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Mitigating the Inherent Risk
Insurance Not a Cure-All
Q. Does BetterInvesting offer insurance for clubs that operate as general partnerships? I have some club members who are a bit concerned about setting up as a general partnership and not having the protection an LLC (limited liability company) would offer.
A . BetterInvesting does offer liability insurance. Regardless of your club’s business structure, however, there’s always some risk involved in any enterprise dealing with money and investments. These risks include market risk, opportunity cost, investment fraud, brokerage bankruptcy, bank failure and embezzlement.
Market risk is the fundamental unpredictability borne by the entire market. Also known as undiversifiable or systematic risk, this uncertainty cannot be avoided no matter how diversified your club’s portfolio is or what the club’s legal structure is. Only a clairvoyant can eliminate all opportunity cost. As defined by Investopedia, opportunity cost is the difference in return between a chosen investment and one that’s necessarily passed up.
Investment fraud comes in many forms. The Securities and Exchange Commission details many types of fraud at its website. Other organizations offering this education include the Financial Industry Regulatory Authority (aka FINRA), National Fraud Information Center, Investor Protection Trust, Alliance for Investor Education, Securities Industry and Financial Markets Association and your state securities agency (see Websites of Interest).
The number of brokerage bankruptcies reported each year is fairly small, but it’s important to know that they do occur. Also, assets go missing from investors’ accounts occasionally. In the United States, the Securities Investor Protection Corporation protects the cash and securities held by a customer at a brokerage firm. Not all investments are eligible for SIPC protection, however.
The Federal Deposit Insurance Corporation protects customers against the loss of deposits if an FDIC-insured bank or savings association fails. The FDIC covers only deposits. It doesn’t cover stocks, bonds, mutual funds, life insurance policies, annuities or municipal securities — even if these investments were purchased at an insured bank. To check whether your financial institution is FDIC-insured, call 877/275-3342. The main difference in protection between a general partnership and an LLC lies with liability treatment. Liability insurance is included in BetterInvesting’s club startup kit. Coverage includes premises, medical payments, fire damage and host liquor liability.
The policy doesn’t include embezzlement or mismanagement of the club’s portfolio. For this protection, the club should purchase bond insurance. Also, homeowners insurance usually covers both damage to property and liability or legal responsibility for any injuries and property damage caused by policyholders or their families.
If you’re really concerned about liability protection, the homeowners of your meeting places should purchase an umbrella policy. This policy includes claims for libel and slander and has higher liability limits. Your club can learn more about the various types of insurance available at the Insurance Information Institute.
Ways you can protect you and your club:
• Make sure your club receives a written confirmation of each transaction from your brokerage firm or bank .
• Make deposits to your club’s account payable only to your SIPC/FDIC-member broker.
• Ensure that your club’s statements are received on a timely basis.
• Check the SIPC database to see whether your broker is a member.
• Conduct an annual audit of your club’s books.
• Review your membership statements to verify that the deposits made by you match the club’s records.
• Avoid investments that aren’t covered by the SIPC.
• Consider purchasing bond
• Consult an attorney and CPA before making any changes in the club’s business structure.
Understanding the risks to your club and the ways to protect yourself may put fellow members at ease.
Websites of Interest
Federal Deposit Insurance Corporation
Insurance Information Institute
National Credit Union Administration
Securities Investor Protection Corporation
SIPC member database
Financial Industry Regulatory Authority
National Fraud Information Center
Investor Protection Trust
Alliance for Investor Education
Securities Industry and Financial Markets Association
North American Securities Administrators Association (state securities regulators)
Colleen Mulder-Seward is a BetterInvesting member and freelance writer.