Posted by Chuck on December 14, 2018
High-Yield APY Accounts

Published on December 14th, 2018 | by Chuck

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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.”

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.



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Ted
Ted

It’s just a money market fund. Same idea different name.

lenin1991
lenin1991

Many people said the same of the commercial paper market in 2007: nearly guaranteed! always easy to liquidate! no problem!

…then that market completely froze as the financial crisis hit.

sloebrake
sloebrake

For further reading on what can happen to money market funds when the market crashes, google ‘Primary Reserve fund broke the buck 2008’

E
E

Plenty of risk depending on the duration of the UST bonds. Not that they will default, just that the underlying asset value will go down significantly. As yields go up, prices go down…

Humphrey
Humphrey

A couple of Issues here.
1. Suppose it is covered under SPIC, if the accursed interests would be covered is in question. I can argue that the lost accursed interests would be an investment loss in the hypothetical failure of the company.

2. RH is a very small and very new company compared to giants like CITI. Considering the actions of CITI in the last crisis, it is very uncertain how much faith one should put into RH.

3. 6-month CDs as for now have interest around 2.7% in Fidelity. The opportunity cost does seem too high, considering the interest gap.

In the end, nothing matters: one is responsible for one’s own actions. This part is for sure.

Billy Bob
Billy Bob

Hmm… if you have $250K to plop down in an account at a place called Robin Hood, it’s not hard to guess which character they see you as in that story…

Dan
Dan

lol

Mike M.
Mike M.

I don’t agree with you but this made me laugh.

Duke I.

If they offer a signup bonus I’ll sign up.

Debit
Debit

Sipc protects against malfeasance not market loss.

If you are greedy now don’t be a pig and cry later. Americans do that a lot and get politicians to bail them out.

bax
bax

Cross out politicians. It’s the rest of the taxpayers who pay for the bailout.

raj
raj

This doesn’t make sense to me. You’re saying not to do something, but also that it tends to work?

Zalmy
Zalmy

It’s probably those religious extremists, right? Their immense greed, violence, and bent on world domination. Maybe you should go shoot up a synagogue in Pittsburgh to protest all of the Americans’ “greed”? (This comment is assuming you’re the same Debit from Lucky’s posts.)

It wasn’t the everyday American’s greed in ‘08. It was the greed of the elites on Wall Street- the investment bankers, and Moody’s and other credit ratings companies.

Piss off and take your agenda elsewhere, this isn’t a political forum.

Debit
Debit

Fuck off zalmy. Assuming you are the same zalmy that begs politicans for hand outs.

DM
DM

Thanks Chuck for this post, there has been a ton of misinformation out there on this. I have a whole lot of thoughts about this and I think some of it is nuanced, but honestly think about RobinHood like a less egregious version of Moviepass. They have a base business (free trades) that is fundamentally money-losing and have not been entirely straightforward to the public on how they make money (they say that they don’t sell order flow, but there is real evidence that it is how they make a lot of their money). They are constantly changing their business model. Now they are using this to get more users onto the platform, which is great for them because they are likely valued by investors on daily active users and total AUM.

Again, there are plenty of more complex discussions about this particular product and SIPC insurance and I’ll leave that to actual financial advisers, but honestly the best thing that can probably come out of this is that it drives up the Ally’s of the world to offer higher rates in the same way that MoviePass forced AMC to come up with an attractive alternative (whether or not their pricing remains attractive after the first year is obviously up for debate).

Frank

Lol you clearly don’t know what you are talking about. Offering free stock trades is not a “fundamentally money-losing base business”, they make money from other areas (selling order flow — this isn’t a bad thing, options trades, etc.). The “changing business model” is them adding lines of operation and expanding what they do as they grow (that’s what successful companies do).

AS far as this account goes, there are legitimate questions as to if SIPC covers this and since their are other accounts that pay 3%+, probably not worth taking the risk.

DM
DM

Sorry, I think you are misinterpreting my point. I’m not saying operating a brokerage house is a money-losing business. I’m making a much more narrow point. There is a fundamental cost to executing a trade. Schwab et. al probably make a nice margin by charging $3.99 or $4.99 or whatever they charge on this, so let’s just imagine it costs 20c variable/fixed cost to do it. Therefore, Robinhood is “losing” 20c every trade they execute. So they come up with other ways to monetize these trades. Selling order flow is not fundamentally bad, most brokerage houses do it. I think consumers don’t necessarily realize it is happening, but whatever. For a while, Robinhood did not disclose on “how we make money” that they were doing so (now I believe they do). They are still being purposely opaque on disclosing how much they make off of this because they disclose order flow in terms of dollars instead of shares (https://www.bloomberg.com/news/articles/2018-10-15/robinhood-gets-almost-half-its-revenue-in-controversial-bargain-with-high-speed-traders).

The narrow point that I was making here is that RobinHood has taken a different approach to the market. They are offering a money-losing service in order to gain enough users to reach scale or who they then hope will buy into their other money-making products. This is an oft-repeated strategy that you see everywhere (Uber, Blue Apron, whatever your favorite unicorn-of-the-day is). I’m just saying that the idiosyncratic risk you are taking with them is a little bit different than the one you are taking with an established brokerage house.

Which gets to your point of SIPC risk. If you think that these guys aren’t going to be covered by SIPC, then I agree it’s probably not worth the incremental interest.

LWT3
LWT3

Agree, DM. RH has been honest in interviews about the fact that they are not making any money now. They’ve compared themselves to Amazon in the way Amazon ignored profitability for years, instead investing for future growth. Which is fine in theory. But that’s also what every dot.com with a non-viable business model said before the bubble burst in 2000. “Gain users now, figure out how to make money later” is a risky business model for shareholders and creditors. For now RH doesn’t care. They are happy to burn their venture capital funding today and are probably planning to continue burning capital in the form of IPO proceeds.

aubergine
aubergine

I work in an adjacent industry and DM is right. (exceptionally cogent assessment of RH’s issues and biz model). I am not surprised that Robin Hood didn’t clear this with SIPC/SEC ahead of time for the simple reason that they pretty much knew that this would not fly. They were trying the Travis Kalanick strategy of ‘we’ll build and always be hustling and be one step of ahead of regulators’ Maybe that’s ok if you’re just selling a cheap ride to a bunch of drunks trying to get home….that’s much dicier when dealing with people’s life savings. Many many years ago we had to go find excess SIPC protection for some of our products, it was very hard. Most insurers have totally gotten out of that space. There’s a reason they won’t touch something without being a govt regulating body.

Zaos
Zaos

Yeah, so when you deposit 100k you’ll get 100k shares of their mmf. There is no guarantee that each share = US$1. SPIC does not protect that.

Ferris
Ferris

Robinhood allows margin (up to 2x), so there is certainly risk that they could lose enough money in a quick market selloff to bankrupt past the point where the other funds could help them. Even since the stock market selloff in October, over 170 hedge funds have closed and the stock market is only down 10% due to margin losses

Frank

That is completely irrelevant.

1. RH won’t be investing on a margin basis (honestly I don’t even see how that point is connected).

2. “Hedge funds” have nothing to do with SIPC protected brokerages or checking accounts.

3. How did you connect 170 hedge funds as all closing due to margin losses?? — I can’t imagine that is either true or you have data for that.

sam
sam

he’s making point #1 as a way of talking about risk of systemic failure. Not sure how valid that point is given that other brokerages allow more than 2x margin, so by that point alone robinhood would be less risky…

momosan
momosan

Generally speaking, in the case of a brokerage/bank/investment house going down like a whale, what happens is what happened to Lehman Brothers. Barclay came in at a fire sale and took over and made good the accounts. The alternative is a Madoff style blow up, where 10 years (as of the November report) later the trustees recovered about 75% of the money.

RobinHood has to clearly notify their clients what that money is being kept as, and it pretty much HAS to be cash equivalents. Otherwise the SEC would be breathing down their necks.

The most similar account is probably Schwab’s One account (at around .35%), which uses their own bank to get FDIC insurance.

Fidelity’s Cash Management Account has rates of .33% (100K) and is FDIC insured through their partner banks, and has the additional feature of using those banks to get up to $1.25M FDIC covered.

Both of those choices have the advantage of getting you access to their credit cards. Both allow you to easily move cash out of your brokerage account.

So in terms of these banks and brokerages, there is always a balance between risk, reward and liquidity. Truthfully, you’d probably be best off with Schwab or Fidelity and using the excess in a CD or Tbill or even in the MM fund in the connected brokerage account as opposed to the “checking” account. You do lose some liquidity, but that’s life.

Frank

Not really on the first point — Lehman was an investment bank which means there was no FDIC OR SIPC protection. Lehman went bankrupt so I don’t think Barclays really “made good” on accounts. Madoff was an investment fund so again no FDIC OR SIPC protection.

Assuming the account is SIPC covered a blow up would be resolved quickly (<1 year), barring a financial crisis causing delays. But RH needs to clarify because this seems like a totally new product that might not be SIPC protected.

momosan
momosan

In both cases, the firms were liquidated under a specialized form of bankruptcy that SIPC oversees.

SIPC was one of the first groups called in during the Lehman mess. The Trustee was a SIPC trustee overseeing the liquidation. Oh hell, I’ll google it – quickest answer is the Daily Mail from 20 Sept 2008

“The Securities Investor Protection Corporation liquidated Lehman accounts on Friday under a bankruptcy-style process to transfer assets from 639,000 Lehman customer accounts – about 130,000 of which are owned by individual investors – to Barclays accounts.” If you pop over to SIPC, they have an entire file on Lehman. Barclay literally took over those accounts.

Now, this doesn’t include accounts at subsidiaries like Neuberger and Berman, which were segregated and ended up being sold to it’s management and is now employee owned, and was also SIPC covered. (to state my interest here – I sold out of N&B Guardian just before they were sold to Lehman)

Madoff was also a broker. In this case, he was actually stealing from clients, which is something SIPC specifically covers. It was SIPC that filed for the liquidation of the firm. Bingo – here – https://www.sec.gov/divisions/enforce/claims/madoffsipc.htm

SIPC – it does more than you think. And as of about 30 minutes ago, word is they are NOT happy with RobinHood.

Frank
Frank

Please ignore my comment. The above is extremely clarifying and correct.

MoreSun
MoreSun

Very interesting research. I can’t imagine the other brokers would agree to cover Robinhood loses if they go under when the big boys go to the effort to sweep cash into FDIC backed accounts.

Vince
Vince

The SIPC will not insure the product according to Stephen Harbeck, the president and CEO of the SIPC:

Stephen Harbeck, the president and CEO of the SIPC, tells Axios that he never heard from Robinhood before the announcement, and that he will not insure such a product.

https://www.axios.com/robinhoods-new-checking-account-b2b0df32-40c6-4bd1-b336-2408b27f16b0.html

Max
Max

Looks like this is gonna go to court. SIPC has specific regulatory requirements that their firms need to adhere to, if Robinhood is adhering to this (investing the funds in a money market government mutual fund or treasury bond) it doesn’t matter if it “looks” like a loan to him, it fits the legal definition of a security, and SIPC must by law cover it, he doesn’t really have the discretion to deny.

Frank
Frank

Lol that would be quite a twist for it to be covered not because it is cash but because it’s a loan to RH. I think he’s got pretty good cover since it’s advertised as a checking account and they don’t cover that.

Wilson
Wilson

“never heard of Robinhood”…must be one of those executives who has never used a computer

Paul
Paul

One of those “executives” who can barely open a PDF…

Steve

“heard from” not “heard of”

LD
LD

Check out beam if you haven’t already: https://www.meetbeam.com/
It is in Beta right now, but the account is FDIC insured. Their model is to offer higher rates (minimum 2% interest currently) and dis-intermediate the banks, which could mean they need to start being more competitive as rates are going up and company’s like RobinHood are coming out with this 3% account. Beam does require some annoying daily interaction with the app to get a higher rate, but it is an option play.

Without FDIC insurance on Robinhood, I do not think its worth chasing the extra less than 1% for a few extra dollars. Remember history repeats itself and we have seen banks go under during a financial crisis. Even if it does not seem likely right now , in a year or 2 you may regret your decision.

Eric C
Eric C

Beam seems pretty suspect too and that you can get a 2-4% interest rate if you do these daily “Billies”. Their beta program has gone pretty slow and I can’t seem to find anything on how the beam banking program is going. Who knows if it it will ever go full public.

Ann
Ann

Beam looked like a waste of time to me once more details came out. You start over again each day at 2%, and there’s very little way to get “billies” to temporarily increase that rate, besides referring significant amounts of people constantly. And you have no web-based access to your account, it’s app-only. And interest rates on more normal bank accounts that aren’t a constant pain-in-the-a$$ have caught up with them in the looong time it took for them to finally partially launch.

Previous discussions at:
https://www.doctorofcredit.com/beam-2-4-apy-savings-account-launches-private-beta-ios-only/
https://www.doctorofcredit.com/beam-2-4-apy-savings-account-set-to-launch-beta-at-end-of-march/
https://www.doctorofcredit.com/beam-review-high-interest-savings-account-earn-2-4-apy-no-fees/

sam
sam

honestly this is sounding more and more like a poorly thought out and rash move by robinhood. this is precisely the issue with fintech, you get these tech minds who are used to innovation and no bounds and reaching for the stars, and you put them in the most regulated industry on the planet (yes bernie supporters, despite what he tells you about greedy “bill-yun-nairs” the financial industry has incredibly burdensome regulations compared to just about anything else). still mind-boggling that they did not pre-clear this product with the very group they are claiming would insure it (SIPC)

Tom
Tom

“Just got off the phone with the head of the SIPC and he says Robinhood never contacted him and he has serious concerns about this new product. Story coming soon.”
From tech reporter https://twitter.com/julieverhage/status/1073583035986137089

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