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CDs Not As Safe As Many Investors Believe

David P. Meyer, Esq.

Most investors assume CDs are entirely risk-free. And, thanks, in part, to the volatility of the stock market over the past several years that means CD purchases are on the rise. But, that assumption is incorrect. There are risks associated with CDs, particularly higher-yield CDs purchased through a deposit broker, that investors don't always understand.

Most CDs are purchased directly from FDIC-insured banks by individual investors, which means the CDs are backed by the U.S. government for up to $250,000 per investor as long as the investor holds no other FDIC insured accounts at the issuing bank. (The U.S. government guarantee only covers up to $250,000 per customer per bank - regardless of number of accounts or products owned by the customer, which means that an individual could hold more money at one bank than is covered by the guarantee.

Some investors, however, choose to purchase CDs through a deposit broker (i.e. brokered CDs). Brokered CDs often offer higher-yields because the deposit broker can negotiate a higher rate of interest by arranging to bring a certain number of deposits to the issuing institution. These higher yields often attract investors and convince them to purchase their CDs through deposit brokers, many of whom are brokerage firms and independent salespeople.

While a higher-yield CD sounds like an investor's best bet, it could mean becoming a victim of fraud.
The SEC has issued a warning to investors about the potential risks associated with brokered CDs. According to the SEC, deposit brokers are not required to meet any licensing or certification requirements and they are not examined, approved, or licensed by any state agency. Basically, anyone can say he or she is a deposit broker, especially a con artist.

To protect themselves, the SEC recommends investors ask:

  • What are my financial goals? How will the purchase of this CD meet those goals?
  • What's the deposit broker's background? Are there any complaints against him or her?
  • What institution is issuing the CD? Is it FDIC insured? Do I already have accounts with the issuer that will put me over the FDIC guarantee?
  • When does the CD mature?
  • Are there any call features? (A "callable" CD means the bank could terminate or "call" your CD if interest rates fall.)
  • What's the interest rate and how will I be paid?
  • Will the interest rate change?
  • Are there penalties for early withdrawal?

The SEC also recommends investors ask for a copy of the exact title of the CD and ensure that all of the information (such as the identity of the issuer and the owner) is correct. Investors should verify that the title reflects that the deposit broker is merely acting as an agent for the investor. Legitimate titles should read something like: "ABC Brokerage as Custodian for Investor's Name." If there are multiple owners, the title will likely not list each owner's name but may simply read "for Customers."

Remember: The ultimate reason for purchasing a CD is that the FDIC insurance protects you from loss. If the CD isn't covered by the FDIC program or if the deposit broker cannot prove that it is, then don't buy the CD, no matter what rate of return the broker promises. Shop around until you find a guaranteed CD that better fits your needs.