27 September 2023

When buying stock, do you own the shares?

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Michael Janda* says share investments are often held by custodians. Who are they, what do they do and are they safe?


Last year saw an unprecedented wave of amateur investors hit the stock market.

Australia’s biggest broker, CommSec, said the number of first-time traders more than doubled.

Data from the financial regulator, ASIC, shows a record 110,000 share-trading accounts were opened in March alone, as Australia went into lockdown and share prices bottomed.

The fad has continued into 2021, with another 51,000 accounts opened in January.

The rise of trading apps from brokers big and small has made it quick and easy to dive in. Perhaps a bit too easy, according to Alex Dunnin from financial analysis firm Rainmaker.

“Slow down. You don’t need to trade today, this hour, this minute, this nanosecond. Just calm it down, it’ll still be there for you tomorrow,” he counsels would-be investors.

“Do you understand what’s going on, who’s getting your money?”

To help answer that question, and explain who really owns your shares, we need to dive into the world of custodians.

Who holds your shares?

While many new investors spend a great deal of time researching which stocks to buy, few spend much time considering how to buy them and who really owns them after they’re bought.

“When you invest in a share market you can basically invest in two ways,” explains Chris Brycki, the founder of online investment adviser Stockspot.

“You can invest directly, which means that you have the legal and beneficial ownership of the investments you are making; or you can invest via a custodian, which is basically a middleman that looks after your investments for you.”

Under the first method, you have a “holder identification number” in the stock exchange’s registry, CHESS.

When your broker or fund manager buys shares on your behalf, you’re registered at the ASX as the legal owner.

You might get mail directly from the companies you invest in, inviting you to shareholder meetings or telling you how much you’ll get in dividends.

If your broker or fund manager goes bust it doesn’t matter because you own the shares directly.

But, under the second method, your broker or fund manager uses a custodian or nominee company to hold the shares bought on your behalf.

If your broker or fund manager goes broke, it still shouldn’t affect your investment, but it’s a different story if the custodian collapses.

The custodian is the registered owner of your shares, even though you are what lawyers call the “beneficial owner” … and there might be many other beneficial owners and other creditors with a claim on that company’s assets.

What’s the risk?

“When that company goes belly up, you become a secured creditor and you actually have to chase your investments,” explains Chris Brycki.

“So you’re not only wearing the risk of the share market, you’re risking your money with a counter-party that you’re not sure how credit worthy they are.”

This isn’t just a hypothetical risk.

Several major stockbroking and funds management firms have collapsed in Australia over recent years, with their clients often waiting years to access their investments, or what’s left of them.

“You may not end up getting all of your money back,” Brycki warns.

“So, in some recent cases, it may be somewhere like 80 to 90 cents in the dollar — you may be lucky and get more, but you could also be unlucky and get a lot less.”

And, he says, that means it’s important to know who you’re dealing with before you hand over your money.

“If you are investing with a nominee company or a custodian, what’s important to uncover is who the custodian really is and is it a trustworthy business.”

Where do I find the info?

The first place to start is the product disclosure statement. But be warned.

“I think I’m reasonably smart — I can use a chainsaw, I can reverse a trailer, I can read and write, I’ve got a pure maths degree, I’ve done all those sorts of things through my life — I find this pretty confusing and I’m in the business of trying to explain these things,” says Alex Dunnin.

“I’d say to a novice consumer, ‘good luck to you’.”

What are you looking for?

Hit control F and search for terms like custodian, nominee, agent — which companies are listed?

Are they big global investment banks or fund managers or, as in some cases, are they part of the firm or brokerage you’re investing through?

“Sometimes organisations might use a custodian which they own themselves, and so if their business goes bankrupt it might bring the custodian down as well,” cautions Dunnin.

Why use a custodian?

So why does anyone invest through a custodian?

In some cases, there’s not much choice.

If you want to invest in US shares, for example, most Australian brokers do it through a custodian, even the biggest players like CommSec.

Space to play or pause, M to mute, left and right arrows to seek, up and down arrows for volume.

When it comes to local shares, even though Chris Brycki’s fund doesn’t use custodians, he acknowledges there are some benefits.

“As you mash everyone’s holdings together you’re able to get a benefit in trading costs and you can pass that on to the end user,” he explains.

“Something that’s becoming very popular in the US is the ability to buy a tenth of a share or a hundredth of a share and, obviously, in order to buy a part of a share you need some sort of custodial arrangement and some way of fractionalising those shares.

“So, it improves access, but it also increases risk.”

That’s why Alex Dunnin says you need to hit pause and do some research about who you’re investing with, not just what you’re investing in.

“What happens if something goes wrong? Who actually gets this money?” he says investors should ask before parting with their savings.

“If something blows up where do I turn up with my baseball bat?”

*Michael Janda is the ABC’s Online Business Reporter.

This article first appeared at abc.net.au.

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