Is a Certificate of Deposit Considered a Security?

CDs are time-deposit agreements between individuals and banks that involve a depositor committing funds to the bank for a predetermined period of time in exchange for a specified rate of interest.

Early versions of securities known as annua existed in Roman times, and by the 13th century securities traders in London had to be licensed. In the U.S., Massachusetts began regulating securities in 1852, and in 1911 Kansas passed laws requiring the licensing of securities and traders. After the Wall Street crash of 1929 and the onset of the Great Depression, Congress passed the Securities Act of 1933. The act required most securities to be registered when first issued and subsequent acts in the 1930s and 1940s added further layers of regulation.

Standard bank CDs pay account holders a set rate of return over a period of time. Clients who withdraw funds during the CD term incur a penalty that depletes the interest earned and may reduce the principal. Some bank CDs have variable rates, and others allow clients to bump the rate once during a term if general interest rates are rising. Penalty-free CDs allow customers to withdraw funds at any time without penalty. Brokerage CDs are sold by banks directly to investment companies, which market them as securities to customers.

The Federal Deposit Insurance Corp. insures the balances of bank-issued CDs up to $250,000, as of 2010. The FDIC coverage includes all deposit accounts held by an individual at any one bank. Accounts held jointly have double the coverage as each owner enjoys $250,000 of protection, and pay-on-death beneficiaries enjoy the same coverage. People can open CDs and other accounts at multiple banks to maximize FDIC protection, and CDs kept in brokerage accounts allow account holders to expand coverage even further.

Generally, long-term CDs pay higher rates than short-term CDs unless the banks anticipate a deflationary cycle. Banks sell CDs that last from between one day and several years, although typical time frames are six months, nine months, one year, two years and five years. Some CDs designed for use in individual retirement accounts do not have set time frames or interest rates. IRA CDs do incur IRS penalties if withdrawn before age 59 1/2.

Many conservative investors purchase brokerage CDs that offer higher returns than local banks. Brokerage CDs are securities and many have call features, which allow the issuer to terminate the contract early. In declining rate environments, issuers often use the call feature to the detriment of the account holder.

Some brokers promote FDIC insurance as a safeguard for people buying CDs from distressed banks, but if a bank fails and its assets are sold to another bank, the FDIC does not require that bank to uphold the terms of the CD.