For almost all private investors, asset custody will form the base on which all else is built. A custodian—typically a very large bank—safeguards investment assets by holding them in a segregated account owned by the investor.1 The fact that the account is segregated is important. By “segregated” I mean that the investor's assets are formally segregated from the assets of the bank that is serving as the custodian. In the unlikely event that the bank should go bankrupt,2 the investor's assets will not be subject to the claims of the bank's creditors. Hence, although there might be some delay in retrieving the assets, and some cost and annoyance, the investor will in fact get his assets back.
This is not the case, it is important to note, with brokerage firms that are acting as a custodian. If the broker goes under, the investor's assets go with it. For this reason, all brokerage firms carry vast amounts of insurance, designed to protect investors against just this possibility. Unfortunately, one has to wonder whether the insurance firms themselves could survive the bankruptcy of a major brokerage house.
Surprising numbers of investors don't bother to have their assets held safely in a custody arrangement, but simply place the assets at the disposal of whoever is managing the money. In such a case they are placing themselves entirely at the mercy of the honesty of the money management firm and all its employees.
A few years ago a money manager named John Gardner Black ...