Perhaps the single most widely misunderstood term in the world of High-Performance Private Placement Programs and Trade Platforms is “Blocked Funds”.The nomenclature was incorrectly renamed by brokers and intermediaries as a spinoff,derived from the phrase “Segregated Account”. There are many myths about blocked funds and its aliases, “Reserved Funds” and “Administrative Holds”, which this white paper will clarify.
First let’s understand the origin of segregated accounts. The Segregated Account is unique to the trading industry. It is a third party fiduciary account structure established at a highly regulated clearing institution, bank or broker/dealer which acts much like a custodian. The segregated account is designed to prevent the trader from being able to directly manipulate or liquidate the client’s capital and it also protects investors from fraud.
Speaking of fraud, let’s disclaim a common misconception about Blocked Funds,Reserved Funds, and Administrative Holds. Investments involving Segregated Accounts, Blocked Funds, Reserved Funds or Administrative Holds are commonly claimed by uninformed parties to be entirely free from risk; in other words a client cannot lose their money in the investment. This could not be any further from the truth. Investments using segregated accounts are not exempt from investment or market related risk. Segregated accounts minimize risk of misappropriation by the traders and should be considered more like a system of checks and balances.Segregated Accounts are a function of government-mandated account segregation and regulatory necessity and for various types of trading; however they are also carried out in different manners.
Individual Trader Strategies
The client that invests directly with an individual trader is traditionally participating in amanaged account, an investment on retail side of the market normally done at less than institutional levels. The client opens their segregated account at a regulated clearing institution,bank or broker/dealer; it is advisable that the segregated accounts are opened with a larger clearing institution, bank or broker/dealer who does not
have significant conflicts of interest with the traders. When investing directly in an individual managed account with a trader, the trader has the ability to make trades, buy or sell on behalf of the client’s account with a LPOA (“Limited Power of Attorney”). The applicable clearing institution, bank or broker/dealer clears
and executes the transactions; profits and losses are booked, marked to market, on a daily basis. It is true an investor could allocate some or all of their capital to an individual trader and open up a direct segregated account with a clearing institution, bank or broker/dealer that can clear and execute the trades. However, investors who concentrate their entire investment with a single trader should only use risk capital with which they can easily part. While allocating to individual traders is quite commonplace in retail investment industry practice, this could be the riskiest of strategies in an already risky investment, in this author’s opinion.
A more balanced option for qualified investors might be an Institutional Private Placement Program or Multi-Strategy Trade Platform and its associated limited liability investor protection. Investors in highly-regulated Institutional Private Placement Programs and Trade Platforms can typically allocate capital at a minimum ranging between Two Hundred Fifty Thousand Dollars ($250,000.00) and Five Hundred Thousand Dollars
($500,000.00) to obtain trader diversification that would be equal to a direct investment of several million. However, just like in all investing, there are risk rewards and payoffs. Allocating capital to Private Placement Programs or Trade Platforms allows managers to diversify the client’s allocations, on a weighted basis, to a number of traders which are trading in a spectrum of markets to maximize the potential for high performance and minimize downside deviation. The primary structural difference in a Private Placement Program over an Individually Managed Account, outside of the diversification and potential performance, is that instead of the client, the Trade Platform or Private Placement Program opens the segregated accounts at a regulated clearing institution, bank or broker/dealer. In Institutional Private Placement Programs and Multi-Strategy Trade Platforms, the trader has the ability to make trades on behalf of the Private Placement Program’s or Trade Platform’s account with a LPOA (“Limited Power of Attorney”). The applicable clearing institution, bank or broker/dealer clears and executes the transactions; profits and losses are booked, marked to market, on a daily basis.
The bottom line is that the definition of “Blocked Funds” in this industry is actually referring to a “Segregated Account”; all managed accounts, Private Placement Trading Programs and Trade Platforms use Segregated Accounts” as they are a government required structure. The “Blocked Funds” in this “Segregated Account” are actually at full risk in the investment. The funds are actually and simply being blocked for the use of the investment and cannot remain in a personal account for such use. They must be placed into a “Segregated Account” specifically for the use of the investment and the entire amount is at risk in that investment.