The government cannot “steal” an investor’s 401k and brokerage account assets in order to pay off debt. These are investment misconceptions.

Q: On Ilyce’s radio show this past week, she took a call from someone who asked what worries her about the economy. She talked about the upcoming presidential election, among other issues like the Euro debt crisis and China slowing down, and said something like “It doesn’t matter who wins the election really because neither party has the political will to really do anything about the fiscal cliff and looming debt crisis.”

I really appreciated her remark that it really doesn’t matter who wins the election. But I had a question about a related issue. She and you seem to believe that all investments will be honored by the FDIC, but the recent case of the Supreme Court vs. Sentinel Management Group states that the investment companies will get paid first and that they can confiscate our money to pay their debt.

What are your thoughts? Is the government going to take our money to pay off the national debt?

A: We have not followed the case and we have not seen the United States Supreme Court case you mention. If you can provide a link, that would be helpful.

If you are referring in general to the wacky notion (perpetuated by some radio talk show hosts) that somehow the government will “steal” our 401k and brokerage account assets to pay off debt, we don’t believe for a moment that will happen. While those claims may make for good radio, they aren’t based on anything real, as far as we can tell.

If you’re referring to the MF Global case, there are some issues worth discussing, but first let’s start by clearing up some misconceptions.

The Federal Deposit Insurance Corporation (FDIC) is the insurance policy for member banks (almost all of the banks in the US are FDIC). Should a bank go underwater, the FDIC will pay up to $250,000 per person, per account. In other words, if you and your spouse are named on a bank account, the FDIC will protect the cash in your account up to $500,000.

The Security Investors Protection Corp. (SIPC) protects the assets in brokerage accounts in case of fraud or theft. It will not protect you if you make poor investments and the value of those investments declines. The amount of the protection is up to $500,000 per investor, of which up to $250,000 can be cash.

Of the two, the FDIC is probably stronger protection. But if your broker is a member of SIPC and steals money to fund an extravagant lifestyle, let’s say, the SIPC would reimburse you up to the amounts prescribed.

Given this information, there has been talk about how to distribute funds when certain situations arise. When funds go missing from investment companies, as they did with MF Global, the remaining funds must be distributed to those that claim to be owed money. Some of these claimants include investors, business partners, and other companies that may provide goods and services to the entity that is in trouble.

Creditors are always fighting about who should get their money first. You may be alluding to some situations where clients’ money has gone missing and other financial institutions lay claim to money that could be used to pay customers.

In some situations, other financial institutions may have a higher interest legally in receiving that money than customers. Whether that’s ultimately the case would depend on the circumstances. In various recent cases where customer money was used in a manner that did not benefit the customers, you would expect and want that money restored to those customer accounts.

There was a case with Sentinel Management Group decided back in August 2011 by the United States District Court in Northern District of Illinois in favor of Bank of New York. The bank had loaned money to Sentinel and used money held by Sentinel as collateral for the loan. The money used for the loan was actually customers’ money that was supposed to be held in a segregated account.

The court concluded that the bank was entitled to money that was held as collateral for the bank’s loan even when those funds had come from customers’ accounts. If the money was left in the customers’ accounts, the bank would not have had a claim. Your statement that investment banks will be paid first assumes a right the investment banks would have to grab customers’ money from their accounts. That statement would be false.

However, if the institution you invest in transfers money out of your account, that transfer will jeopardize your money. You can only hope that Congress passes a law that changes the way clients’ funds can easily be taken out of their accounts. Otherwise, a company that is going under or under financial stress can use customer funds to try to keep the business afloat. It appears this is what happened with Sentinel and also with MF Global.

The lenders that dealt with these entities received money that originated from customer’s accounts. They were able to keep this money at the risk of a loss to the company’s customers. The SIPC might pay off some of the claims held by customers, but it appears that laws need to be tougher to tighten the ability of institutions using customer funds for their own account and risking their customer’s money.

Thanks for your comments.