A recent case of fraud perpetrated against a TD Direct Investing customer highlights a little-known risk for do-it-yourself investors with basic investing accounts.
Ray Politeski, a retired teacher in Lloydminster, Alta., said criminals took over his account in mid-February, liquidated his holdings and bought hundreds of thousands of dollars of a thinly traded Chinese stock, as previously reported by The Globe and Mail. The transaction pattern matched that of a sophisticated and increasingly common form of fraud in which scammers steal an investor’s log-in credentials, then use the stolen funds to help push up the price of a stock in likely a pump-and-dump scheme.
The financial losses for victims can be amplified when they have margin accounts, which allow the criminals to borrow funds to buy even more of the targeted stock. This can leave investors facing negative account balances and interest charges.
But what stands out in Mr. Politeski’s case is that fraudsters were reportedly able to place a stock purchase that was more than $100,000 larger than the value of the funds in his account – even though it was a cash account.
Retail investors are typically told that, with a cash account, they can only use the cash in their account to buy investments. Less well-known is that brokerages may allow purchases whose value exceeds that of the available funds, provided clients pay off the balance in full on or before the day the trades settle.
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This means that even DIY investors who don’t have access to margin borrowing may see their accounts driven into the red if they fall prey to online scams, which are becoming increasingly elaborate and hard to detect.
When investors place a trade, such as a stock purchase, the transaction typically takes one business day to be finalized, or settled. Some investment dealers allow clients to proceed with a buy order even if they don’t have enough funds in their account, with an expectation that they will deposit additional funds to cover the trade by the settlement date.
Investors can also sell some of their securities to fund a purchase that is larger than the amount of cash in the account, as long as the sale settles on or before the day the purchase transaction is finalized.
For example, suppose a client has $4,000 in cash in their account but would like to buy $6,000 worth of a stock. Certain brokerages allow such a purchase order if the investor sells enough of their holdings to cover the $2,000 difference and any commissions by the day the buy order settles.
Investment dealers do this so investors can move fast to seize opportunities in the market, said Jean-Paul Bureaud, president and chief executive officer at Fair Canada, which advocates for the rights of individual investors.
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“It’s largely about efficiency, because clients may want to purchase something and they’re moving money into the cash account, but it hasn’t hit the account yet,” he said.
But that flexibility can work against investors in cases of fraud, Mr. Bureaud added.
The Canadian Investment Regulatory Organization, the investment industry regulator, said its rules simply require that any purchase in a cash account be paid in full by the time it settles.
“Within that requirement, dealers set their own limits on the size of trades they permit during this period as part of managing their credit risk,” Ariel Visconti, a spokesperson for the organization, said in an e-mail.
Those limits vary from brokerage to brokerage. TD, for example, may allow trades of up to twice the value of the equity in a cash account, subject to certain restrictions, according to information available on its website.
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At Scotia iTrade, the Bank of Nova Scotia’s online brokerage, how much investors can purchase depends on the cash and equity in the account, according to information available online.
At RBC Direct Investing, the amount available to complete a trade is calculated in real time based on intraday activity, the Royal Bank of Canada said. At Qtrade Direct Investing, a division of Aviso Financial, clients can place a purchase of up to the value of certain securities they already own, but they can also ask to limit trading to available cash, the company said.
The Canadian Imperial Bank of Commerce said its online brokerage, CIBC Investor’s Edge, requires full funding of a trade before it is placed.
Questrade said investors can only buy securities with the funds they have in the account, while Wealthsimple said it limits buy orders based on the available cash balance.
BMO did not directly answer questions from The Globe and Mail. Interactive Brokers did not respond to a request for information, while Desjardins declined to comment.
Fair Canada’s Mr. Bureaud said investment dealers should clearly disclose to clients what the limits are for cash accounts and give them the option to restrict trades to the funds immediately available.
“People should have a choice,” he said. “They can view it as a way to mitigate potential losses in a fraud.”