While sources tell us that several other states are considering similar legislation, this is something that all states must prioritize because this issue completely transcends traditional party lines.
Essentially, the world’s largest financial institutions—quietly preparing for the event of a major financial meltdown—successfully lobbied state legislatures to change the way that collateral is held under state laws. Among other things, these efforts have given creditors—in the form of “too-big-to-fail” banks and other powerful financial interests—priority claim over all wealth stored in investment securities, such as in stocks, bonds, mutual funds, exchange-traded funds, 401(k) accounts, IRA accounts, and other types of securities, instead of the security purchaser.
From a legal standpoint, much of what we believe to be our wealth is not, in fact, ours. And, in the event of a financial crisis—which seems more and more likely with every passing day—we could lose everything to the “too big to fail” financial institutions.
It’s important to clarify that when I say “we,” that truly means everyone who holds any type of investment security. No one is exempt from this potential “taking,” from the least wealthy to the most affluent members of society.
To put this in simpler terms, consider the following example: If you were to contact your broker today to purchase 10 shares of a certain company (Google, for example), your broker would then add those 10 Google shares to your account. You would probably think that you would own those 10 Google shares, but you wouldn’t. What you would actually own is a “security entitlement” to the shares rather than the underlying shares themselves. This is explicitly stated throughout Article 8 of the UCC.
A security entitlement is basically a contract with your broker that grants certain rights to a specific type of security, meaning that when you “purchase” a security, you own only certain contractual rights to it, rather than the security itself. This is bad enough on its own, but the problem is actually far worse.
Under UCC Article 8, protected creditors of securities intermediaries—such as the world’s largest banks—are given priority ownership to security entitlements if they use customer assets as collateral. What this means is that if your broker were to go bankrupt, the broker’s secured creditors would be given priority over what you thought was your security entitlement. You would become an “unsecured creditor,” and your claim to your securities would be at the very back of the line. In the event of a widescale financial crash, millions of investors could lose everything to those secured creditors.
In “The Great Taking,” Mr. Webb concludes that “the bankruptcy of Lehman Brothers was used to establish case law precedent that the ‘protected class’ of secured creditors have an absolute priority claim to client assets, and that, potentially and practically, only they will end up with the assets.”
The scale of the “taking” of our property rights that has occurred is nothing short of stunning. The next step could be the “taking” of our actual property, not just our rights to it.
The problem we face is daunting. So are the adversaries who will come out of the woodwork to ensure this corrupt system remains in place, primarily in the form of bank lobbyists and other powerful financial interests backed by unlimited resources and a special relationship with the U.S. Federal Reserve.
The good news, however, is that there are solutions. Because the UCC is state law, state lawmakers can take very concrete steps to restore the property rights of their constituents almost immediately.
As the first-of-its-kind South Dakota legislation attempts to do, policymakers must ensure that individual investors have priority claim over their security entitlements held by brokerage firms and other intermediaries.
Second—again, as the South Dakota legislation attempts to do—policymakers should alter jurisdictional provisions so that cases are determined in the state of the individual investor, rather than the state of the broker, creditor, custodian, or clearing corporation.
There are likely additional alterations to UCC Article 8 (and Article 9, for that matter) that should be explored. However, these two policy changes are a critical place to begin.
I don’t believe that a system that would sacrifice the wealth of individual investors in favor of the world’s largest banks is worthy of protecting. I would imagine that state legislators and the general public would agree.
The clock is ticking. Policy changes such as those now on the legislative docket in South Dakota should be replicated in the 49 other states to protect the property rights of all Americans.
