Is My Money Safe?
Since the collapse of Silicon Valley Bank (SVB) on March 10, 2023, I have received many questions that all center on the central theme of "Is my money safe?" The short answer is that with the regulatory framework and insurance backstops in the United States, your banking and investment accounts are about as safe and secure as possible. The longer answer is that there are always caveats and limitations, sometimes making all the difference.
What is FDIC, and what does it cover?
I spent some time in a prior letter discussing FDIC (Federal Deposit Insurance Corporation) and its coverage for bank deposits.
The major limitation of FDIC for some depositors is the $250,000 per bank per depositor limitation (up to $500,000 for a couple). Based on what happened with Silicon Valley Bank, the Federal Reserve, the FDIC, and the US Treasury have implicitly guaranteed deposits above the $250,000 limit. It's important to note that this was done under a special provision that allows extraordinary measures in a time of crisis, and there is no explicit guarantee that all account holders will be made whole in future bank failures.
All that said, bank failures can and do happen. When banks fail, the FDIC is incredibly efficient. Several years ago, I had an account with a bank that failed. Before I knew there was an issue, the FDIC shut down the old bank, closed my account, and credited me with my entire account balance. I learned about it when the monthly statement came in the mail.
A few options are available if you are above the $250,000 limit. Some banks participate in a program called IntraFi (https://www.intrafinetworkdeposits.com/). I have also used a FinTech program with some clients called MaxMyInterest (https://www.maxmyinterest.com/). Both solutions involve an automated process to move money between banks to stay within the FDIC limits.
What is SIPC, and what does it cover?
Most people are familiar with FDIC, but there is a lesser-known cousin for investment accounts called SIPC. The Securities Investor Protection Corporation (SIPC) protects customers if their brokerage firm fails, and SIPC provides a guarantee on account values up to $500,000 per account holder, per brokerage firm, and account type. A caveat is that only $250,000 of cash is covered, bringing it in line with FDIC coverage.
SIPC is a bit more generous than FDIC in that each "account type" receives $500,000 of coverage (SIPC refers to this as "separate capacity"). By way of example, if an individual owns an IRA worth $500,000, a Roth IRA worth $500,000, and a Trust account worth $500,000, each of those accounts enjoys full SIPC coverage.
What does SIPC not cover?
There are some limitations to the coverage that SIPC provides. In addition to the cash limit and the total account size limit, there are limits to the types of assets covered. Holdings that are derivatives, such as options and futures contracts, are not covered. Also not covered are non-standard and private placement assets.
One other consideration for SIPC is that it does not cover you for market losses. If you own shares of Company XYZ, and the value of those shares goes to zero, your loss will not be covered.
What happens above the $500,000 SIPC limit?
It is worth noting that if your account is above the $500,000 limit, SIPC will make a "best efforts" attempt to make your account whole. In the case of insolvency, it is straightforward for all account holders to be made whole. In the case of fraud, it is more complex, but the SIPC will aggressively pursue all options.
Are there protections for my account balance above $500,000?
Yes! Schwab and Fidelity have implemented additional insurance policies to cover accounts above $500,000. Schwab has indicated they have supplemental insurance of $600 million (in aggregate), with individual account protection up to $150 million. Fidelity has indicated they have $1B of coverage (in aggregate) with no account balance limit.
Hypothetically, what would happen if my custodian failed?
When you open a brokerage account (at Schwab, Fidelity, or TD) and deposit cash or securities into that account, the brokerage firm holds these funds for your benefit. In conversations with clients, I usually refer to these brokerage firms as "custodians" because they act as the custodian of your assets, safeguard your assets, and fulfill regulatory and reporting requirements. There is a legal requirement that custodians segregate your assets from the custodian's balance sheet. In other words, the custodian cannot spend money in your account to pay their bills. This segregation between client assets and custodian assets is how it is possible for a brokerage firm to fail and for clients to be made whole. By way of example, if you own a share of Microsoft (MSFT) and your custodian fails due to insolvency, you will still own that share of Microsoft in a segregated account.
Assuming a custodian were to fail, SIPC would immediately step in and take control of the failed brokerage. The first step is generally to move the accounts to a new financial institution on sound financial footing, subject to the SIPC limits. The second step is for SIPC to make a best-effort attempt to recover the remaining assets.
Some recent examples of failures
Bernie Madoff, 2008. Bernie Madoff Securities, owned by Bernie Madoff, was a Ponzi scheme that came to light in 2008 when redemption requests soared due to the financial crisis. I often get asked about this situation along with the "Is my money safe" question. In the most straightforward analysis, Madoff committed fraud, violated the segregation rule separating client and firm assets, and used client assets to enrich himself and those close to him. Madoff could pull this off because there was no separation between the advisor (Bernie Madoff, investment advisor) and the custodian (Bernie Madoff, custodial firm).
The Madoff situation is considered one of the most significant regulatory failures ever. The fraud should not have lasted more than a few years if regulators had done their jobs correctly. Madoff himself admitted that he fully expected to get caught very early on.
Settlement of the Madoff fraud is ongoing. In late 2022 the Justice Department reported that clients had been made whole 88% of account balances.
Lehman Brothers, 2008. Lehman Brothers was a major wall street firm that failed due to losses in "proprietary trading." A proprietary trading loss is when the firm makes bad investments in its accounts, and enough losses will eventually result in insolvency. In this case, Lehman did not violate the segregation rule; it lost money in its accounts but did not tap into customer assets to cover its losses. According to an analysis by the New York Federal Reserve, clients were made 100% whole on their investments, most within a few days and some more complex clients within a few months.
FTX, 2022. FTX was a "crypto" brokerage firm based in the Bahamas. The dust is still settling on the collapse of FTX, but it is most likely a situation where the segregation rule was violated. Initial reports by the bankruptcy team are that there were no barriers or controls between client assets and FTX spending on employee benefits, charitable contributions, and bets that FTX was placing in crypto markets.
What seems obvious in hindsight is that FTX was utterly unregulated. FTX, a company founded in California, moved to the Bahamas, which now appears to be an attempt to avoid US jurisdiction and oversight. Since there was no real regulatory oversight of FTX and no SIPC-type coverage for Crypto, customers of FTX will likely receive a small fraction of their original account balances.
Tell me more about Schwab and Fidelity.
Charles R. Schwab (Chuck) founded Charles Schwab (the company) in the 1970s. Initially an upstart rival to the big brokerage firms, today Schwab is a publicly traded company and has grown to be one of the country's largest independent financial institutions, with 33.7 million active retail accounts at the end of 2022. When Schwab completes the acquisition of TD Ameritrade in 2023, it will become the largest independent financial brokerage firm. Chuck semi-retired in 2008, continues to serve as the board's chairman, and is the largest single shareholder.
Fidelity Investments was founded in 1946 by Edward C. Johnson II. Founded as an asset management complex (a mutual fund company), today, Fidelity is the 800-pound gorilla in the 401(k) space, manages $4.5 trillion in the mutual fund division, and had 37.1 million active retail accounts at the end of 2022. The founder passed away in 1984, but his granddaughter, Abigail Johnson, has been the CEO since 2014. Fidelity is a privately held company; the Johnson family still owns 49%.
There are only two ways for a brokerage firm to fail: insolvency and fraud. Both custodians we work with, Fidelity and Schwab, are on sound financial footing. Both firms are highly regulated and well-regarded, with professional management and corporate controls. Both carry additional insurance on top of SIPC to protect client assets. Your assets are about as safe and secure as they could be with Schwab and Fidelity.
This is being provided for informational purposes only and should not be construed as a recommendation to buy or sell any specific securities. Past performance is no guarantee of future results, and all investing involves risk. Index returns shown are not reflective of actual performance nor reflect fees and expenses applicable to investing. One cannot invest directly in an index. The views expressed are those of Chris Duke and do not necessarily reflect the views of Mutual Advisors, LLC, or any of its affiliates
Investment advisory services are offered through Mutual Advisors, LLC, DBA Context Wealth, an SEC-registered investment adviser.