I’ve got that queasy feeling again in my stomach.
The recent collapse of Bear Stearns gave me flashbacks to the 1990s during which we struggled with insolvency issues affecting ERISA plans.
If you were around back then, you’ll remember the insurance companies that failed or were seized by insurance regulators as a result of failed investments in real estate or junk bonds. And it was not just these companies. The financial stability of the rest were called into question in 1991 by the four insurance company rating services that downgraded their ratings on the claims paying ability of virtually every life insurance company in the country.
And you may also remember the insolvencies of Mutual Benefit Life Insurance Company and the infamous Executive Life Insurance Company whose GICs and annuities had been used to fund retirement plans – and what was involved to get these issues resolved for plan participants.
But that was then and this is now. Or is it? The recent volatility in the credit markets reminds fiduciaries yet again of the need to be proactive in protecting the assets of plan participants. This time around potential insolvency issues involve plan assets held by brokers, custodial banks, and financial contracts such as repos, swaps, securities lending, etc.
James Stewart writing in the Wall Street Journal after the Bear Stearns collapse tells us no worries because Safety Nets Protect Brokerage Accounts.
But with all due respect to Mr. Stewart, if you’re a fiduciary out there, you need to have more than a “feel good moment” after reading his article. A good starting point is to read the K&L│Gates law firm’s recent Financial Services Alert, “Key Insolvency Issues for Broker-Dealers, Custodial Banks and Counterparties to Repos, Swaps and Other Financial Contracts.” Here is what they say about evaluating whether assets are sufficiently protected.
A key to evaluating whether your assets and financial contracts with a broker, custodial bank or counterparty are sufficiently protected is to know your contractual and statutory remedies. As shown above, these vary with:
- The type of broker: U.S. or offshore;
- The type of security-holding arrangement: “customer name” or street name;
- The amount of leverage on a securities account: fully paid or on margin;
- The existence of other contracts with a broker and its affiliates, which might be cross-collateralized by the same assets;
- The type of assets covered: securities or other types (commodities, currency, etc.);
- The type of contract: securities brokerage or other types (repos, swaps, etc.);
- Whether the broker carries “excess SIPC” insurance, and if so the coverage limits;
- Whether assets and cash at a bank are held in a trust or fiduciary capacity;
- Whether a financial contract is the type that qualifies for the “safe harbors” from the automatic stay in a bankruptcy or an FDIC receivership or conservatorship;
- Whether your institution is the type that qualifies for exercising termination remedies under the “safe harbors” from the bankruptcy stay.
This list illustrates that the degree of exposure for financial arrangements with brokers, custodial banks and counterparties can vary widely. Some assets and contracts will be entitled to greater protection, in terms of distribution priorities, account insurance and termination remedies. Others may be more vulnerable and risk a lower percentage recovery in the event of an insolvency. Each asset and contract must be evaluated separately to determine where it lies on that continuum.