How safe are your investments?

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How Safe Are Your Investments? After FTX, It’s Worth Checking

Here is what happens to your money if your bank, brokerage or crypto exchange goes bust

By Anne Tergesen, The Wall Street Journal, Dec. 13, 2022

… Bank deposits have been backstopped by the Federal Deposit Insurance Corporation since the Great Depression. In the crypto world, there are no clear protections…

If a brokerage fails, customer assets should be safe.

The U.S. Securities and Exchange Commission prohibits broker-dealers from using customer money or commingling it with the firm’s assets.

SIPC covers up to $500,000 per account, including up to $250,000 in cash.

If you have a brokerage account in your own name, a traditional individual retirement account, a Roth IRA account and a joint account at the same brokerage firm, each might be eligible for up to $500,000 of protection, according to SIPC…

If a company with a 401(k) plan files for bankruptcy, the plan’s assets are protected. The federal Employee Retirement Income Security Act, the 1974 law that governs 401(k) plans, requires the assets to be held in trust…

When you transfer cash to a cryptocurrency exchange to make purchases, the company often holds the money in an FDIC-insured bank account where it is available for trading. If the cryptocurrency exchange fails, customers should be able to access any cash they have in a linked bank account, provided the cryptocurrency firm titled the account properly…[snip potential complications]… [end quote]

Whenever I open an account at a new bank I always double-check their FDIC coverage.
FDIC.gov

SIPC protects against the loss of cash and securities – such as stocks and bonds – held by a customer at a financially-troubled SIPC-member brokerage firm. The limit of SIPC protection is $500,000, which includes a $250,000 limit for cash. Most customers of failed brokerage firms are protected when assets are missing from customer accounts.

SIPC protection is limited. SIPC only protects the custody function of the broker dealer, which means that SIPC works to restore to customers their securities and cash that are in their accounts when the brokerage firm liquidation begins.

Except as specifically provided above, the term “security” does not include any

currency, or
any commodity or related contract or futures contract, or
any warrant or right to subscribe to or purchase or sell any of the foregoing.

I can verify that FDIC is efficient since it managed the failure of 3 banks where I held assets in 2008.

Of course, protecting an investment (such as stock or crypto) only makes sure that the shares are there and doesn’t protect against market-related price drops.
Wendy

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Well, for this, blame your lawmakers’ inaction.

Here is the US SEC reasoning why it put additional, costly regulations onto digital asset custodians:

Legal risks – due to the unique characteristics of the assets and the lack of legal precedent, there are significant legal questions surrounding how such arrangements would be treated in a court proceeding arising from an adverse event (e.g., fraud, loss, theft, or bankruptcy)

Get that - the SEC is not confident that the US legal system will recognize digital assets under custody as safe from ordinary creditors because that premise hasn’t been „legally tested“ yet.

If a brokerage fails, customer assets should be safe.

The U.S. Securities and Exchange Commission prohibits broker-dealers from using customer money or commingling it with the firm’s assets.

If fraud is in play that is of little help however. Operating in a poorly-regulating jurisdiction to escape costly US regulations makes matters worse.

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It is very hard to protect idiots from themselves, which is why we have Darwin awards to deal with them.

Crypto currencies are private fiat currencies backed by the full faith and credit of unknown private parties.

How much is a Bitcoin worth? One Bitcoin – just like a US$ is worth one US$.

The Captain

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So , given that SIPC only protects $500,000 what is the answer for people who may have several million invested? Do folks have money spread over 5-10 brokerages?

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My hope that Vanguard never becomes a fraudulent corporation. :person_shrugging:

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Check with your brokerage. Many carry additional protection up to something like $2.5 million. Cash at your broker may be covered by the FDIC if it is held the right way (which I don’t recall at the moment).

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Depends on what the particular brokerage uses for a sweep account. One of the brokerages I use used the Reserve Primary Fund for it’s default sweep account. I looked at the garbage Reserve had on it’s balance sheet, and looked at the options. Found there was an FDIC insured bank CD option, so switched to that. A year later, the Reserve Primary Fund “broke the buck” as the garbage on it’s balance sheet blew up.

Steve

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Some brokers carry supplementary insurance for outfits like Lloyds of London to higher limits.

It is important to realize that if you have a “cash only” account, your assets are prioritized, but if you allow margin on your account, the stocks you “own” may be lent out by the broker without informing you and, should they go belly up, you will end up with all the othger unsecured creditors rather than getting your shares back.

Jeff

Jeff

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Just to be more precise here, if you have a margin account, but no debit balance (you have not borrowed on margin), then the broker (at least in the US) does not use your long stock in its securities lending. However, if you carry a debit balance, then the broker may lend out your stock up to an amount of 1.4 times your debit balance (Rehypothecation: Meaning and Examples).

A reason to have a margin account but to not actually borrow is that a margin account is required to trade certain kinds of options.

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Selling covered calls is one such reason but there is another valid reason, to improve your cash management. Should you find yourself in an emergency, the margin account gives you instant borrowing capacity to manage the crisis. While you don’t use margin it costs you nothing!

The Captain

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