The Segregated Account Fallacy
|I want to clear up some misconceptions around segregated accounts.
When a broker tells you that your funds are kept in a segregated account, it means that they keep client deposits in a separate account to the money they use for the operation of the business.
Firstly, yes this is a good thing. In the past, some brokers deposited client funds into their operating account, and used them for all sorts of purposes. Sometimes this ended very badly.
Now that funds are kept separate, it means that brokers do not typically use client funds for operating expenses (I use the word typically in the above sentence on purpose). What is more important, though, is what“segregated funds” does not mean:
1. It does not mean you have your own individual bank account with the broker. Your funds are mixed in with other clients’ funds. So if a client goes into negative balance, that client’s deficit is taken out of that account as a whole (although the broker will generally top it up). They literally just track how much money is in each client’s account in the back office accounting program.
2. It does not mean the broker cannot use the funds for margin. Unless you are specifically advised by your broker, you will likely find that the segregated account is used for margin that the broker might be required to put up for the positions it holds (either prop trading positions, or off-setting client positions). So your funds in this sense can be used as margin on another client’s position.
3. Most importantly, it does not mean your funds are secured if the broker goes bankrupt. When you hand your funds over to a broker, for all intents and purposes they become the broker’s funds. If the broker goes bust, and has more debt than operating capital, your funds in the segregated account can be used to pay off that debt. You are not necessarily going to be first in line for your own money. It will depend:
a. If other creditors in line are secured
b. On the rulings made in the insolvency process
Basically what this means is that you may or may not get your money back, even though the account is segregated.
While segregated accounts are a good thing, please don’t think that they are something they are not. You can still lose your funds if they are in a segregated account.
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