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Some types of brokerage accounts allow the stock broker to lend my shares to short sellers (probably without needing to notify me). Do I incur any risks when I sign up for such accounts? Is there any risk that I can lose my shares? If there are risks, how am I compensated for the risk (e.g. higher interest rates on idle cash, a small share of the commissions from the short seller, etc.)?

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  • The risk will probably depend a lot on the exact terms and conditions of a specific broker. The only example I've read, it is the broker, not the third party that borrows the shares from the investor. For you to lose, not only would the borrower have to default (and do so beyond any security the broker requires from them), that (plus any other potential losses) would need to bankrupt the broker themselves (so the broker is unable to repay the shares to you). Again, compensation for allowing your shares to be lent is likely to vary: for the case I mention above, fees are reduced.
    – TripeHound
    Jun 27 '20 at 10:39
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Jurisdiction matters so my answer is applicable to the USA.

SIPC insurance guarantees the custodial function of brokers so if the borrowing broker defaults, you won't 'lose' your shares. I would surmise that this is not your problem because you own the stock in book entry form at your solvent broker and therefore you have the right to sell them at any time. Therefore, default is an issue when it's your broker that goes under.

Some brokers share a portion of the borrow fee with the lender of the shares (you).

When a dividend is paid, the buyer of the borrowed shares receives the dividend. The share lender (you) receives payment-in lieu (PIL) from the trader who shorted the shares. The downside of PIL is that it does not qualify for favorable tax rates on qualified dividends and they are taxed at ordinary income rates.

Shares in a cash account cannot be loaned out. When you open a margin account, there is a customer loan consent form. You do not have to sign it but if you don't, the broker can refuse to open margin the account.

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  • It appears that this answer is incorrect. Loaned out securities are not insured by SIPC. Could you check your answer?
    – Flux
    Sep 7 at 15:55
  • @Flux Is it really possible that a brokerage could be lending out your shares, invalidating your SIPC insurance, without your consent?
    – Craig W
    Sep 7 at 16:07
  • SIPC guarantees the custodial function of brokers so if the borrower goes bankrupt, shares are returned. Technically, the clearing agent must post collateral of cash and securities equal to or greater than the value of the securities on loan, MTM at the close of each trading day. Therefore, the loan is 100% covered. Sep 7 at 16:10
  • @CraigW Brokerages must ask for your consent before they are allowed to lend out your shares. Refer to FINRA rule 4330 Customer Protection — Permissible Use of Customers' Securities.
    – Flux
    Sep 7 at 16:16
  • @BobBaerker Thank you for the clarification. FINRA rule 4330(b) says: "... the provisions of the Securities Investor Protection Act of 1970 may not protect the customer with respect to the customer's securities loan transaction and that the collateral delivered to the customer may constitute the only source of satisfaction of the member's obligation in the event the member fails to return the securities ...".
    – Flux
    Sep 7 at 16:20
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Below are my opinions, researched done by me and not advice. Check with your financial planner and or broker for confirmation.

There are many misinformation being put out on the internet about retail investors being concerned with their current shares being loaned out by broker to shorts.

A valid concerned and question for sure. It is your money..

To eliminate the worries about being vulnerable with your borrowed shares, you must contact your broker such as TDA or Fidelity and verify with them if you signed a "CUSTOMER LOAN CONSENT FORM". When I signed up with TDA some years ago, I did not consent for the broker to loan out my borrowed shares. I am currently on a margin and cash account. They cannot loan out my shares as long as I DID NOT consent for them to loan my shares out.

For example; If I did consent and would like to cancel the "CUSTOMER LOAN CONSENT FORM" I may do so by calling my broker. It's that simple.

I hope this help others that may be concerned.

Happy trading and investing!

Other materials that pertained to borrowed shares.

https://www.investopedia.com/ask/answers/05/lendersellshare.asp

https://www.finra.org/rules-guidance/notices/08-38

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