Stock Loan Financing:
by Daniel W. Stafford, Writer-Editor Former president, HedgeLender LLC ***Warning: Recently, some private companies without securities licenses that are involved in transfer-of-title lending have begun to use the former HedgeLender's name and/or terms such as "Financial Engineering" and "No-Doc Loan" to attempt to push their sites higher in the search rankings for terms like "stock loan". Their goal is simple: to lure naive and unsuspecting new stock owners into their risky programs. No matter how flashy the sites, remember that you are better off selling your securities on your own than giving them to a "lender" who sells your stock as if they were a stock broker - without a license to do so - to fund your "nonrecourse stock loan." ONLY use lenders where there is no transfer of title, that are regulated and licensed. Read the FINRA Warning against nonrecourse stock loan "lender's here. Ask if you are uncertain. Demand written proof of your broker or "lender". Look in your loan contract for terms such as "beneficial ownership" or "extinguish all rights" in the small print, which disguise the fact that you are actually (according to the U.S. Internal Revenue Service) simply engaging in a taxable sale of your securities to your "lender." When you lose all true ownership rights, and they hand you some cash as a "loan", the IRS has spoken, and you are engaging in a reportable, taxable sale. If you are in danger of being victimized by a transfer-of-title stock loan company, we urge you to report the company to FINRA and the SEC and to walk away from it. Sell your stocks yourself, or locate a non-transfer-of-title stock loan company that does nothing but work with licensed, regulated institutions where your shares remain in your title and account at all times (Here is one such stock loan firm offering only non-transfer-of-title lending programs through SIPC/FIDC-member firms). We repeat: Anyone considering a stock loan should ONLY work with licensed, regulated lending institutions where your securities remain in your own title and account with FINRA-member advisors, SIPC/FDIC-member institutions, and fully regulated and licensed programs in all 50 U.S. states and overseas. Do not undertake ANY stock loan with ANY firm that does not offer these safety features! The legality and safety of these types of loan programs are very suspect at the least, and undertaking a program with these firms can easily cost you IRS penalties, fines, the loss of all of your securities assets, or worse. **NewsFlash - Additional Dangers of Transfer-of-Title Stock Loan Companies A new danger, and just another reason why you should never do business with a nonrecourse stock loan company. Once again, the risk is especially high with those who tout "nonrecourse stock loans" or any stock loan where ownership in fact changes to that of the "lender". Here, a victim's identity - social security number, account numbers at brokerages, and so forth - are stolen by the perpetrator, and the perpetrator uses this information to pose as the securities and bank account holder to gain access to the real owners brokerage account. The individual obtains brokerage account records to give to their lender, and is able to answer all the typical verification questions (social security number, etc.). The slickest of criminal hackers will even find a way to present a phony picture ID. Using this information, the attacker applies for an account and has the lender transfer their client's stocks to their lender, putting the stock in lender's name. The transfer of title, nonrecourse "lender" then sends the criminal the loan proceeds and unless the actual owner discovers the ruse in time, they will lose their assets. All of this is possible because the due diligence operations of a transfer-of-title, private, unregulated "stock loan lender" are very minimal. These "lenders" are focused on selling your stock ASAP so that they can hand you your "loan" (80% typically) and they can then pocket the 20% difference as their profit. They do not have the sophisticated systems of a major, regulated and licensed lender or brokerage to ferret out these transactions. The good news is that major regulated institutions have very strong verification systems that can almost always catch any scammer bent on using another individual's account to tap for cash. A very small number get as far as an account opening, but virtually none get past this level, and that is good news for clients and lenders alike who are smart enough to avoid transfer-of-title lending facilities. At the end of the day, whether considering a nonrecourse stock loan or being free and loose with personal information, these issues should cause anyone considering a stock loan to pause, at the very least. Only a securities-based financing program though a licensed and regulated entity - or the brokers who work with such entities - can allow you the confidence you need to proceed. Brokers and the Nonrecourse Stock Loan Myth Unless you are working with a transparent, regulated, licensed financial institution offering full disclosure and open, audited financial statements showing substantial, liquid cash reserves, you are almost certainly NOT serving your clients as you should. If you choose to proceed you will be putting your clients as well as your business at serious. As a broker or marketer or consultant, that means it is at the very least unethical if you market or introduce stock loan services to your clients without the level of assurance needed to protect their assets and their interests, and/or without fully disclosing the funding mechanism and all of the risks honestly and openly with each client. Result? Unless your lender can provide the same degree of verification that a major regulated organization would require, you should not be in the business of promoting or brokering nonrecourse stock loans for the sake of the almighty dollar. None of the current nonrecourse, transfer-of-title stock loan providers in the market today - and don't be fooled by Better Business Bureau A+ logos (BBB has notoriously lax standards) or Mortgage Broker or Lender registrations (a stock loan is not a mortgage!) can or will pass this litmus test. Because they cannot do so, as an informed financial consumer, you must take heed and reject marketing such products or services. The SEC, most state regulatory agencies, and the IRS are but a few organizations that expect you to do so or face the consequences. Emptiness of the "Beneficial Owner" Relationship to Your Securities Think about it: It's just common sense isn't it? Yet many clients are lured into "loans" through firms that immediately sell all or part of a client's portfolio in exchange for "beneficial ownership" on a piece of paper with the expectation that the "lender" will be around five years later. They do so, however, with no facts, no audited financials, and no regulatory inspections or licensing - to make that assumption. You can avoid risky, private nonrecourse stock loan programs. It's not hard; simply ask if you must give up title to your securities. You are giving up title to your securities if: You transfer them into a lender-owned account that allows the lender to sell your shares whenever they wish, as owner of the account and the shares therein. You send your shares to a transfer agent, such as Penson or one of the many others, who then converts or "transfers" the title of your stock certificate into the lender's name or into electronic format that the lender can then sell because the shares are in the lender's account. Institutional, non-transfer-of-title lenders have none of these drawbacks because their procedures are strictly governed by the SEC and other regulatory agencies. They can open an account for you or your company. That account is not theirs in any manner; it is yours. They can accept your stocks into your account that you own over which you have total control. They can offer you a credit line or loan against your shares, sitting in your own account, and if you say yes, can place a lien on your account with your permission that will allow the loan or line to be opened. A licensed, regulated lending program such as the one we offered through this company cannot sell your shares. They must use their own lump funds to provide your loan or credit line - not the proceeds of the sale of your stock. Their advisors must be licensed to dispense advice - not like the "nonrecourse stock loan" lenders who have no such financial advisory or stock brokering licensure yet are happy to tell you how secure their risky programs are. A regulated, institutional non-transfer-of-title stock loan program does not have to go into the market to buy back any shares when you pay off your loan because they were never sold to fund the loan in the first place, so when you want your shares back, you pay off your loan and the lien is removed (unless it's a credit line and you want to keep it available for future cash draws.) With a regulated, licensed non-transfer-of-title lender, your shares haven't moved, and are right where they've always been — accessible to you online 24/7. The Correct Alternative, When a Securities-based Loan is Your Objective In short, they constitute rational, safe, and secure nonpurpose lending structure ("Nonpurpose" lending is lending against securities where the proceeds, per FRB Title 12, may not be used for the purchase of more marginable securities, but the loan-to-value can be considerably higher than the 50% maximum of a "Purpose" loan. i.e., a margin loan). Risk That Cannot be Overestimated Let us be more blunt: When you as stock owner have contractually provided the right to sell your property — your shares — to a lender about whom you know very little, you have potentially lost future access to your assets forever. When you let them sell your shares, give 80% back to you, and pocket the 20% difference, you have handed them 20% of your cash, cash that rightly belongs to you, not them. This may seem like common sense when presented in this way, but in fact virtually every nonrecourse stock loan provider has used contracts whereby the owner of the securities did provide full control and power to an unlicensed and unregulated third party in exchange for the aforementioned "beneficial ownership." Whereas the risk inherent in a transfer-of-title stock loan may not have been perfectly clear in the past, it is undeniably clear today. No financial consumer should feel they have any excuse if they transfer title to their valuable assets to an unlicensed, unregulated party who has the right to sell those assets as part of the loan process and upon repayment, they find their lender cannot return their shares. The HedgeLender Story: Times have changed, and we are all wiser now. But once upon a time the picture was not nearly so clear. Back in 1999 I founded a firm that became HedgeLender LLC, dedicated to the memory of my father, a journalist and humanitarian, after several years of working on international trade finance for the U.S. Dept. of Commerce in Washington. I became president and partner of what was widely regarded as the most successful loan brokerage and marketing firm in the United States for this niche financial product from 2001 to 2008 at a time when regulators had left nonrecourse stock loan financing in a regulatory gray area in terms of tax status. This "limbo land" — legally clarified only in late 2010 when a U.S. Tax Court finally issued a formal ruling on the tax status of 90% LTV nonrecourse stock loans — led our firm to put the onus for tax issues in the hands of our clients, but we believed all along that it could and should be interpreted as a loan, not a sale, if the shares were hedged in some manner. Did a lender have the right to sell if the client gave him that right contractually to do so? The evidence appeared to say yes, but it never said how much information on the selling they had to disclose to the client. Most lenders chose to bury it in a paragraph deep in their loan contract; a few left it out altogether. A famous court case in 2002 where the state of California contended that a nonrecourse stock loan lender did not have the right to sell the shares ended in defeat for the state. The lender apparently did have the right -- if the client had signed a contract giving the lender that right. The court ruled that since the borrower had signed a contract in which the right to sell shares was agreed, they could not complain later if that lender sold those shares - even if that right-to-sell was buried in small print and de-emphasized by the lender. But the tax status of doing so was still unclear. Was it therefore a sale? Was it only a sale if the client defaulted and the "beneficial ownership" was terminated so that there was no doubt that the ownership had transferred to the lender? Did it have to be reported on taxes if the client had not yet defaulted? Or was it a means to obtain cash without having to declare it as a sale? Nobody could answer that question definitely. HedgeLender left the matter up to the individual tax advisor and thought that would be enough. These questions still bubbled up, and finally the IRS stepped in. In a case involving the nonrecourse stock loan firm Derivium's clients, the Internal Revenue Service issued a Technical Advice Memorandum ("TAM") stating that they viewed anyone holding a 90% nonrecourse stock loan who did not declare such loan as a taxable sale at moment of transfer to be liable for repayment and fines, as applicable, against any taxes due. In short, the IRS's advice - though not a legal ruling - was that such loans should be treated as sales. Brokers and lenders were left to read the tea leaves and draw their own conclusions, often with lawyers and tax experts of varying opinions also operating in the dark. Many believed that no capital gains taxes should be due until default occurred - a view that HedgeLender adopted - while others stated that any nonrecourse loan under 90% was not affected - a position later discredited in court. Brokers who marketed these nonrecourse stock loan lenders to their brokers had the daunting task of determining what they should or should not say about them. Lenders depended on those brokers to decide, and "carry the ball" into the market to refer in new clients. This was the environment that HedgeLender faced by 2004. The All-Important Loan Contract and the Silent Treatment for Brokers In HedgeLender's case we operated through three nonrecourse stock loan lenders. Each stated unequivocally that they did not sell shares to fund their stock loans. Each allowed this impression to remain — that shares were not sold to fund the loans. We were led to assume that the right to sell was only when the client defaulted and it seemed a very fair right given that the lender should have the right to recoup its loss if the client defaulted and walked away from the loan. Lenders backed this up, in writing. The "right to sell" provision, brokers were told, was only for the case where the borrower defaulted and the securities reverted to the ownership and control of the lender. This position was held out to all marketers, brokers, and clients - not just the HedgeLender organization. HedgeLender held this out to its affiliates, and this was how the client understood his/her loan. There was nothing in these lenders' loan contracts—which contained the "right to sell or sell short"—that would have lead anyone to the conclusion that the shares would be sold immediately to fund the clients' loans. Years later when the lender operations collapsed during the economic meltdown that started in 2007 was it clear that these lenders made sure that their brokers were unaware that the outright sale of the clients' securities was standard for funding their client's loans, knowing full well that companies like HedgeLender would cease sending new referrals over if they were aware of the practice. Selling to fund was never divulged to any broker or any client at any time for any reason. Doing so, would have meant and end to new client referrals. In addition, firms like HedgeLender were told that the portfolios were hedged by options, cash reserves, or other methods to mitigate risk of loss and to ensure that the client's securities were safe and would be returned if the loan were paid off. But even this was not always true, as struggling private lenders sought to cut corners to stay afloat. Misplaced Trust and the Nonrecourse Stock Loan Lender Here is what FINRA (The Financial Industry Regulatory Authority) has said in a warning in 2011. (Click here for the FINRA press release on avoiding nonrecourse, transfer-of-title stock loans from May, 2011.) In HedgeLender's case, we sought and obtained written and verbal assurances from one of our lenders that hedging was being carried out to ensure return of our client's securities. From another lender, we received assurance in a signed letter that the shares were not sold to fund their loans. Our understanding of hedging was not based solely on options hedging, and we never represented that this was the only form of hedging that was involved in these loans because though we were informed that options were used by one of our lenders and noted that investment grade options through S&P AAA-rated Options Clearing Corporation (OCC) were employed just as our lender had stated to us, we understood and embraced the term "hedge" always by the broader Webster's dictionary definition of that term, e.g., the same usage as in "to hedge one's bets" that is, to reduce or mitigate risk. We believed, based on our lender's' documentation and verbal/written attestations of their financial health, that these risk mitigation measures were being practiced regularly, that some form of "hedge" was being applied per the above definitions for all of the clients who had placed their trust in us. We drew up all of our marketing messages based on these understandings and assumptions. How Regulators Dropped the Ball When it Came to Risky Nonrecourse Stock Loans However, nonrecourse lending entities like the ones with which my company worked were allowed to remain in business and to recruit new brokers and marketers into their networks with no opposition from the SEC or any regulatory agency. To later go after brokers like HedgeLender for misleading clients with product marketing and information that was delivered to it verbatim by the entities that had misrepresented their loan products to HedgeLender — was a relatively easy task, since the cost of defense against a government agency with taxpayer-funded attorneys is very prohibitive even for large companies and we had no desire to remain in the nonrecourse stock loan industry given the information we learned following our lenders' demise. Still, it is a fair and perfectly legitimate question to ask why nonrecourse stock loan lenders that sold shares to fund loans were allowed to continue with no questions asked for year after year. Had such lenders not been allowed to offer their products and services — had they been forced to hold licensing, or to disclose assets publicly, and/or to hold cash reserves to hedge their portfolios — then neither HedgeLender nor any other broker would have ever had the opportunity to conclude that such programs were legitimate. It is true, in hindsight, that HedgeLender was marketing a program that was riskier than it understood at the time because of the limited factual information its lenders had provided. But the government also had a role in ensuring that no such lender was in a position to recruit a firm like HedgeLender for the marketing of its loan programs. In pointing this out, however, I want to make it clear that no broker can shirk responsibility for verifying and correctly portraying their loan programs to their clients no matter what their lender discloses or does not disclose. This is a lesson that I hope all brokers reading this article will take to heart. When Your Transfer-of-Title Stock Loan Firm Collapses Let us say you have paid off your loan to your nonrecourse lender, and happily expect to have your shares returned to you. Your portfolio is worth much more now, let us say, growing in value over time as your stocks' prices rose. That, in fact, is usually the only scenario in which you would have any reason to want to pay your loan off, for if it did not grow thus, you would have no reason to pay the principal off just to regain shares that are not worth as much as what you have to pay to pay off your loan and get the shares back. You'd walk away in that case - exercising the "nonrecourse" provision of your stock loan that you thought was so wonderful when you first explored your financing. You would have lost a lot by losing your shares this way, but you'd owe the lender nothing more and he'd breath a sigh of relief as you are out of his hair. When stocks go up in price, but the lender has already sold the shares, that lender must then go back into the market and buy up all the stock needed to return your securities per your "beneficial owner" loan contract. He will take your loan payoff repayment and will either have to dig deep into his own pockets to make up the difference, or in the worst case, use the sale of new borrowers' portfolios for the case he needs to help buy up shares needed to return all of the shares belonging to the first client. The riskiness and shakiness of this scenario must be obvious to all. Collapse occurs when there are several payoffs in a row for the lender to deal with, or perhaps one very large payoff for a portfolio that has gone up dramatically, as was the case with many oil stocks 2008-2009. A rising stock market is thus always worrisome to the nonrecourse, transfer-of-title lender. If the stocks have done very well and have risen very high in price/value, the lender will have a very difficult time buying the needed shares to return to you. If that lender has insufficient financial resources, then he will at first make excuses as to why your shares haven't yet been returned, but will then eventually go bankrupt to escape repayment responsibility. Those who think they have just paid off their loans then find they have not only no stocks but also no cash either, once the bankruptcy master moves in to sort things out. This is precisely what happened to HedgeLender's lenders in 2007-2008. Bankruptcy. Soon it becomes apparent that the nonrecourse stock loan lender does not have sufficient financial resources to remain in business. Regulators move in to sort the situation out. Clients of such lenders who thought they had no capital gains taxes find themselves ordered to pay back taxes and penalties for loans that the IRS considers to be taxable sales even if the lender did not disclose to the lender or broker the fact they the shares had been sold at the outset. Let us be clear: as in HedgeLender's case, the fault lies entirely with the lenders when they withhold essential information from clients and brokers about the financial health of their companies, their methods, their systems. We cannot point the finger at anyone but the lenders themselves for being the first source of loan information, holding themselves out in the market and on the internet as valid operations. Government agencies charged with taking out such entities so that they cannot lure in brokers or clients also bear responsibility. Finally, brokers and then clients have responsibility to never undertake any securities-based loan program that they have not valid, objective information about. Written emails or spoken phone assurances is woefully insufficient to ferret out shaky private lending operations. Still, it is the duty of brokers to ensure that the messages it carries into the market are accurate before they are relayed to clients. Conclusion When it comes to your personal information, be sure that it is going to regulated, licensed institutions with secure online systems and firm privacy policies. Most of all, as a borrower you should demand licensing and disclosure and you should be able to trust those from whom you are obtaining your loan. As a broker you are responsible for the quality of the loan programs you market. For lenders, both law and regulation require that if you put forth a lending program to the public, you are bound to be truthful in all ways, every time. When you are not, you have no business offering your program to the public in any capacity. ### A Tribute to Steven Jobs (1955-2011) Steve Jobs was a man who represented everything that has made America the innovative, creative birthplace of so many ideas that have shaped and shaken mankind. Here is a man who let intuition be his guide, and refused to let that river of inspiration and vision be disturbed by anyone. He was brusque, but all great people of history run roughshod over lesser persons. They wouldn't be who they were if they didn't. People supplemented Steven Jobs; they did not influence him. He saw his vision, then he worked overtime to see it come to life. In so doing, he gave us the same kinds of devices that he himself wanted to use. Watching him demo the Ipad, for example, was as if he was explaining it to himself. I own something that feels personal when I pick up my Iphone, as personal as it was to Steve when he created it. That's exactly how he wanted it. Pure, unadulterated vision. Almost childlike, really. The same thing only a few people in history have had: Edison. John Lennon. Reagan. Martin Luther King. And a handful of others who saw the future so clearly they could touch it, but had the courage to bring it to life against the advice of all naysayers. Every now and then somebody sees over the noise, over the input, over the "what's best" to what they know to be true, people who blessed by God with the protection and drive to see what they want to happen, happen. Such a person was Steven Jobs. Intuition was his light. A huge chunk of our country's creative genius is gone from our mortal earth now. Other visionaries will come and they will go as the generations and history unfold. They will be praised, they will be mourned. This one will have a special place for the way he changed our world so profoundly by sticking doggedly to his dream. His life, like so many other divinely inspired geniuses, will have reverberations for all of human history. Rest in peace, Steve. - D.W. Stafford Return to Top Media and Economics: The Middle Eastern gas station attendant at my local Liberty station came out to help the elderly Asian woman at the pump next to me who was having a problem. "Here you go Ma'am. Just enter your discount card number here", he said. She did so, then she turned to the attendant and yelled as he walked back to his cash register. "But the price still shows $3.65!" I told her that was a good price and pointed to my pump, where it was $3.98. She looked at me with resignation, we nodded to each other and signed in unison. For American families, those that had lived comfortably in the middle class but who know found themselves squeaking by during the Obama presidency, this was hard to figure. Yes, there was unrest in the oil producing regions of the Middle East, but nobody was really surprised. Aging despots were being ousted by the younger, wired generation in ossified counties and cultures everywhere. Each was going through their own version of the Philippine "People Power" revolution that had ousted Ferdinand Marcos. But unrest was still unrest, and that meant two things:
Stock markets were of course ready to accommodate. Unrest fueled rumors of supply shortages, so stock market reeled and responded. For some stocks, like oil, that meant an increase, as the assumption was that profits would ultimately go up as they did in the past. High prices for oil meant higher prices for anything that depended on oil, however, from airline flights to corn flakes a farmers once again shifted deliveries to Ethanol makers and out of the lower-paying supermarkets. Our newspapers and television stations, ready for a good story and always eager to justify their staff's salaries, prefer any story that can be examined and re-examined from every possible angle - the root of the phrase "talking heads of media" -- because this gives them the opportunity to create far drama and drama - of course - sells far more newspapers and ad space than a simple recitation of the facts. Just as lawyers have gotten a bad reputation for years over their penchant to chase disasters and problems and turn them into billable hours, so the media happily pick up every disaster, problem, or uncertainty in order to pump it up way out of proportion and thereby ensure that the readers/watchers give sufficient attention to it -- sufficient, that is, to sell airtime to commercial providers and to sell more newspapers. Is this bad? Well, if one cares about fair and accurate reporting, yes. But if one believes in free enterprise, then it might just be seen as good business. After all, no laws are broken and it is profitable. Newspapers and other media have every right (and obligation) to stay in business as long as possible. And no laws are usually broken. But the downside is more than meets the eye, in fact. This relentless pursuit of eyeballs and newspaper sales distorts the true nature of an event or situation. The stock markets react to not only react to what's happening on the ground, (e.g., what the reality of our oil supply situation is actually is), but focuses rather on the public's perception of that situation. In other words, media in America today see their role as the shaping of opinion - not the mere reporting of the news. Here's an example: If the public perceives an oil shortage through the verbiage of their newspapers, they will react in a variety of ways designed to protect themselves and their assets. This could therefore cause a general panic or panic buying, even when there actually is plenty of oil to go around. The media needs a new code of honor to reflect the speed with which news travels today and the tsunami-like effect it can cause on policy and governance if for no other reason than that it can have a profound effect on the health of our economy down the road.
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Titles Avoiding the Risks of Transfer-of-Title Stock Loans ( top ) Securities line of credit with no transfer of title or sale of assets can be a safe means to tap your stocks' value for today's financial needs without a sale - and with the insurance of a fully regulated institution. |
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| Analysis is for general reading purposes only. |
Tags: securities credit line, securities-based credit lines, credit line against stocks, stock credit line, stock loan, stock lending, loan against securities