Weathering Wall Street's Storm

by Eleanor Laise and Shefali Anand

Clients of Merrill, Lehman Should Be Largely Secure, But Brokers May Jump Ship

No one could blame clients of Merrill Lynch & Co. and Lehman Brothers Holdings Inc. for feeling like they've been sandbagged. Now the question many are asking: How safe are their accounts and investments?

For brokerage clients of these firms, account assets should be largely secure, industry experts say. There are strict rules, for example, that protect customer assets in the event a firm goes bust. Workers whose 401(k) retirement-savings plans are administered by Merrill can also feel secure. But Lehman clients holding certain sophisticated investments, such as certain derivatives, may have trouble exiting their positions quickly.

Both Merrill and Lehman clients will likely face some tough decisions ahead. One issue: Many brokers are likely to leave these firms and either strike out on their own or join another firm, industry experts say, and their clients must weigh the pros and cons of following along, staying behind or moving their assets to an entirely new firm.

Amid the upheaval, brokerage customers should be aware of the rules that protect their accounts in times of crisis. Brokerage firms are required to keep clients' cash and securities separate from their own accounts and keep certain levels of liquid assets on hand. The industry-funded Securities Investor Protection Corp., or SIPC, helps protect investors when a brokerage firm fails. In such an event, customers receive all their assets back from the firm, and if any assets are missing, a reserve fund maintained by SIPC satisfies each customer's remaining claims up to $500,000.

Since SIPC was founded in 1970, there have been only 349 people who weren't made completely whole, said Steve Harbeck, president and CEO of SIPC. But SIPC doesn't cover ordinary market losses, and some holdings, such as currencies, hedge funds and limited partnerships not registered with the SEC, aren't covered by SIPC.

Though the moves at Lehman and Merrill come amid a tumultuous year in the markets, clients had little advance warning. The situation at the Wall Street giants deteriorated quickly over the weekend as Lehman failed to find a buyer and the government declined to step in and bail out the firm. But investors got a picture of how quickly a Wall Street titan can crumble earlier this year when Bear Stearns Cos. narrowly avoided a bankruptcy filing by agreeing to sell itself to J.P. Morgan Chase & Co.

Here's what the latest Wall Street turmoil means for small investors and account holders:

Merrill account holders. Merrill Lynch account holders are on their way to becoming part of a brokerage behemoth. A combined Bank of America and Merrill brokerage would have more than 20,000 financial advisers and $2.5 trillion in client assets.

But the deal with Bank of America may prompt many Merrill brokers to jump ship, industry experts say. The more conservative culture at Bank of America may not mesh well with the more aggressive, risk-oriented atmosphere at Merrill. That means many Merrill brokers are likely to ask clients to move with them to a new firm, and that could cause some headaches for investors.

Clients switching to a new firm may need to sign new account and margin agreements, locate paperwork for any trusts, and get new checks or check cards on their brokerage accounts, said Matt Bienfang, senior research director at financial services research and advisory firm TowerGroup. On top of that, of course, customers will have to consider the products offered and fees charged by the new firm.

Merrill is also a major administrator of 401(k) retirement savings plans. But 401(k) assets are held in trusts, and "it's all separate from all the activities of plan sponsors and providers," said David Wray, president of the Profit Sharing/401k Council of America -- so the Bank of America deal should have little impact on participants in these plans.

Lehman account holders. Lehman Brothers said on Monday that its investment-management unit, which includes its investment services for high-net-worth individuals, is not part of the bankruptcy filing and will continue to operate.

"We assure you that as our clients your assets remain safe," wrote Jack Petersen, Lehman's global head of private investment management business, in a letter sent to clients early Monday. "We continue to operate business as usual, and are fully staffed and ready to handle your immediate needs, including the facilitation of proper execution and the orderly transfer of assets as needed."

SIPC's Mr. Harbeck said that "to the best of our knowledge ... there are no missing customer assets," and Lehman clients still have normal access to their accounts. Should SIPC discover otherwise, "we're obviously ready to take action," he said. In addition to SIPC, Lehman clients are covered by the Customer Asset Protection Co., an insurance company that offers coverage beyond SIPC's limits.

It's quite likely that Lehman's high-net-worth business could be acquired, said Lauren Smith, brokerage analyst at Keefe, Bruyette & Woods Inc. In any case, many Lehman clients will wind up simply following their financial adviser to a new firm.

Lehman's broker-dealer, Lehman Brothers Inc., "is expected to close only after the orderly transfer of customer accounts" to another firm, the Financial Industry Regulatory Authority, a Wall Street self-regulatory group, said Monday.

Yet Lehman clients who hold complex investments with the firm may face greater complications. "The more complicated the security, the more difficult it's going to be to liquidate those securities or have those positions transferred out to another brokerage firm," said Steven Caruso, partner at New York law firm Maddox Hargett & Caruso.

Clients with holdings such as derivatives in which Lehman has the other end of the trade, or limited-partnership investments offered by Lehman, are likely to face such issues, industry observers say. It's very difficult to say how much these investors will recover, said Ms. Smith, and it could take weeks or months to get answers.

Another issue: Clients with margin loans may be forced to quickly inject more money into their accounts if they hold hard-to-value assets with the firm, as the valuations of those holdings could decline substantially, Mr. Caruso said.

One especially vulnerable set of investors are those who bought billions of dollars of auction-rate securities from Lehman. Other large investment banks have recently announced plans to buy back such securities issued by them, but Lehman hadn't done so, leaving a question mark as to whether investors will get their money back. Auction-rate securities were marketed as cash-like investments, but when the market froze earlier this year, many investors found that they were unable to sell their holdings.

Investors also hold about $900 million in auction-rate securities issued as closed-end fund preferred shares by Neuberger Berman, Lehman's mutual-fund unit, according to research firm Thomas J. Herzfeld Advisors.

"I'm very worried this morning," said Ed Dowling, 53, of Huntington Station, N.Y., who owns $300,000 in such preferred closed-end shares issued by Neuberger and is concerned that whoever buys the Neuberger unit may find a loophole that will keep them from honoring the funds' debt obligations. Legally, closed-end funds aren't obliged to redeem preferred shareholders, though many, including Neuberger, have announced plans to do so in recent months to preserve their reputations.

In all, Mr. Dowling, who owns a manufacturing business, has about $2 million in preferreds from five different closed-end fund companies, which he said he will need by the end of this year to build a house.

Investors in Lehman's exchange-traded notes, a type of debt instrument that trades like a stock, are also facing an unsure fate. Lehman has three ETNs with around $13 million in assets, and since these are unsecured debt instruments, owners will have to stand in line like other creditors. "They're looking at [getting] pennies on the dollar," said Matt Hougan, editor of, a Web site that tracks index-based investments.

For Lehman clients, "the safest course is to get all the assets away from the firm so they're not subjected to uncertainties as things develop," Mr. Caruso said.

Money-management clients. Lehman's bankruptcy filing doesn't directly affect shareholders of its Neuberger Berman mutual funds, and investors can continue to trade in and out of these funds easily. "As a fund investor, you have the luxury of sitting back and see how these things play out," said Don Phillips, managing director of investment-research firm Morningstar Inc.

Anne Jackson, 34, an associate at architecture firm Perkins+Will in Charlotte, N.C., directs 15% of her 401(k) retirement savings to the Neuberger Berman Socially Responsive fund. "I haven't been paying attention" to recent developments, she said.

That may well be fine for now. But over the next few weeks and months, fund shareholders should watch out for one key factor -- will their fund managers stay at the funds or defect?

The answer will largely depend on who ends up buying the Neuberger unit, which manages 26 mutual funds and six closed-end funds with nearly $25 billion in assets, according to Morningstar. In recent weeks, some private-equity firms have shown interest in buying the unit. If that happens, analysts expect that the firm would leave the fund managers alone to do business as usual, increasing the chances that they will stick around. However, if the buyer is another fund company, it might attempt to merge Neuberger funds with its own and prompt managers to bolt.


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