Brokered CD

A brokered CD is a certificate of deposit issued by a bank or credit union but bought through an intermediary rather than at the issuing institution. The Securities and Exchange Commission calls those intermediaries deposit brokers, a group that includes SEC-registered brokerage firms and, in its words, "unregistered independent salespeople". A deposit broker can sometimes negotiate a higher rate from an institution by promising to bring it a certain volume of deposits, and then offers the resulting CDs to its own customers. Banks generally issue them through a single large "master CD" sold to the deposit broker, who sells interests in it to individual buyers.

The name is market and regulatory vocabulary rather than a separate legal category. Underneath, a brokered CD is still a bank deposit, and what a certificate of deposit is under federal banking law does not change because a broker sold it. What changes is everything the intermediary touches. FINRA adds a caution worth reading literally: "Although most brokered CDs are bank products, some may be securities, which won't be federally insured." The document that settles which one you bought is the offering paperwork, not the product name.

The first question is whether the money reached an insured bank at all, and it is not rhetorical. The FDIC states plainly that it "does not license or register deposit brokers and an unscrupulous broker could mislead or defraud its customers", and that "[i]f the broker fails to place your funds into a CD at an FDIC-insured bank; your money will not be insured by the FDIC." Deposit insurance attaches to a deposit at an insured institution, not to a transaction with an intermediary. That is why both the SEC and the FDIC tell buyers to confirm in writing which bank will hold the money and to check that bank in the FDIC's BankFind directory.

The second question is how the deposit is titled, because pass-through insurance depends on the records. Unlike a CD bought at a branch, a brokered CD is often held by a group of unrelated investors who each own a piece rather than the whole. The SEC's guidance is to confirm in writing how the CD is titled and to make sure the account records show the broker acting only as agent or custodian, with no ownership rights of its own, giving "XYZ Brokerage as Custodian for Customers" as the model. Where several investors share one CD, the broker will not list each name in the title, and the SEC notes this "may make it harder for you to submit an FDIC insurance claim" if the bank fails.

The third question is aggregation. Federal deposit insurance is $250,000 per depositor, per insured bank, for each account ownership category, and the FDIC notes the limit "includes the principal and accrued interest". A deposit broker may place money at a bank where the customer already holds deposits. If the brokered CD pushes the total in that ownership category at that bank above the limit, the excess is uninsured, which is a risk created purely by where the broker chose to place the money.

The fourth question is how you get out, and this is where a brokered CD behaves least like a bank CD. Brokered CDs generally do not carry an early withdrawal penalty. Instead of surrendering the deposit to the issuing bank, the holder normally sells it on a secondary market, and the price moves with prevailing rates. If rates have risen since purchase, a lower-yielding CD fetches less than face value and the loss is a market loss rather than a penalty. If rates have fallen, it may sell at a profit. The deposit broker may also charge a sales fee to execute that trade, which the SEC says can reduce the return or increase the loss.

The important qualification is one that a page describing only the mechanism would leave out. The SEC prints it as an "IMPORTANT" note: brokered CDs "can generally be sold at any time through a secondary market", but "depending on market conditions, some brokered CDs may not have a secondary market. This will require you to hold the CD until it matures, is called (if possible), or market conditions change to allow for a secondary market sale." A CD that cannot be sold and cannot be surrendered is simply illiquid until its maturity date, and maturity dates on brokered CDs run as long as thirty years.

Interest is usually simple, not compound, and that quietly changes the comparison. A bank CD typically lets interest accumulate and compound inside the account. A brokered CD generally pays interest out to the holder in cash at a set interval, monthly, quarterly or semiannually, so earning anything on those payments requires reinvesting them somewhere else. Two CDs quoting the same rate therefore do not produce the same amount of money over a multi-year term. Many brokered CDs also carry call features, which let the issuing bank end the CD early on its own terms and are covered under callable CDs.

A deposit broker offers a menu of CDs issued by various banks, each with a stated rate, term and maturity date. You buy through the brokerage account, the broker places the funds with the issuing bank, and the CD appears as a holding in the account. Interest is paid out to the account on a schedule. At maturity the principal returns to the account.

A hypothetical example of the simple-interest gap. Priya buys $50,000 of a three-year brokered CD paying 4% simple interest, paid out semiannually into her brokerage cash. Each year the CD pays $2,000 ($50,000 × 0.04), so three years pay $6,000 and she ends with $56,000 if that cash sits idle. A bank CD at the same 4%, compounding annually inside the account, would reach $56,243.20 ($50,000 × 1.04 × 1.04 × 1.04). The $243.20 gap is not a fee and nobody misquoted the rate. It is what "simple interest" means, and it widens with the term and the rate.

A hypothetical example of the exit. Eighteen months in, Priya needs the money. Her brokered CD carries no early withdrawal penalty, so there is nothing to surrender to the issuing bank. Her firm offers the CD on the secondary market, where prevailing rates for similar maturities have risen, so a buyer will only take her 4% CD at a discount. At a price of 97 cents on the dollar she receives $48,500 on $50,000 of face value, before any sales fee the broker charges, and she keeps the interest already paid to her. Had rates fallen instead, the same sale could have returned more than face value.

Pros

• One brokerage account can reach CDs from many issuing banks, which makes it practical to stay under the insurance limit at each of several institutions.
• A broker promising volume can sometimes obtain a rate an individual walking into a branch would not be offered.
• Selling on a secondary market can be faster and, when rates have fallen, cheaper than paying a bank's contractual early withdrawal penalty.
• Maturities range far wider than a branch menu, from a few months out to thirty years.

Cons

• Insurance depends on the broker actually placing the funds at an insured bank and keeping records that identify the true owners, neither of which the buyer performs or witnesses.
• The FDIC does not license or register deposit brokers, and the SEC notes that some are not licensed, examined or approved by any state or federal agency.
• A secondary market is not guaranteed. Without one, the CD cannot be sold or surrendered, and the money is locked until maturity or a call.
• Selling after rates rise returns less than face value, and the broker may charge a sales fee on top.
• Simple interest means a quoted rate does not compound inside the CD, so it is not directly comparable to a bank CD quoting the same number.
• Where several investors share one CD, no individual name appears in the title, which the SEC says can complicate an insurance claim.