On Monday,lawmakersinSouth Dakotaintroduced groundbreaking legislation that would help protecttheretirementaccounts and property rights ofthecitizensintheirstate.
Legislatorsinstates acrossthecountry should consider similar action, because without important legal changes, tens of millions of American familiescouldbe at risk of suffering substantialfinancialand/or property lossesintheevent of a futurefinancialcrash.
TheProblem
Inthe1990s, a highlyinfluential organization calledtheUniformLawCommission convinced policymakersinall 50statestoquietly makesubstantial alterationstoArticle 8oftheUniform Commercial Code (UCC).TheUCCisa set of uniformstatelaws that have been adopted by allstatestoensure that commercial activities are governed bythesame rules across borders, improving economic efficiency.
Changes in the 1990s revised how states treat investments and property held by financial institutions. (iStock)
ThechangestoArticle 8 revised howstates treatinvestments and property held byfinancialinstitutions, as well as allowedinstitutionstouse customers’investments and property as collateral fortheir own businesses.
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Underthese alterationstotheUCC, people’sinvestment securities are typically owned bytheinvestment firm, brokerage house or otherfinancialinstitution helpingtheconsumer manage his or her securities.They are not owned bythepurchaser.
VideoThis rule appliestostocks, bonds, mutual funds, exchange-traded funds and other common forms ofinvestment,includinginvestments heldinretirementaccounts such as 401(k) and IRA accounts.
Thefollowing hypothetical example helpstoillustratetheproblem. Imagineyoucontact a brokertodaytopurchase 10 shares of stockina publicly traded company – Microsoft, for example. Afteryoupaytheprice oftheshares and broker fees,thebroker wouldthen add those 10 Microsoft sharestoyouraccount.
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Ifyou’re like most people,youwould probably think thatyouown those 10 sharesinyouraccount, but thankstothelaws passed as part oftheUCC,youdon’t. Whatyouactually ownisa “security entitlement”totheshares, notthesharesthemselves. All of thisisexplicitly outlinedinArticle 8 oftheUCC.
VideoA security entitlementisa contract that guarantees thatthepurchaser will receive certain benefits, but it does not transfertothepurchaserthefull ownership oftheunderlying security, such astheMicrosoft stockinour example above.
Whenthefinancialsystemisoperating normally, customers are rarely impacted bythese arrangements, whichiswhy most people don’t know aboutthem. But ifthereisafinancialcrashsimilartotheonethat occurredin2008 or larger, itcouldtrigger a widespread confiscation of wealth, unlike anything America has ever seen before.
Thereason thisispossibleisbecause undertheUCC, protected creditorstoinvestmentintermediaries, such as large banks, are given prioritytothesecurities held on behalf of customers byintermediaries, such as a stockbroker. Examples of a securitiesintermediaryinclude Fidelity and Merrill Lynch.
VideoWhat this meansisthat ifyourbroker, such asthecompany managingyourIRA or 401(k) account, weretogo bankrupt,thebroker’s secured creditors (thepeopletowhomthebroker owes money) would be empoweredtotaketheinvestments thatyoupaid forinordertosettle outstanding debts.
Intheevent of a widescalefinancialcrash, millions ofinvestors, pension funds, and some companiescouldlosemost oftheir wealth overnighttothese secured creditors.
Author and former Wall Street hedge-fund manager David Rogers Webb has aptly referredtothisincredible and terrifying possibility as a”great taking.”
Raindrops hang on a sign for Wall Street outside the New York Stock Exchange in Manhattan, on Oct. 26, 2020. (Reuters/Mike Segar/File Photo)
OneStateFightsBack
Toavoid a catastropheinthefuture, a nationwide movementisdesperately neededtoaltertheexisting Uniform Commercial Code. Of course, that won’t be easytoaccomplish, especially because bank lobbyists and other powerfulfinancialinterests will almost certainly fight kicking and screamingtostop policymakers from taking awaytheir advantage over consumers. But something must be donenow, beforethenextfinancialcrisis hits.
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Thegood newsis, this “great taking” can be stopped atthestatelevel. Americans don’t needtocount on a divided Congresstogetthejob done. BecausetheUCCisstatelaw,statelawmakers can take concrete stepstorestoretheproperty rights oftheir constituents and protectthemintheevent of afinancialcrisis.
On Monday,South Dakota legislatorsintroduced a billthat would do just that.Thelegislation would ensure thatindividualinvestors have priority over securities held by brokerage firms and otherintermediaries.
The state Capitol building in downtown Pierre in central South Dakota (Education Images/Universal Images Group via Getty Images)
It would also alter jurisdictional provisions so that cases are determinedinthestateoftheindividualinvestor, rather thanthestateofthebroker, custodian or clearing corporation. This would ensure thatindividualinvestors are abletorely onthelaws oftheir localstate, rather than permit biginstitutionstoeffectively pickthestatelaws and judicial venue most likelytogivethemtheresultthey want.
Thequestion thatstatelawmakers must askthemselvesisthis:Isa system that would sacrificethewealth ofindividualinvestorstoprotecttheworld’s largestfinancialinstitutions truly worthy of protecting? We don’t think so, and we hope thatstatelegislators agree.
Policies such as those being consideredinSouth Dakota – and soon, hopefully otherstates – must be enactedtosecuretheproperty rights of all Americaninvestors, as well asthehealth oftheentire U.S. economy.
