Are Brokered CDs too Good to be True? Look Closer

It seemed like a low-risk move - until the bank that issued the CD failed. Then Katker had to get in line with other former customers of California-based IndyMac Bank to recover his cash. It took him nearly a month.

“I didn’t lose my principal, but I lost access to the money and almost a month’s worth of interest,” said the retired stockbroker, who lives in Orlando. “It upset me because my brokerage knew IndyMac was having problems but didn’t tell us.”

Even relatively safe, federally insured certificates of deposit issued by banks and credit unions can pose hazards for investors seeking to squeeze the biggest returns from their portfolios amid a slumping stock market and historically low interest rates.

In some cases, investors are turning to their brokerages, which offer them higher CD rates based on special deals negotiated with certain banks. In other cases, nonbrokerage firms are luring investors with high rates they claim to have tracked down at relatively unknown banks.

Experts say that, even with something as straightforward as a savings CD, you should be wary of any claim that sounds too good to be true.

“There is a real need for consumers to be on their toes and do their homework,” said Greg McBride, senior financial analyst for Bankrate.com in North Palm Beach, Fla.

Start with the basics, such as the current limits on Federal Deposit Insurance Corp. coverage. Generally, each account holder at a single bank or credit union is covered for as much as $250,000, though people can increase their coverage by having both joint and individual accounts.

Next, you should know something about the bank or credit union whose CD you’re planning to buy. The FDIC (1-877-275-3342 or fdic.gov) can tell you whether the bank is still in good standing. For credit unions, call 1-800-755-1030 or go to ncua.gov. Any sign of financial difficulty at an institution should give you pause, even if it is insured by the FDIC. If the bank does fail - as 64 U.S. banks have since early 2008 - you may have an aggravating and income-losing wait before you regain your money.

Buying a CD through a broker, as Katker did, can complicate things further.
Although “brokered CDs” typically offer some of the best rates available, there are limits, in some cases, to the FDIC insurance that could result in loss of principal.

“If you need to get your money out prior to the CD maturity date, it’s not as easy as forfeiting some interest as an early-withdrawal penalty and going on your way,” McBride said. “In fact, the CD will be sold to an investor, and the amount you receive back depends on what the investor will pay on the secondary market.” You should also be sure you know how long your money will be tied up before you bite on a high rate. Fidelity Investments, for example, recently offered its clients a CD paying 5.5% from a community bank in Georgia. The catch? You would have to lock in your money for 20 years.

Buying through a brokerage also may expose you to account fees, said Jason Chepenik, managing partner of Chepenik Financial in Orlando. “Some brokerage accounts have closing fees of up to $100, so that would eat into any extra income you’d get” from the higher CD rate, he said.

Potentially worse are high-yield CDs promoted by unfamiliar companies that may, in fact, be peddling much riskier investments.

Florida regulators broke up a CD-related fraud two years ago run by some companies in Fort Myers. The scheme promoted high-paying CDs to lure mostly elderly investors but instead sold the victims high-risk, unregistered securities such as viatical settlements, which are life-insurance policies tied to terminally ill policyholders.

Some companies - often known as CD-locater services - operate legitimately by referring investors to a bank that offers the high-yield CD advertised, regulators say. Even if the advertised rate isn’t available, the firms must cut a check to investors to make up the difference in yield.

But people who respond to such promotions should be ready for a sales pitch for other financial products because that’s how such operations really make their money, said Mark Mathosian, an investigations manager for the Florida Office of Financial Regulation.

“These companies are looking for sales leads,” he said, “and if many of the people who come in asking about the CD end up buying an annuity, the company will make some big commissions.” Investors should call the Office of Financial Regulation consumer phone line (1-800-848-3792) to find out if a particular company is properly registered with the state and whether anyone has filed complaints against it. A veteran owner of one such company insists the CD-locater business has unfairly gotten a bad reputation because of a few isolated cases of bad business practices

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