Understanding the Laws That Protect Your Assets

May 2, 2023

The failure of First Republic Bank this week marked the third major bank collapse in the past two months, following the demise of Silicon Valley Bank and Signature Bank in March. Combined, these three institutions had roughly $530 billion in assets and represented the largest bank failures since Washington Mutual, which folded during the 2008 financial crisis. In response, regulators have moved swiftly to stem contagion by invoking a systemic risk exception for both Silicon Valley Bank and Signature Bank, fully protecting insured and uninsured depositors, and by arranging for JPMorgan, the largest bank in the U.S., to purchase First Republic Bank and assume its deposits.

In each of these cases, depositors have been made whole, but understandably, these events have caused some anxiety among investors concerned about the security of their assets. Fortunately, federal laws are in place to keep both banking and investment assets safe. In the wake of these bank failures, we thought providing a refresher on the laws and regulations designed to protect your assets would be helpful.

FDIC Limits and Solutions

Most investors are aware of the Federal Deposit Insurance Corporation, commonly known as the FDIC, which offers legal protection for banking assets. Created during the Great Depression, the FDIC was part of the Banking Act of 1933 and was enacted to inspire confidence in the banking system. Since the Dodd-Frank reforms of 2010, the FDIC insures deposits up to $250,000 per ownership category, including individual accounts, joint accounts, certain retirement accounts, and trust accounts. FDIC protection applies per ownership category, not per account, which means a joint account for two spouses, for example, has $500,000 of FDIC protection.

On the other hand, FDIC insurance applies to all assets at a single institution, for each account ownership category. This means that high new worth investors must be strategic about where they keep their banking assets in order to receive the maximum protection under the law.

So, what should you do if you have more than $250,000 in cash to deposit or to invest in CDs? One solution is to open accounts at more than one institution or to open accounts in different ownership categories, if applicable. However, cash management solutions have greatly improved, and programs exist to seamlessly divide deposits to insure larger sums that exceed the $250,000 FDIC limit.

SIPC Protection for Investments

It is important to note that the FDIC does not insure money invested in stocks, bonds, mutual funds, annuities, municipal securities, or money market funds. Instead, investment assets fall under the Securities Investor Protection Corporation (SIPC), a special type of investment asset insurance created by the Securities Investor Protection Act of 1970.

While similar in mission to the FDIC, the SIPC protects customers of SIPC-member broker-dealers if the firm fails financially or client assets are missing due to fraud. The SIPC offers coverage up to $500,000 per customer for all accounts at the same institution, including a maximum of $250,000 in uninvested cash. In addition, major custodians such as Charles Schwab and Fidelity offer their customers coverage in excess of SIPC limits.

Though the SIPC insures investment assets, there is one important exception: margin accounts.With these accounts, the brokerage firm essentially lends the investor cash, using the account as collateral. Any money owed to the broker must first be deducted from the customer’s assets before claiming SIPC coverage for an investment account. In situations where customers exceed the SIPC limit of $250,000 in cash, they essentially become a creditor of the brokerage firm.

Importantly, the Securities and Exchange Commissions (SEC) Customer Protection Rule safeguards customer assets by preventing brokerage firms from using those assets to finance their own business. Client assets are segregated from the company’s operational balance sheet. In the event of a brokerage firm insolvency, SIPC seeks to quickly transfer accounts to a healthy firm so customers can access their investments in a timely manner.

Money Market Funds

As interest rates have risen, many investors have shifted assets from cash or traditional bank deposits into money market funds to earn a higher return on their cash. Money market funds are essentially short-term fixed income securities that are designed to offer current income, liquidity, and preservation of capital. While not covered by FDIC insurance, money market funds are subject to SEC regulations that are designed to maintain a stable net asset value (NAV) per share.

Money market funds are restricted in the amount of lower-quality securities they can hold, are required to have minimum levels of liquidity, and must have a maximum weighted portfolio maturity under 60 days. Further, money market funds are subject to periodic stress tests to determine their ability to sustain their $1 NAV under adverse conditions. While money market funds are not as risk-free as an insured deposit, they offer a reasonable vehicle for investors seeking short-term solutions for their cash.

Protection and Security

News stories about big bank failures and fears of contagion are certainly a reason for concern. We are fortunate to have a robust set of laws and regulations that help keep customer assets safe in banking and investment spheres during relatively “normal” times, as well as when institutions are in crisis.

Please feel free to reach out to us with any questions. As always, we greatly appreciate the trust our clients place in us.