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  • Writer's pictureSteven Schoenberger

Charles Schwab and Custodian Banks

If you have read the news in the past several weeks, you have almost certainly encountered stories about the failure of Silicon Valley Bank (SVB) and other risks across the banking sector. Given then amount of press that this has garnered, we wanted to take the opportunity in our quarterly updates to share a bit about the importance of custodian banks and Charles Schwab, our primary custodian.

Let us not bury the lead: "your securities—like stocks, bonds, mutual funds, exchange traded funds, or money market funds—held at Schwab are yours. The SEC's Customer Protection Rule safeguards customer assets at brokerage firms by preventing firms from using customer assets to finance their own proprietary businesses." (Emphasis in original.)

With that, hopefully comforting fact out of the way, let us begin with a very short and overly simplified definition of "depository bank" and "brokerage."

A bank is a depository institution where banking customers deposit funds which they can later access via withdrawals. Banks in-turn, earn money by lending out a portion of client deposits to borrowers, who then repay the bank with interest. As long as the banks have enough cash for daily withdrawal needs there is typically no issue. An issue can arise, however, when more withdrawals are demanded than there is cash available. This happens when depositors are concerned about the financial stability of a bank, as was the case with SVB.

The FDIC has sought to reassure depositors that their money is safe by guaranteeing a certain amount of deposits per account (typically $250,000 per account holder). While $250,000 may be a lot for an individual to keep on hand ($500,000 in the case of a joint account), this is not always the case for businesses who may want to keep months of expenses liquid.

Charles Schwab is primarily a brokerage firm. Per an update they issued on March 23 of this year, "Schwab is the largest public broker-dealer in the U.S. and the most regulated, since we are also regulated by the Federal Reserve. Approximately 95 percent of the $7 trillion clients have entrusted us with is custodied at the broker-dealer and segregated for clients and their benefit." While brokerages do not enjoy FDIC protections, there are many other regulations in place to protect account holders. Specifically Securities Investor Protection Corporation or SIPC. SIPC protections are activated in the rare event that the broker-dealer fails (bankruptcy) and client assets are missing due to fraud or other causes. Per SIPC, securities are rarely missing, and in the past 50 years, 99% of investors got their investments back.

Schwab's update goes on to explain, "Schwab also owns a bank, though not like other retail banks. Our bank structure exists to help us serve investors’ banking needs." This means that Schwab's bank's function is primarily to accommodate investors who want to be able to write checks and move cash easily. In a depository bank, they often offer deposit accounts in order to fund the money making side of their business, making loans.

At Open Door we take the choosing of our custodian very seriously. There is a reason we are with the largest public broker-dealer and not one of the many other, smaller brokerages; some of which you may have never heard of. Schwab, because of its size, may garner more headlines, but we firmly believe that its size offers a benefit to our clients that other institutions could not. This is true from a service standpoint as well as an asset security one.

Further, we take additional comfort in understanding where our client funds are held and with whom they are invested. Charles Schwab is the investment manager on only a small portion of client funds, and this is another deliberate decision to diversify a specific type of risk in the portfolio.

While remain vigilant on how the developments in the banking industry impact client portfolios, we invite you to read the full letter from Schwab here: We hope that you will reach out directly with any additional questions regarding your portfolio managed by Open Door, about your bank accounts, or to get our insights on any other investment accounts about which you have concerns.

-Open Door Financial

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