THE collapse of securities execution service provider Sonray Capital Markets is bad news for those clients caught in its funding black hole.

But it is likely to save many more unsuspecting derivatives gamblers and traders from a similar fate. Sonray was a relatively small player with about 4000 clients.

Buit made a number of costly errors, now being paid for by the clients.

The first of these was the decision not to report a rogue trader to the regulator. The next was Sonray's decision to pay those affected by the non-approved trades with other clients' money. And finally, there was Sonray's attempt to get square by trying to trade its way back to break-even -- again using its clients' money.

One more costly error was made -- this time by Sonray's clients. They signed contracts stating that their cash and securities would be held in a pooled vehicle and that in the event Sonray went under, they would become unsecured creditors. In other words, they were last in line to get some, if any, of their money back.

The only positive to come out of this whole mess is the sunlight it has cast on the treatment of client monies, which should ring alarm bells for clients of other derivatives operators.

It could have been a whole lot worse.

A substantial industry has sprung up in the derivative trading field over recent years. Three main factors have fuelled this once fledgling industry. The first is the volume of advertising and marketing the key players have thrown at novice investors since the introduction of contracts for difference (CFDs). Adopting a shotgun approach to marketing, players large and small saturated the personal finance magazines. But they also peppered news websites and even tabloids with ads.

The second is the ability for the industry to reinvent and rebadge itself in order to give itself currency and appeal. The first craze was futures trading, then options, on to CFDs, "eminis" and now foreign exchange appears to be the latest fad. The punters are becoming more sophisticated though, and it appears that fewer are being automatically drawn in by tales of instant wealth.

But there may be 50,000 Australians playing with financial derivatives accounts as a result of these influences. Many have no idea that their funds aren't actually "their funds" and that in the event the derivatives provider goes broke, clients become unsecured creditors. This is actually quite a common business model in Australia, and clients have actually signed the contract to say they agree to it.
What happened to Sonray could easily happen to any business applying a similar model. Canny traders should assess the risk of their broker going belly up and get out if they don't have that appetite.

The slow, unsuspecting and overly trusting, unfortunately, will be caught out.

There is also a strong argument that these co-mingled models are a fiduciary failure, and that the Australian Securities & Investments Commission should only allow them to be made available to sophisticated investors.

This article by Stuart Wilson, Chief Executive Officer of the Australian Shareholders' Association featured in his weekly Shareholder Opinion column in The Australian on Wednesday 7 July 2010.