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Fed Meeting Preview and Deposit Rate Forecast - March 15, 2023Risks of Brokered CDs
Brokered CDs can have advantages over CDs that are purchased directly from banks or credit unions. I reviewed both the pros and cons of brokered CDs in this 2012 blog post. One important downside is the risk of brokered CDs especially when dealing with an unfamiliar brokerage firm. An example of this type of risk was recently described by DA reader ChrisCD who mentioned a website listing suspiciously high CD rates. As he described in the DA forum and in his blog post, there are many red flags. I’m not sure if that website is claiming to be offering brokered CDs, but it does raise the important point that when you’re going through a middleman like a brokerage firm for your CDs, it’s critical that the brokerage firm be a reputable deposit broker.
The FDIC recently published a guide on brokered CDs in its Spring Consumer News. Here’s an excerpt with advice about ensuring the reputation of the brokerage firm:
If you’re thinking about an offer from an unfamiliar deposit broker, research that person’s credentials and experience. If the person claims to hold any professional licenses or certifications, verify his or her background and standing with the issuing agency, such as FINRA (the Financial Industry Regulatory Authority at www.finra.org or 1-301-590-6500). In addition, your local Better Business Bureau (http://www.bbb.org/) or your state’s consumer protection office (www.consumeraction.gov/state.shtml) may be able to provide information about whether an individual broker or a company has a history of actual or alleged misconduct.
“We’ve heard multiple examples of individuals wiring funds to someone claiming to be a reputable broker, only to later find that the broker disappeared with all of the money,” said Calvin W. Troup, an FDIC Senior Deposit Insurance Specialist. “Whenever you use a third party to establish a bank deposit account, you place your funds at risk if that person does not put your money in an FDIC-insured bank.”
DA reader pearlbrown found a very useful tool inside the FINRA website called BrokerCheck. Here’s an excerpt from the BrokerCheck overview page:
BrokerCheck is a free tool to help investors research the professional backgrounds of current and former FINRA-registered brokerage firms and brokers, as well as investment adviser firms and representatives. It should be the first resource investors turn to when choosing whether to do business or continue to do business with a particular firm or individual.
When you see suspiciously high CD rates, it may not always be an illegal scam. The FDIC Consumer News describes two ways unscrupulous brokers advertise above-market rates on CDs. In both cases, they are using those high CD rates to get people in the door so they can market them other investments that offer big commissions. And in both cases, those high CD rates are very misleading. Here’s an excerpt from the FDIC describing the first example:
In one recent case, a high-rate brokered CD was issued by a foreign bank and therefore not protected by FDIC deposit insurance. However, the marketing materials for the CD included multiple misleading references to an FDIC-insured bank, and that led consumers to mistakenly believe that the investment was subject to FDIC insurance. In reality, the role of the FDIC-insured bank was limited solely to wiring collected deposits overseas to the issuing bank.
The second example involved the deposit broker advertising short-term CDs with very high rates. The high rate was the result of the broker adding in a bonus to make it look like the CD has a high rate. It’s a bait-and-switch strategy in which the broker is using the CD to attract customers for their other investments which of course have high commissions. I have more details on this scheme in in my post on very high CD rates advertised in newspapers.
The other parts of the FDIC Consumer News article describe other potential issues of brokered CDs. These other risks aren’t as serious as the risk of being scammed out of your money, but they could create some unpleasant surprises if you aren’t aware of them. They include the risk of having some of your deposits not insured, the risk of selling your CDs at a loss before maturity and the risk of delays if the bank holding the brokered CD fails.
The banks that issue these CDs, most of the time are in the millions and very few individuals can buy it outright for themselves only.
In other words, your money is just a part of the CD issued by the bank and you are only a fractional owner of that CD. Should the bank goes under, your money is not 100% insured.
Part 4 of the linked document explains how the insurance works.
Here is the permanent URL for all the brokered CDs offered by Fidelity at whatever moment you look there. On Monday afternoon they have 115 offerings, several of which are more than $8 Million apiece. You can buy whatever you want in multiples of one thousand dollars.
http://tinyurl.com/lmpvlua
5 years ago I bought several CDs at different maturities and different banks. The rates offered through Fidelity were quite good. But for the most recent couple of years the rates offered through Fidelity are LOUSY when compared with the rates offered directly by the same bank for the same maturity.
For example, today an Ally Bank 2-year CD offered on the Ally website has a rate of 1.04%, while the Ally CD with maturity date of June 12, 2015 is only 0.50%. And there are three additional advantages by getting the CD directly from Ally that you don't get with the Fidelity brokered CD.
(1) The Ally CD is raise-your-rate, allowing a one-time increase of the rate anytime during the 2 years if you see Ally offering a higher rate on its 2-year CDs, but that feature is not available through Fidelity;
(2) The Ally CD rate is actually 1.29% if you are rolling over a CD that is already at Ally -- they have a 0.25% loyalty bonus, which you do not get through Fidelity;
(3) On the CD through Fidelity you get interest only every 6 months, whereas through Ally you can have it sent to you monthly.
On the other side of the equation, the bank does not know who is in the pooled money and can not individually insure any person who bought brokered CD.
FDIC applies only if the bank fails but not the brokerage, because the money held in the pool at the brokerage is not insured by FDIC and if the money is not FDIC insured, then you have to file a law suit to collect, but if the broker counters with bankruptcy, you are out in the cold.
If the bank fails, FDIC asks the broker for the list of the individuals and the amounts that is insured under $250K, if you are above that at that particular bank, you will loose the rest of it.
Having CDs with a brokerage is not as simple as just holding them at a local bank. There are pluses and minuses for this but over the years we have not had any problems with any of our brokerage CDs or the brokerage.
There is a grey area when you cut a check to the broker and the time he sends it to the bank, it could be a month before your money reach the bank, in mean time the broker can do what ever he want to do with your money, nobody controls his/hers behavior.
SIPC ONLY COVERS LOSSES RESULTING FROM FRAUD OR LOSS BY THE BROKER --
--IT DOES NOT COVER LOSSES RESULTING FROM LOSSES BY THE PRODUCTS THE BROKER SELLS
AND
THERE ARE TWO TYPES OF PEOPLE IN THIS WORLD (AND ONLY TWO)
1] THOSE WHO BELIEVE SOMETHING IS TRUE--BECAUSE THEY WANT IT TO BE TRUE
2] THOSE WHO BELIEVE SOMETHING IS TRUE--BECAUSE IT IS TRUE
RESPECTFULLY--DAVE
"Generally, deposits at a bank held in nonretirement and qualified retirement accounts such as traditional or Roth IRAs are eligible for up to $250,000 coverage per account owner, per depository institution. Certain holdings at Fidelity are eligible for “pass-through” FDIC insurance coverage subject to these same limits.
Eligible positions include:
• Certificates of deposit (CDs) — Brokered CDs that are issued by an FDIC-insured institution
• Core balances in the Fidelity® Cash Management Account1
• Core balances in eligible Fidelity IRAs or Fidelity Health Savings Accounts1
• Any 529 Bank Deposit Portfolio investments
"Please keep in mind, monitoring your FDIC coverage is your responsibility. "
One thing to remember, the broker never specify which bank or banks or other investments created the blended rate of return,
It could be a mixture of 2,5,10 or more institutions were your money is being split or combined into just one bank.
On top of that, your money could be invested in a corporate CD without ever knowing about it.
Since you give the money to broker and expect them back from the broker, he could gamble your money away and pay you back somebody else’s money that is waiting to be invested.
There is a possibility of a ponzy scheme to happen.
Now we have you saying it can be a Ponzi scheme?? So can ANY money we give to anyone for investment. Maybe the teller I gave my interest checks to at the bank today gave me a "pretend" deposit receipt and put the money in her pocket instead?? It's good to be concerned about our money but this paranoia stuff is a bit much. If I had to be that paranoid about the places I do business with, I wouldn't be doing business with them in the first place. You want to know how careful I am with our funds? I made sure I split DP's Rollover IRA between two brokerages instead of just one. That way, if one brokerage gives me problems, I can just roll it all over into the other. I am already more careful than most people but not to the point of what I have read today. Fidelity has always been very trustworthy and never given us any problems over many, many years of doing business with them. I don't think it is right for you to post parnoia crap unless you have proof of what you are posting.
Would you please explain what are these " high interest rate brokered accounts that carry a huge amount of risks" that you are referring to?. I have never seen anything like that on Fidelity's pages for CDs. Are you sure Fidelity carries such things? The only Fidelity CDs we buy are from individual banks. When I check Vanguard's CD page they usually are selling the very same CDs with the same interest rate. I have never seen anything like what you are describing on Fidelity or Vanguard's CD page. I would never buy the type of CDs you are referring to.
“The FDIC's insurance regulations include the following rule: "Funds owned by a principal or principals and deposited into one or more deposit accounts in the name of an agent, custodian or nominee, shall be insured to the same extent as if deposited in the name of the principal(s)." 12 C.F.R. § 330.7(a). In other words, the insurance coverage "passes through" the agent or custodian to the principal. "Pass-through" coverage generally is not available, however, unless the agency or custodial relationship "is expressly disclosed, by way of specific references, in the deposit account records' . . . of the insured depository institution." 12 C.F.R. § 330.5(b)(1).”
I have more if you want it.
We have never had problems with a brokered CD. We did have problems with a direct CD. It was akin to someone's post above about the teller stealing your money. And yes it did take a lawsuit. Very sad. However, as Paoli pointed out, your house can also be burned down or robbed so keeping all of your money there isn't the smartest move either.
Brokerages and Safekeeping agents have audits and have to match money that came in and where it was invsested. In the case of the CD, the system and paper trail has to show that the brokerage is holding a CD for you.
Yes brokered CD rates stink at this point in time, but you can't beat their ease. For high net worth individuals hunting around probably makes sense. For people like me, it would take far too much time for the yield I would receive. Personally, I use Charles Schwab.
For the record, I lost on an Apple Stock purchase. Now the stock market haters can be happy. At least I know with my CDs that my principal will be returned. :O)
If they are at the top of the list on the secondary market and giving higher yields than others, I would think the seller is eager to sell them. This is the main negative I find with brokered CDs. You can't just pay an EWP and get your full principal back. They make sure we know that they don't even guarantee you will be able to sell the CD on the Secondary market if you need to sell. This is why I only buy CDs from brokerages for the IRAs we have with them.
Thanks #40 for bringing this to my attention.
Have a great week!
#42: Thank you for bringing this to my attention. It seems you are so right about Chase. Now they are saying they can't even let me have info about their brokered CDs unless I go to a meeting with a Private Client Agent so they can get to know me better. I have been a client with Chase in my hometown and here for years. I told her I am not looking for friends, I am looking just for higher CD rates so I am not available for any "get to know you" meeting. I would love to hear from someone who is one of their Private Clients to find out what all the mystery is about. If they have better CD rates available, even if brokered, they should at least let their Premiere customers have access to them. So thanks again #42 for letting me know about this.
And I believe Ken touched on it, but that is why you sometime see a 'too good to be true" rate in the newspaper. A firm wants to get you in the door with the offer of the CD, but they hope you will buy something else. They use the higher commisssions from those that do buy something else to pay for the offset they end up having to pay to a small percentage that insist on the CD. These type of deals often have the maximum principal that can be invested in the CD set quite low which also keeps their exposure low.
WHAT ABOUT PEOPLE WHO BELIEVE SOMETHING IS TRUE BECAUSE SOMETIMES IT IS TRUE?