You called anonymously a while back to ask if it were true that Laidlaw Adams & Peck was paying 13.5 percent on insured cash balances. Well, the answer is yes -- and no.
I called Bob Gordon, Washington office manager of the New York Stock Exchange firm, founded in 1842. First he wanted to know how I found out and whether I was calling in my own right or as reporter. The reason for this became apparent later.
Gordon said that Laidlaw had decided to finance the credit balances on margin stock accounts through customer funds instead of by borrowing. Were Laidlaw to borrow from a bank, it would have to pay the broker call rate, now about 15.5 percent. By using customers' cash, for which it pays 2 points below the call rate, Laidlaw saves a lot of money.
It is also a good deal for the cashrich investor. The minimum investment is $1,000. The floating interest rate paid today exceeds that of most money, market mutual funds, which now pay an average of 12.75 percent. Neither type of fund is tied up for six months or any specified period. However, as many nervous investors and savings and loan associations are aware, money market fund capital is not insured. Because a Laidlaw customer doesn't purchase shares in a fund, his or her deposit is insured up to $40,000 by the Security Investor Protection Corp. in case the brokerage house goes bankrupt.
Although Laidlaw has no formal plan for distributing interest, Gordon said the company would make interest, and principal available on request, thus guaranteeing liquidity. The one obvious drawback seemed to be that the amount of the funds that could be received would be limited to that needed to meet margin balances. But Gordon said the company was always in need of a "substantial" amount to meet these needs.
Other brokers pay interest on cash balances, but the terms don't appear as favorable. For example, Merrill Lynch pays 13.3 percent on its Cash Management Accounts; the minimum is $20,000 in cash and/or securities. Its Ready Assets Fund pays 13 percent, yet there is a $5,000 minimum and, as a mutual fund, the principal isn't insured.
Laidlaw's plan sounded like such a good deal for both the broker and the cash customer that I wondered why more people don't seem to know about it. Gordon explained that because the firm isn't allowed to solicit cash customers through ads, the offer was only for those referred by Laidlaw customers. Moreover, the deposits had to be made "for the purpose of purchasing securities." Pressed as to whether this meant a cash customer would be obligated legally to buy stock through Laidlaw at a given time, Gordon replied no.
A call to the Securities and Exchange Commission revealed Gordon was right. Both the Federal Reserve and the Justice Department have ruled that brokers may accept deposits for the purpose of purchasing securities. But they cannot solict deposits otherwise because they would be acting as bankers. However, the meaning of the phrase "for the purpose" hasn't been tested in court. The SEC admits it is a gray area. A senior official of the Securities Industry Association, a New York trade group, said that in his opinion Laidlaw's practice seemed okay provided the company doesn't advertise it. He guessed that this type of financing probably is rare on Wall Street because of the slight possibility that brokers might find themselves in a temporary bind were a lot of cash customers to pull out their fund simultaneously.
Over at the Security Investor Protection Corp., a spokesman said the deposits would be insured in case of bankruptcy provided they were made with the intention of buying stock. Once again there never has been a claim to test what this really means. he added, "I suppose if a client left such funds in a broker's account for 20 years and never bought any stock, you could say he never intended to do so." But he declined to give his opinion on what leaving the money there for, say six months would mean.
In sum, it looked like a loophole that would allow small investors high interest and absolute security. The precedent that comes immediately to mind is the "loophole" money market certificate now in legal use, even though regulators rail against the fact it is contrary to the spirt of the law. This plan allows a depositor with, for example, $3,000 to borrow $7,000 from a bank in order to receive the higher interest rate on a $10,000 money market certificate paid by that bank.
Not satisfied with Gordon's answer, I called the head office of Laidlaw in New York and spoke with the president, Robert H. Clayton Jr. He quoted the New York Stock Exchange rule regarding intent and became quite incensed when the loophole designation was mentioned. He then said the plan would be limited to existing clients, those who had purchased securities through Laidlaw and had deposited funds from the sale of those securities with the broker. He said the firm would accept no more cash clients. And then he added, "If they are doing that (in the future) in the Washington area, we won't pay interest on it." Clayton called back later to say he had given strict orders to Gordon and others to stop the practice.
And so, dear reader, whoever you are, that is the rather lengthy answer to your question. It sounded like such a good idea. . .