How Safe is the New Robinhood Checking Account with SIPC Insurance

[Update 12/15/18: Robinhood is rebranding the account due to the issues discussed in this post.]

Robinhood announced yesterday a checking and savings account with 3% APY interest rate and no fees. There was a lot of discussion which I found interesting about the risks involved in such the Robinhood cash accounts, so here are a few follow-up thoughts. (Here and here are the relevant Robinhood page, for reference.)

• Robinhood says that they’ll only be investing in things like US treasuries and similar. These are the least risky investments available, making the potential for default very low.
• Like other brokerages, Robinhood does not have government-backed FDIC insurance. Instead they are a member of SIPC which basically binds together most/all brokerages so that if one fails, they’ll have to collectively reimburse the customers of the failed brokerage. In the event of a major economic downturn, there may be some level of default where government-backed FDIC accounts will uphold coverage while SIPC – a private entity – will collectively go bankrupt.
• The risk of Robinhood, alone, going bankrupt is well-mitigated by their SIPC insurance.
• SIPC protects up to $500,000 of cash and securities, with a $250,000 limit for cash only. So, for our purposes, you’ll want to limit yourself to $250,000 in the checking/savings accounts. (Not sure if you can put $250,000 in checking and another $250,00 in savings.)
• Where things get interesting is that Robinhood is introducing a new kind of cash account: most brokerages have a cash account where you leave your liquid funds waiting to be invested, but those funds are just sitting there, not invested. In fact, the brokerages may even have an automated sweep system where they – behind the scenes – deposit all your cash on hand into an FDIC-backed account while it waits.
• On the other hand, this Robinhood account is openly investing your funds. Now, they say they’ll only be investing in safe investments. But, let’s do a mental exercise and imagine an SIPC brokerage member who creates a similar kind of checking account promising a steady 10% return by doing overtly risky investments, selling options or whatnot. Would SIPC have your back in case of default? That’s hard to imagine. The purpose of SIPC is obviously not to mitigate an individual’s risk in investment – many investors take big losses when they make poor choices. The SIPC is to ensure against the insolvency of the firm, not the investments. When the firm creates a product which pays a higher rate based on investment, that may not be included.
• A reader shared an article on Barron’s (paywall link) which addressed this very issue:

In an email to Barron’s the head of the SIPC cast doubt on the idea that it would insure checking or savings accounts.

“SIPC protects cash that is deposited with a brokerage firm for one limited purpose…the purpose of purchasing securities,” wrote Stephen P. Harbeck, the president and CEO of SIPC. “Cash deposited for other reasons would not be protected.”

Robinhood says that because the checking and savings products are technically part of a brokerage account, they would be protected by SIPC like other brokerage assets…

Other broker-dealers also offer cash management accounts with checking-like features, though the branding and insurance is different. Fidelity, for instance, offers a cash management account that acts like a checking account and allows people to use fee-free ATMs. But it’s not branded as a checking account, and cash funds are swept to a bank where that money is eligible for FDIC protection.

Robinhood says it will explain the difference to customers in its marketing.

“We don’t think that’s something that a lot of customers are going to be scrutinizing the details of, or will really see value in there being the difference between the two,” Bhatt says. “The product we’re offering has the same insurance amount, which is a quarter of a million dollars.”

• Axios also got a reply from the CEO of SIPC stating that they will not insure the Robinhood banking products. 

At the end of the day, Robinhood feels that their product is covered by SIPC insurance, yet that doesn’t appear to be entirely true. Again, assuming Robinhood keeps to their stated plan of only investing in things like US treasuries, there may not be a whole lot of risk here, but to say that the SIPC is absolutely covering these accounts seems iffy at best.