Betterment Fully Paid Securities Lending Supplemental Disclosures
I. Summary
MTG LLC d/b/a Betterment Securities (“Betterment Securities”) offers customers the ability to lend securities in their brokerage account through Apex Clearing Corporation’s (“Apex”) Fully-Paid Securities Lending Program (the “FPSL Program”). The FPSL Program allows customers to earn lending income by lending their fully paid securities to Apex. To participate in the FPSL Program, customers must (i) accept and execute the Master Securities Lending Agreement (the “MSLA”) between the customer and Apex, (ii) receive and review Apex’s “Important Disclosures Regarding Risks and Characteristics of Participating in Apex Clearing Corporation’s Fully-Paid Securities Lending Program” (the “Apex Disclosures”), (iii) receive and review Apex’s “Fully Paid Lending Trust Agreement” (the “FPSL Trust Agreement ”), and (iv) receive and accept the terms of these Supplemental Disclosures for the Fully Paid Securities Lending Program (the “Supplemental Disclosures” and, together with the MSLA, the Apex Disclosures, and the FPSL Trust Agreement, the “FPSL Program Documents”). Capitalized terms used but not defined herein shall have the meanings set forth in the MSLA.
Apex will be the sole borrower of securities under the FPSL Program, and Apex can lend those securities to other market participants. Securities loaned out typically earn a market-driven rate, which Apex shares with the customer and Betterment Securities.
Customers will receive at least 25% of “Lending Income” for lending their shares. That rate can be adjusted by Betterment Securities from time to time, but will always be at least 25%. Lending Income varies depending on factors such as the type of securities lent, market demand, and prevailing interest rates. Not all customers who qualify for the FPSL Program will participate in every lending opportunity. Betterment Securities may allocate lending opportunities to customers pursuant to the allocation methodology described further below. To see the current percentage share of the Lending Income on loaned securities, please refer to our earnings schedule.
Customers should maintain an up-to-date financial profile, including state of residence, annual income, and other factors impacting a customer’s tax rate, to enable a more accurate securities lending allocation (see more below).
Apex will deposit collateral in a custody account (the “Custody Account”) at JP Morgan Chase Bank, N.A. (the “Custodian”) to secure each loan of securities; the Custody Account is administered by Wilmington Trust, National Association, as trustee (the “Trustee”).
Betterment Securities offers its customers access to the FPSL Program through its omnibus clearing arrangement with Apex. Betterment Securities accounts are governed by the Betterment customer agreements, including the Common Provisions and the Brokerage Agreement. Please read these agreements and the FPSL Program Disclosures carefully before deciding whether to participate in the Program and before agreeing to the Apex MSLA. These agreements and disclosures describe important aspects of the FPSL Program, its structure, potential benefits, risks, and conflicts of interest information.
A customer can opt-out of the FPSL Program at any time in the account settings tab in Betterment’s online account interface.
II. Customer Eligibility and Participation
Customers must first opt in via Betterment’s online account interface. To do so, customers must first have completed the sign-up process for a Betterment account. Based on information customers provide about their financial situation and investment objectives, and the receipt and acceptance of FPSL Program Documents as disclosed above, Betterment Securities will determine which customers are deemed appropriate to participate. By opting-in to the FPSL Program, customers authorize Betterment Securities to lend their Securities to Apex without notice or prior approval of any loan activity. Customers also authorize Betterment Securities to choose which securities are eligible for loans. If a customer chooses to opt-in to the FPSL Program, such election applies across all of the customer’s investing accounts with Betterment Securities (e.g., individual and joint, taxable and tax-advantaged); a customer cannot choose to have some accounts participate and not others. Securities lending and enrollment in the FPSL Program for joint accounts is controlled by the primary account owner.
III. FPSL Program and Omnibus Clearing
Betterment Securities executes and clears trades in customers’ brokerage accounts on an omnibus basis through accounts at Apex. Betterment Securities tracks its customers’ assets and transactions and allocates their assets to and from the omnibus accounts with Apex to effect transactions in the customers’ brokerage accounts. Apex borrows securities directly from Betterment Securities’ customers through the omnibus account as part of the FPSL program. Apex’s direct borrowing makes Apex a “principal” on each loan. Betterment Securities provides access to the FPSL Program to its customers, but is not a party to its customers’ securities loans.
IV. Allocation Methodology
The supply of Betterment Securities’ customer securities enrolled in the FPSL Program can exceed market demand for loaned securities. In these circumstances, Betterment Securities will allocate lending opportunities among participating customers. Betterment Securities does not guarantee that participating customers’ securities will be lent at any given time or at all. Betterment Securities will seek to allocate lending so that every participating customer has the opportunity to loan shares, but at any time some customer securities could be on loan while other customers holding the same security are not. Betterment Securities’ lending allocation is designed to generally lend securities when it estimates a customer’s earnings will, on average, exceed their incremental tax costs, as determined based on a customer’s financial profile, inclusive of any Annual Credit (as defined below). Customers who lend their fully paid securities are entitled to receive the value of all dividends and distributions made in respect of the loaned securities, and will receive cash in lieu of dividends on certain lent shares. Such payments are not the same as qualified or exempt dividends for tax purposes and are taxed as ordinary income, rather than at a potentially preferential qualified or exempt dividend rate.
Betterment’s lending methodology calculation also depends on customer-provided financial profile information: self-reported annual pre-tax income, tax filing status (e.g. individual, married filing jointly), state of residence, and number of dependents, and, if applicable, a spouse’s income, or a secondary user’s income (in the case of joint accounts). This information is used to estimate your federal and state income tax rates, long-term capital gains (“LTCG”) rates, and applicable standard deduction. Betterment’s methodology for estimating a customer’s tax rates is further described in the tax loss harvesting disclosure. You understand that it is important to keep your financial profile, including your self-reported income, up-to-date in order to enable a more accurate securities lending allocation. You can update your financial profile information in your Settings on the Betterment website or in-app.
Because Betterment Securities seeks to lend securities when it estimates a customer’s earnings will, on average, exceed their incremental tax costs, estimated tax rates can cause Betterment Securities to prioritize lending shares of certain customers relative to others on certain days. Betterment’s allocation methodology prioritizes lending securities held in tax-advantaged accounts, then securities held in taxable accounts of customers in lower estimated tax brackets, who are generally less affected by the tax treatment of cash in lieu of dividends, and finally, securities held in taxable accounts of customers in higher estimated tax brackets. As a result, on any given day, customers lending securities from tax-advantaged accounts are more likely to have their shares lent, followed by customers in lower estimated tax brackets lending securities from taxable accounts, and finally, customers in higher estimated tax brackets lending securities from taxable accounts. Within this ordering, Betterment Securities seeks to allocate lending opportunities to customers generally on a pro-rata basis, subject to a minimum floor of shares in the security and the above-described tax optimizations. Customer securities that are pledged as collateral in a Securities Backed Line of Credit (SBLOC) will not be lent under the Fully Paid Securities Lending Program if the customer has any such amounts outstanding under their line of credit.
Although Betterment Securities’s allocation methodology is generally intended to lend shares if it estimates a customer will on average, exceed their incremental tax costs (as described above), Betterment Securities does not guarantee that earnings from lent shares will offset tax impact to the extent a customer’s financial profile is inaccurate or outdated. In order to mitigate the impact of paying cash in lieu of dividends to taxable accounts, Betterment Securities can return shares prior to a dividend record date or provide an additional annual credit (the “Annual Credit”) to offset the estimated tax burden associated with the receipt of cash in lieu of qualified dividends (based on Betterment’s estimated tax impact described above, and which credit is determined according to the most recent financial profile data supplied by the customer at the time it is calculated). Customers will be notified when such credit has been applied to their account.
The Annual Credit can be increased or decreased from time to time by Betterment in its sole discretion. Betterment does not guarantee that this adjustment will be sufficient to eliminate the full additional tax burden associated with all the dividend distribution. Betterment can, in its sole discretion, provide the Annual Credit in any form or manner it deems appropriate, including through a reduction or waiver of fees or any other type of credit. When customer shares in the FPSL program are loaned, Betterment Securities will make available a securities lending report on the Betterment account interface on the day of such loan. Betterment reserves the right to remand, or to refuse to offer, a credit if Betterment determines that you provided inaccurate or incomplete financial information, or that your account otherwise reflects wrongful or fraudulent conduct.
V. Allocation of Lending Income
On a monthly basis, Betterment Securities will receive accrued aggregated Lending Income from Apex for all loaned securities, and will allocate the Lending Income among applicable Betterment Securities customers following the month in which the income was accrued. Betterment Securities will withhold taxes on your Lending Income if you (or your other account holder, in the case of a joint account) are subject to backup withholding, unless an exception applies.
VI. Collateral
As security for its loans, Apex will pledge to customers cash collateral of at least 100% of the market value of the securities on loan. Apex will deposit collateral to the Custody Account with the Custodian, which is administered by the Trustee. Each day, Apex will compare the market value of securities on loan to the value of the deposited collateral, and deposit additional collateral by the end of the following business day as necessary to maintain the required cash collateral for the duration of each loan.
VII. Risks and Conflicts of Interest Associated with Omnibus Clearing in FPSL Program
Customers incur no direct fee to participate in the FPSL Program, but there are certain risks in participating in the FPSL Program. Please consider these risks before participating in the program.
Customers Do Not Approve Individual Loans: Betterment Securities, in its sole discretion, determines which customer accounts and which shares in each customer account are eligible for the FPSL Program, or deem any previously eligible securities to be ineligible. Customers cannot approve individual loans of securities. Betterment Securities will, in its discretion, allocate borrowings of securities by Apex among eligible customer accounts as described above in “Allocation Methodology”, and those assets will be loaned to Apex in accordance with the FPSL Program Documents without the customer’s further approval or consent. This can impact the overall income the customer could receive from the Program. Betterment Securities can decide at any time for any reason that a customer is no longer eligible to participate in the FPSL Program and will make reasonable efforts to notify such customers.
Earnings by Betterment Securities and Customer: Betterment Securities will receive proceeds from the FPSL Program and has a financial incentive to share a lower percentage rate of its total income with customers. Income that Betterment Securities receives reduces customers’ earnings. Factors including, but not limited to, the type of security, market demand, availability of securities, prevailing interest rates, and the perceived stability of a loan, impact the total amount of Lending Income available to be shared with customers. Further, on days when a security is designated as “hard to borrow,” Apex receives both Lending Income (a negative rebate from other market participants) and interest earned on the cash collateral. For “hard to borrow” securities, interest on the cash collateral is excluded from Lending Income and customers do not receive any portion of such interest. Betterment Securities has an incentive to lend customers securities when they are designated as “hard to borrow” because it receives a portion of the interest on cash collateral for such securities from Apex in addition to its share of any Lending Income.
Betterment Securities reserves the right to amend the rate of Lending Income it shares with customers, upon advance written notice to customers. Betterment LLC (“Betterment”) also continues to charge its wrap fee on assets that are on loan.
Lending Allocation Methodology. Betterment’s lending allocation methodology evaluates securities-lending opportunities by ticker and estimated tax bracket across customers, in order to determine whether to lend any eligible security. Betterment Securities’ lending allocation is designed to generally lend securities when it estimates a customer’s earnings will, on average, exceed their incremental tax costs, as determined based on a customer’s financial profile. As described in Section IV, this means shares are more likely to be lent from tax-advantaged accounts first, followed by securities held in taxable accounts by customers with estimated lower tax brackets, and then securities held in taxable accounts by customers with estimated higher tax brackets. This ordering reflects differences in estimated tax impact under Betterment’s allocation methodology.
Use of Third Parties: Betterment Securities and multiple third parties including, without limitation, Apex, the Custodian, and the Trustee, are involved in making the FPSL Program available, as described in the FPSL Program Documents. Any of the parties that provide services to the FPSL Program could fail to timely perform their obligations, make errors, provide inaccurate or incomplete information, or otherwise take or fail to take any action which adversely affects the administration of the FPSL Program, which can cause customers to experience losses. Further, any interruption of services to or operations of any of the parties involved in making the FPSL Program available could result in delays in the administration of the FPSL Program and in losses to customers.
Market Risk: The value of securities involved in the lending program can fluctuate based on market conditions. A decrease in the value of loaned securities can result in losses. Customers can also have market risk of losses, or adverse tax consequences, if Betterment Securities must purchase securities to replace securities from loans that have defaulted.
No Guarantee of Recovery: Although the FPSL Program is designed to mitigate the risk of losses to customers by requiring Apex, as borrower, to deposit collateral in an account administered by the Trustee, there is no assurance that a customer will be able to recover the full amount of any losses they experience in connection with the FPSL Program, including the loss of the value of securities loaned and loss of collateral. Customers further understand, agree and acknowledge that neither Betterment nor Betterment Securities guarantee Apex’s performance on any loan under which Apex borrows securities from customers, and that customers do not have any right of setoff of obligations against Betterment or Betterment Securities arising out of Apex’s failure to perform on any loan under the FPSL Program.
Apex or any third party borrower could default on their loan obligations, including but not limited to the obligation to pay lending fees and cash in lieu of dividends, and/or return securities on loan at the termination of the loan. If a borrower defaults, Betterment Securities will assist customers in accessing their collateral held in trust by Wilmington Trust. Customers should be aware that the cash collateral is the only available recourse.
Voting Rights and Treatment of Dividends: Customers will not have the right to vote or take part in other proxy related actions for securities on loan. Customers who lend their fully paid securities are entitled to receive the value of all dividends and distributions made in respect of the loaned securities, and will receive cash in lieu of dividends on certain lent shares. Such payments are not the same as qualified or exempt dividends for tax purposes and are taxed as ordinary income, rather than at a potentially preferential qualified or exempt dividend rate. If a customer’s ordinary income tax rate is higher than the preferential qualified or exempt dividend rate, cash in lieu of dividends are taxed at a higher rate than qualified or exempt dividends. Betterment Securities will withhold taxes on such payments if you are subject to backup withholding, unless an exception applies. You should consult a tax advisor to understand how these payments are treated under applicable tax laws. Neither Betterment nor Betterment Securities is a tax advisor.
Account Statements and Confirmations
Each customer participating in the FPSL Program will receive (1) securities lending reports accessible in the customer’s profile, which include information about fully paid securities that Apex has borrowed from the customer; and (2) consolidated account statements that include information on Lending Income attributable to securities lending and collateral that Apex has deposited for the securities borrowed. Customers acknowledge and consent to receiving information regarding the FPSL Program in consolidated reports and account statements.
Tax Reporting
When applicable based on customer earnings, Betterment Securities will issue customers participating in the FPSL program a Form 1099-Misc. Customers are responsible for satisfying their tax filing obligations. Betterment Securities is not a tax advisor, and customers should consult with a tax advisor to understand their obligations under applicable tax laws.
Customer Authorization for Information Access
Apex does not store individualized information about Betterment customers and their brokerage accounts under the omnibus clearing arrangement in the ordinary course of Apex’s trading and custody functions, but requires certain individualized information to operate the FPSL Program. Customers authorize the sharing of relevant customer information between Betterment and Apex, and with third parties, as Betterment and Apex reasonably determine is necessary, in furtherance of providing the FPSL Program to customers. This authorization includes, but is not limited to, details of the securities lending activities, contracts, personal details, account information, and any other pertinent data necessary for the purpose of providing the service. Customers understand that the shared information will be treated with confidentiality and used solely for the specified purpose. Customers acknowledge that the rights and responsibilities of Betterment and customers regarding the collection, processing, and use of a customer’s personal information and a customer’s right to limit the use and disclosure of such information, are set forth in Betterment’s Privacy Policy.