What savers should know about FDIC and SIPC protections

Savers have been hurting after nearly a decade of interest rates at most savings accounts being stuck below 1 percent. That’s what made free stock trading startup Robinhood’s offer in December so attractive. The Robinhood Checking & Savings account would provide customers a place to earn 3 percent on their cash with no fees or account minimums. That is nearly one percentage point more than even a high-yield savings account.

Unfortunately, the good news didn’t last long. Robinhood paused the program within days because it needed to clear its plan with regulators after lawmakers raised concerns. The company wanted its turbo-charged account to be safeguarded by the Securities Investor Protection Corporation (SIPC). However, Robinhood’s account was not insured by the Federal Depository Insurance Corporation (FDIC), like most bank savings accounts.

Regulators’ main concern: Were depositors protected the way passbook savings account holders are insured in the case of a bank failure? Robinhood initially said yes, regulators said no, and the 3 percent accounts may be in limbo as a result.

“We plan to work closely with regulators as we prepare to launch our cash management program, and we’re revamping our marketing materials, including the name,” Robinhood co-founders Baiju Bhatt and Vlad Tenev wrote in a recent blog post about the company’s cash management program.

The Robinhood saga shined a bright light on the important question of depositor insurance and protection, something most people don’t think about. Americans trust they’ll never lose money they deposit into savings — even if their bank fails. That trust is absolutely essential to the workings of the financial system.

Here’s what you should know about those safeguards:

What the FDIC insures

If savers ever got scared en masse, and a “run on the bank” ensued, the domino effect on the financial system could be devastating — as we learned during the Great Depression.

Back then, federal regulators created the Federal Depository Insurance Corporation, which guaranteed that savers didn’t have to worry about losing their deposits up to a certain point. Today that point is  $250,000.

Deposit insurance has worked. Even during the Great Recession of 2008-2009, a feared “run on the banks” never materialized. As the FDIC likes to point out, “No depositor has ever lost a penny of insured deposits since the FDIC was created in 1933.”

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What SIPC protects

In 1970, a similar — but not precisely identical — protection plan was created for investors whose money and stocks are held by brokerages. Directed by Congress through the Securities Investor Protection Act of 1970, Wall Street firms created a nonprofit called Securities Investor Protection Corporation that protects consumers if their brokerage goes belly-up. The limits top out at $500,000 total and $250,000 in cash. SIPC protection kicked in when Lehman Brothers failed back in 2008. Roughly 110,000 accounts were transferred to the control of SIPC, and all those account holders had their investments restored.

So from a consumer’s point of view, is the SIPC basically the same as the FDIC? No.

Stephen P. Harbeck, president and chief executive officer of SIPC, puts it very bluntly: “If you deposit money with a bank you cannot lose money. That is not the case with investments protected by SIPC,” he told me in a recent phone call.

On one level, the distinction sounds pretty obvious. SIPC doesn’t stop investors from losing money because of bad investments — because stock drops or a company you’ve invested in goes bankrupt.  SIPC only helps if the brokerage holding custody of your investments fails, like Lehman did.

Say you have $50,000 worth of stock in Bob’s Coffee Shops you bought through a brokerage. The coffee stinks and the stock’s value goes down to zero. SIPC wouldn’t help you. On the other hand, say you have $50,000 worth of Microsoft stock, which you purchased through a brokerage. If that brokerage suddenly went bankrupt, the SIPC would replace your $50,000 in Microsoft stock.

“SIPC protests the custody function that brokerage firms perform,” Harbeck said. If you held shares of Bob’s coffee and they were valued at $0, and then your broker failed, SIPC would only work to replace the shares for you. You’d still be left holding shares worth $0.

So if you’re seeking a “safe” place to stash your cash, an SIPC-protected account comes with some risks that FDIC-insured accounts do not.

SIPC is not a regulator. It’s a non-profit, non-governmental entity, and has broad powers to make decisions about who gets protection and who doesn’t. Also, investors can’t appeal directly to SIPC. By law, only the Securities and Exchange Commission or the Financial Industry Regulatory Authority can direct SIPC to get involved in a situation, Harbeck said. The SEC can sue SIPC if it fails to act, which happened only once, after Allen Stanford’s notorious Ponzi scheme. SIPC decided not to cover investor losses, the SEC sued, and in 2014, SIPC won.

FDIC vs. SIPC: Why it matters

So what does this all mean to you? In today’s volatile market, and with interest rates increasing, some investors have sold a portion of their holdings to keep in cash. However, a SIPC-protected account could be a risky vehicle for doing that because cash put in a brokerage account merely to accumulate interest is not protected, according to Harbeck. Only cash deposited with a broker “with the intention to buy securities” is protected, Harbeck said. It’s unlikely, but in the event your brokerage firm goes fails, if you are keeping cash in an account with no intention of ever investing it, SIPC may decide not to restore your losses. That’s the obstacle Robinhood’s cash management program ran into.

An important note: Most “cash” held in brokerage accounts is actually swept into money market accounts, which typically pay a higher rate than savings accounts and invest in certificates of deposit, government bonds, and commercial debt. So it’s not really cash – it’s an investment in the eyes of SIPC. That’s good. Money market accounts would be entitled to SIPC protection, and that protection is capped at $500,000 — not the $250,000 cash cap.

The bottom line for savers: FDIC-insured bank accounts are guaranteed not to lose value up to the $250,000 limit. SIPC protected accounts enjoy no such guarantee when it comes to cash. So choose your savings alternative wisely.

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Bob Sullivan is a veteran journalist and the author of five books, including the 2008 New York Times Best-Seller, “Gotcha Capitalism,” and the 2010 New York Times Best Seller, “Stop Getting Ripped Off!” He specializes in computer crime and consumer fraud stories. He has won the Society of Professional Journalists Public Service Award, a Peabody award, and the Consumer Federation of America Betty Furness Consumer Media Service Award.  He’s now a syndicated columnist and frequent TV guest. He is also co-host of the podcast Breach, which examines history’s biggest hacking stories. Opinions are his own.

Haven Term is a Term Life Insurance Policy (ICC17DTC) issued by Massachusetts Mutual Life Insurance Company (MassMutual), Springfield, MA 01111 and offered exclusively through Haven Life Insurance Agency, LLC. Policy and rider form numbers and features may vary by state and may not be available in all states. In New York, Haven Term is DTC-NY 1017. Our Agency license number in California is OK71922 and in Arkansas, 100139527.

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