E. Bankruptcy of Security Firms

Author:Roderick J. Wood
Profession:Faculty of Law. University of Alberta

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In the past, bankruptcies of securities firms usually led to protracted litigation as each investor sought to argue that the value of their property was traceable into the assets of the securities firm. This difficulty was further compounded by the rise of the system of indirect securities holdings. Most investors are not registered holders of the securities they purchase. Instead, they rely upon the fact that they are reflected as having an entitlement to the security in the records of the securities firm. In this environment, tracing becomes extraordinarily difficult, if not impossible. The BIA was amended in 1997 by the addition of special rules relating to the bankruptcy of securities firms.

On the bankruptcy of a securities firm, the assets are placed into three categories: (1) customer name securities; (2) the customer pool fund; and (3) the general fund. Customer name securities are those that are held on behalf of the customer and registered or recorded in the name of the customer.177The fact that the securities firm may have internally allocated some of the securities to certain customers is not sufficient to make them customer name securities.178These assets belong to the customers and therefore do not vest in the trustee.179The customer is entitled to delivery of the security, but the trustee may sell sufficient securities to discharge an obligation owed by the customer to the securities firm if the customer fails to pay it.180Cash and securities, other than customer name securities, are used to establish a customer pool fund.181The customer pool fund is distributed first towards the costs of administration if these cannot be satisfied out of the general fund.182The balance is then distributed to the customers in proportion to their net equity. If there is anything remaining, it is paid to the general fund.

All of the remaining property is used to form the general fund.183

The general fund is distributed first to satisfy the claims of preferred creditors. Once these claims are satisfied, any remaining funds are distributed rateably to the eligible claimants.184The claimants who are

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entitled to participate include the customers to the extent of any deficiency claims after payment received from the customer pool fund, the claim of any customer compensation body that has paid or compensated customers, and ordinary creditors of the firm. Creditors who have entered into non-arm’s length transactions that are not...

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