SIPC? FDIC? A Primer on US Account Structure and Insurance

Is my money safe? This question is top of mind for many following the failures of Silicon Valley Bank and Signature Bank, not to mention the near-failure of Credit Suisse before its emergency buyout by UBS. Being exposed to market volatility is one thing, but failures have raised chatter about people finding their money is suddenly gone—erased in a bank or brokerage failure. A slew of articles understandably dot the Internet on this now. Some are ok, some less so—but we don’t think any give a detailed enough picture. Look, we don’t see systemic risk presently and think the recent episodes were isolated and stemmed from unique circumstances. However, if you are worried, it is worth reviewing the protections in place—and, perhaps, getting a better understanding of how to augment them in certain cases.

The bank failures put the FDIC’s $250,000 deposit insurance cap in the spotlight, as it took a special guarantee from the Fed and Treasury to ensure amounts over that limit wouldn’t be subject to losses. That guarantee applies only to Silicon Valley Bank and Signature for now, raising questions about the safety of uninsured deposits elsewhere—and spurring Congress and regulators to mull raising the cap. Theoretically, this shouldn’t be very relevant to individuals, as holding more than $250,000 in cash in the bank probably doesn’t mesh with most folks’ goals. Emergency funds should typically cover somewhere around six months or one year’s worth of expenses, which is probably below $250,000 for the vast majority of households. While some might need to hold more cash than this for large short-term expenses like a down payment on a home, money market funds are probably a more sensible option given their higher yield and immunity from bank failures (more on this momentarily). Still, if for some reason you need to hold more than $250,000 in a bank account, you can augment your protection by using multiple institutions, as the cap applies on a per-depositor, per-institution and per-ownership category basis. So if you hold $250,000 at Made-Up Bank and $60,000 at Hypothetical Bank, you should be fully insured.^[i]

Money market funds are generally insulated from a financial institution’s failure because they are held in brokerage accounts. Brokerage accounts aren’t bank deposits. The brokerage firm acts as custodian—they provide a house for your assets, which stay in your legal possession. When you deposit money in the bank, that is a liability for the bank—technically, you are lending your money to them, and they are using it to try to generate returns (by buying bonds or making loans, etc). If the bank fails, it can default on that liability, which is where FDIC insurance comes in. But assets in a brokerage account—including money market fund balances—are simply assets under the brokerage firm’s supervision. It isn’t a liability. The brokerage therefore can’t default on it, which means it can’t go poof if the brokerage house fails.

Since brokerage accounts aren’t a liability, it is typically pretty easy for healthy firms to take over accounts from failing institutions. Even when Bear Stearns and Lehman Brothers failed in 2008, the account takeover processes by JPMorgan Chase and Barclays and Neuberger Berman, respectively, were pretty seamless from the customers’ viewpoint. All their stocks were still their property, in accounts in their name—they just moved to new houses. If another brokerage were to fail today—not that we think any are on the verge of doing so, based on our ongoing securities research—a similar merger would likely result. If it didn’t, your assets would still be there, available for transfer to a new brokerage.

Nevertheless, brokerage firms have their own insurance via the Securities Investor Protection Corporation—SIPC for short. This protects against the loss of cash and securities in a brokerage account, up to $500,000 total and $250,000 for the cash specifically. This is a safeguard in the event that the firm fails and there are securities missing from your account. How might this happen? Fraud and theft, for one. Bad record keeping. Illegal or unauthorized trading. Now, in the event a brokerage fails, SIPC encourages every client of a failed firm to file a claim, whether or not their assets are missing, just to ensure their transfer to the new firm goes smoothly. But if securities are missing, then the insurance kicks in. Many firms even augment standard SIPC coverage with higher-limit surety bonds from private insurers.

If you are in a situation that requires SIPC assistance, the Feds do their best to make it as simple as possible. When Lehman failed in September 2008, SIPC mailed claim forms to all of its customers in early December. By this time, over 100,000 accounts had already been transferred to Barclays or Neuberger Berman. As SIPC noted: “This transfer of customer accounts in a liquidation proceeding of unprecedented size has been handled in record time, according to SIPC. The procedures being followed in the account transfer process and liquidation of LBI reflect the safeguards provided by the securities laws and the Securities Investor Protection Act (SIPA) in protecting customer assets.”^[ii] While the program is rarely used, it isn’t rusty. Technology advances in both record keeping and account transfer likely help quite a bit versus the paper-based days of yesteryear.

For participants in defined contribution plans (e.g., 401(k)s, etc.), there is an added layer of protection through the Employee Retirement Income Security Act (ERISA). Given 401(k)s and the like are custodied at SIPC-member brokerage firms, they will have the previously mentioned protections. But on top of this, they will have protections against the plan administrator violating their legal duties.

Investing isn’t risk-free, of course. None of these protect against volatility and the risk of loss. That is ever-present. However, they do offer significant and strong protection if a brokerage failed, arguably much more so than standard FDIC bank account coverage. Again, we don’t see that as likely now. But we think understanding the guidelines and protections, and perhaps navigating the FDIC world, can help keep many of these fears at bay.