Security 401k Index Funds

[Steve98]

Hi,

I have a question regarding the security of 401k index funds.

PNC bank manages my 401k account that is provided through my employer. If I were to invest money in an index fund, issued by Federated, who is the registered owner of those assets? PNC bank, Federated, or I?

Moreover, could I potentially lose my money if PNC or Federated went bankrupt?

Thank you

[bUU]

Generally, the folks who manage the 401(k) accounts (in your case, PNC Bank) are custodians. They don't own the assets; they just manage the accounts, keep records, etc. They get a fee for their service (extract through various means) and that's it. If they go under, they're obligated to pass those records onto another custodian.

Funds are a little different. But let's be clear: There is a difference between the fund's sponsoring company (Federated) and the fund. The fund is a separate legal entity - a separate company - and you, as someone who invested in the fund, are part owner of that company. If the company goes bankrupt, then you get nothing, of course, but if the sponsoring company goes under, again, you're unaffected. The sponsoring company is simply coordinating and managing these other company (the funds) - it doesn't own any of them.

[Steve98]

Thank you for your reply.

I know Vanguard is set up that way, but I thought they were special in that regard. What you are saying is that the only way I could lose my money is if the company I (and many investors) own go under, which would only be the case if the assets in that portfolio go under (i.e. all stocks in the portfolio go to zero). Is that correct?

So, the only money I could lose is due to my own bad investment choices, correct? It also means that it makes little difference which Bank or index fund company I chose as they can be replaced if they go under.

[Mill]

Not sure if this is what you are looking for, but this is an email I kept when I was asking the same questions about my money.

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Not sure if you saw this at Bogleheads.org, but I remember you stating concerns about Vanguard ending up a scam like Bernie Madoff or something. This guy really breaks it down well and I didn't realize some things, like each fund is actually a seperate entity.

What if Vanguard Went Broke?
This is a very serious and timely issue, so I'll address it to hopefully set everyone at ease.

First, The Vanguard Group Inc. (VGI) is actually a subsidiary of the various mutual funds, each of which is a separate legal entity. The best way to describe Vanguard's unique structure would be to think of General Motors turned upside down, with Chevrolet, Cadillac, Oldsmobile, Pontiac, etc. as the corporate parents, and General Motors as a subsidiary. If you think of Chevrolet, Cadillac, Oldsmobile, Pontiac, and the other GM divisions as mutual funds, and General Motors (the subsidiary, in this situation) as Vanguard Group Inc., you'll get the picture.

Since VGI is actually owned and funded by the various mutual funds, it technically couldn't go bankrupt unless all of the various mutual funds that support it went bankrupt. The only way that could happen would be for the value of all of the stocks and/or bonds held by each and every individual Vanguard mutual fund to go to zero. So, forget about Vanguard going bankrupt -- it just isn't going to happen.

It's also important to point out that even if VGI were to somehow go broke, VGI has no recourse to the assets of the funds. Rather, each fund's custodian holds that fund's assets. Even the fund managers do not have custody of their fund's holdings. They simply decide which stocks/bonds to sell, and the custodian actually delivers (in the case of a sale) or takes delivery (in the case of a purchase) of the actual asset.

Another huge and very important difference between Vanguard's mutual funds and the Enrons and WorldComs of the world is that Vanguard is required to "mark to market" (value each fund share based on the value of all of the fund's holdings) each day the market is open. That keeps the fund's books current. This "marking to market" pricing is subject to both routine and spot audits by both the SEC and the Pennsylvania Department of Banking.

One major reason for the lack of problems with mutual funds comes from the fact that they're regulated by the Investment Company Act of 1940, which spells out the legal responsibilities of the mutual funds to their investors. In addition to the provisions of the Investment Company Act of 1940, the SEC also directly regulates mutual funds. While the SEC can investigate fraud allegations against investors at public companies like Enron and WorldCom, where the accounting is much more complex than at mutual funds, it has no authority to set corporate governance rules for these public companies. These are huge differences.

Keep in mind, too, that, despite all of this, if something were to happen to the Vanguard Group (the entity that provides the fund with the administrative services they need to exist), the funds would continue to operate and would simply replace VGI with another entity to provide these same services.

Some have expressed concerns about putting "all their eggs in one basket" by consolidating their investments at Vanguard. There's simply no need to worry about that. Each fund is a separate investment company (and part owner of the Vanguard Group, rather than the other way around). Thus, having all of your investments in several Vanguard funds is tantamount to having your investments spread among a variety of baskets, each independent of the other. So, put your fears to rest; your investments are safe at Vanguard.

For what it's worth, other than my Savings Bonds, all of my investments are at Vanguard, and I sleep like a baby!

[Katsmeow]

I've seen that Vanguard reply and I agree with it...to a point. That is, if my money that I've sent to Vanguard is in fact invested in each of the funds that the money is supposed to be invested in I'm not worried about VGI itself going broke.

However...that reply does not exactly address the real issue. It does not address how you can be sure that Vanguard (or Fidelity or anyone else) is not engaging in some massive fraud (To be clear - I don't think that Vanguard or Fidelity for example are engaging in any major fraud). That is, the reply assumes that when you send your money to Vanguard and tell it to - for example - invest $50,000 in Wellesley and $50,000 in the total stock market fund that in fact someone takes that money and actually invests it in the mutual funds you have requested.

The real thing that most people are just taking on trust is that assumption. The reality could be that Vanguard - in that situation - takes your $100,000 and spends it on whatever (high living, trips to Tahiti, bon bons, etc.) and doesn't actually invest it at all. And that they, in fact, send you statements saying you are invested in Wellesley and the total stock market fund when really your money is long gone.

And, then when this gets discovered you try to get money from Wellesley, for example, and Wellesley very politely tells you that you don't actually own any part of Wellesley. And since Wellesley is a separate entity from VGI, then it isn't responsible for the fraud perpetrated by VGI and you are SOL.....

Again - I don't think this is happening. I think Vanguard is a reputable firm and doesn't do that. However - this is the type of scam that people do get taken in by. And everyone of those people who got taken in thought that who they were investing with (Madoff, etc) were reputable firms.