference - you cannot collect anyway as the positions are in the name of the broker.

If the company is under administration not Liquidation, then is it fair to say they have may not have closed the positions yet? And if a deal could be made, then refrain from said?

John Hempton said...

I do not think you can make a deal - that would be a liquidation preference.

I really believe re open positions you are stuffed and on straight cash balances you are dependent on their honesty... an honesty that is enforced in no manner that I know of.


The current regulation and enforcement is a joke.



IF said...

John, could you clarify the following about the Australian laws?

1) If a client did not open a margin account his assets are ok?
2) If a client has opened a margin account and did not use any credit?

Anonymous said...

John who can I use to buy australian shares? is commsec or etrade ok?

John Hempton said...

As long as the shares wind up registered IN YOUR OWN NAME you can use almost anyone to open an Aussie brokerage account.

Comsec is fine.
NOLT is fine.

I would prefer one with the major banks because it is then funded out of an aussie bank account.

Margin accounts are generally awful in Australia because they allow pledging of your securities even if you just OPEN the margin account - and don't use it.

There are some exceptions - there used to be a margin account funded by securitising the margin loans - but I have not seen it.

I would NOT use an Australian margin account at all. If you want to buy Aussie shares on margin then unless it is the one that funds by securitising the loans (and sorry I have forgotten which that was) use a US broker to do so. You will then have problems with franking credits.

But if you ever needed a reason for NOT buying Australian equities on margin this is it.

But then it is hard to justify buying a market this expensive on margin anyway.


John Hempton said...

If this is right -

A margin call that could not be paid out of the client segregated accounts - is how it reads...

That makes me think your cash is toast.


Ed said...

Out of interest, why, in your view, are the politicians so reluctant to do anything about this? Is it that they don't understand the issue, is it that at present there is no public appetite to protect those losing their shirts (I'm writing from the UK where this attitude is common), or is there shadowy lobbying at work?

I only ask because I have never fully understood why rehypothecation of this sort isn't banned - it seems self evident that it serves no public good (only the private good of a lower cost of capital for the broker).

John Hempton said...

In the UK I think it was just deregulation gone crazy... there was a genuine (and we now know false) view amongst policy makers that people would not commit capital to entities with dodgy balance sheets - that was that the markets were the best regulators.

The situation now is that the regulator is totally deskilled - and would not know how to fix it if the thing popped out in front of them.

In Australia - I think it is deskilled generally.

There was a LOT of thought that went in the US 1934 Act. It was hard-won legislation done the way the US does thing when at its best. That doesn't mean I like all the legislation - but at least I get it...

Generally there are no votes in this stuff - and it requires disciplined and competent politicians to get this right. Those politicians - of all stripes - are thin on the ground - and there are LOT of issues that require that level of thought. This is not a unique situation...

(I do not now how to improve political processes - and ultimately that is the problem...)

Anonymous said...

Does this mean any cash ( forget margin shares CFD etc) held with any AFSL broker( Equity / FX/ CFD) can be at 100% risk
Even if in a pooled segregated client account!
And what on earth is a point of pooled segregated client account IF THE BROKER CAN use that money to cover its business failure? where caused by it's blow out of business expenses or because it allowed one/ group client to go on a huge Margin call?
By the way in this model does sonray makes the market or Saxo ( which is an overseas entity?)
I used to think ASIC regulation was much better then places like Cyprus and Malta or British Virgin islands but it seem AFSL is as dodgy as those form the smaller nations... ASIC = toothless dog

Anonymous said...

Thanks again for the education I only half understand these products but I get dont invest in them. I find the assumption of people that regulators in this country are capable from a government that couldn't manage to put pink batts in ceilings safely and a new idiot PM who thought the US education system was an example to us all and meaningless league tables were worth a big fight over. No not batting liberal, most of this failure to act happened under them, its amazing they didnt destroy the banks, probably just inertia. Thanks again.

John Hempton said...

I think the failure to act on this is universal... apart from Turnbull (who really does understand this stuff) there is nobody on the coalition side who would care.

Nobody at all on the Government side would have a clue...

I door-knocked for Maxine McKew at the last election. I am finding it hard to even vote at this one.


Unknown said...

The company's 3000 clients, who are classed as unsecured creditors, were expected to receive only 25c to 30c in the dollar

Anonymous said...

After Sonray I started to read other FX brokers PDS and realized no matter where you go your in Australian FX / CFD borkers your money is at risk if broker goes out of business it can take your money with it.
SO is there any broker in Australia who is better than this?
Why can't the watchdog applies the same rule it applies to ASX participating brokers?
As we speak Millions of $ are at risk

John Hempton said...

There is NO solution with Australian brokers. We simply do not regulate. The only solution is to hold equities directly and NEVER in the name of a nominee...

ALL CFD providers suck...


But if you think that it is millions of dollars at risk you are wrong. It is billions - no tens of billions. Australia has its asset security wrong GENERALLY - be it superannuation, broking or insurance.

I am currently working on a short driven by asset security issues in Australia.

Somewhere along the line the legislation in the US that got asset security right was just skipped in Australia. This is a disaster in the making.

I have written to the government several times... it hardly helps and I am well connected in Canberra. The issues are hard...

Would love it if some enterprising journalist would take this up as a popular cause... but I have little hope on that...


Anonymous said...

Would love it if some enterprising journalist would take this up as a popular cause... but I have little hope on that...

Try Pied Piper I think Fin Review or Crikey

Anonymous said...

Have a look at information on it;s major Counterpart Saxo bank

Agus said...

Hi! Has any of this changed in these 8 years since 2010?

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