Risks of Fully Paid Lending Programs
1. Loss of Voting Rights
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When your shares are lent, the borrower becomes the temporary "holder of record."
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You lose proxy voting rights during the loan period, which can matter during shareholder votes on mergers, board elections, or governance issues.
2. Dividend Substitutes (Tax Implications)
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If a dividend is paid while your shares are on loan, you receive a "substitute payment" instead of a qualified dividend.
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These substitute payments are typically taxed as ordinary income, not qualified dividends — potentially increasing your tax liability.
3. Counterparty Risk
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Although brokerages require borrowers to post collateral (usually 102% of market value), there's still a theoretical risk if the borrower defaults and the collateral loses value rapidly.
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Most brokerages mitigate this with daily mark-to-market adjustments, but it's not zero-risk.
4. Market Liquidity Risk
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You retain the right to sell your shares at any time, but in volatile markets, there could be a delay in recalling shares from the borrower, especially if demand is high or the stock is hard to borrow.
5. No SIPC Coverage for Lent Shares
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The Securities Investor Protection Corporation (SIPC) does not cover shares that are out on loan.
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If your broker fails while your shares are lent, recovery could be more complex.
6. Limited Transparency
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Some brokers don’t disclose exact lending rates or borrower identities, making it harder to assess whether you're getting fair value.
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Rates can fluctuate daily, and you may not know how aggressively your shares are being lent.
Risk vs. Reward: A Quick Framework
| Factor | Benefit | Risk/Trade-off |
|---|---|---|
| Income Generation | Earn interest on idle shares | May be modest unless stock is hard-to-borrow |
| Liquidity | Can sell anytime | Possible delay in recall during volatility |
| Tax Treatment | Passive income | Substitute payments taxed less favorably |
| Control | Retain economic exposure | Lose voting rights temporarily |
| Protection | Collateral posted by borrower | No SIPC protection for lent shares |
