Brokerage sweep accounts using low-yielding bank deposit options continue to attract the interest of regulators, lawyers and the financial press. A new posting on the website JDSupra from lawyers at Katten, Muchin, Rosenman, titled, "SEC Scrutiny into Cash Sweep Programs: What Investment Advisers Need to Know," explains, "In recent years, the US Securities and Exchange Commission (SEC) has initiated several probes into how advisory firms manage their cash sweep programs, which are designed to transfer idle cash from investment advisory accounts into interest-earning sweep vehicles to generate additional interest income for the investors. While broker-dealers also provide cash sweep programs, the SEC probes have been limited to an investment advisor's use of cash sweep accounts and potential breaches of an advisor's fiduciary duty to its managed accounts. The most common sweep options offered by investment advisors are bank deposit accounts and money market funds."
It continues, "Cash sweep programs have been on the SEC's radar since July 2016, when the SEC Division of Examinations (then named the Office of Compliance Inspections and Examinations (OCIE)) issued a risk alert -- 'OCIE's 2016 Share Class Initiative' -- giving notice of a sweep exam focused on conflicts disclosure and compliance with fiduciary duties. In February 2018, the SEC's Division of Enforcement Asset Management Unit launched a Share Class Selection Disclosure Initiative."
The piece says, "Around that same time, the SEC also took a deep interest in disclosures and conflicts related to cash sweep arrangements, with a particular focus on the potential for breaches of fiduciary duties, undisclosed conflicts, and revenue-sharing payments received in connection with cash sweep programs. In recent weeks, there have been reports of ongoing probes by the SEC into how advisory firms are managing their bank deposit sweep programs. While these inquiries are said to focus on an advisor's fiduciary duties relating to the interest rates clients receive through such sweep programs, recent SEC exams and public comments by the regulator point to eight areas of focus for the agency."
These include: "Conflicts of Interest — Failure to disclose conflicts of interest where revenue-sharing payments incentivize advisers to recommend cash sweep options to clients; Inappropriate Advisory Fees — Charging advisory fees on cash balances where arguably no investment advice is offered on cash positions; Low Rates of Return — Sweep programs paying below-market interest rates when other investments offer significantly higher rates; and, One-Size Fits All — Programs in which the only automatic sweep option available to clients does not allow the firm to manage client-specific risk tolerance/investment objectives."
The brief adds, "Separately, cash sweep programs are subject to the watchful eye of the Financial Industry Regulatory Authority (FINRA), albeit for different reasons. FINRA's 2020 Risk Monitoring and Examination Priorities Letter focuses on operational matters for cash sweep programs (such as proper customer reserve formula computations), but also reminds FINRA member firms to properly disclose the manner in which their brokerage cash sweep programs operate, including the availability of alternatives and the extent to which FDIC protection applies. Finally, recently filed class action lawsuits by investment account customers allege breaches of contractual and fiduciary duties and, in some instances, state consumer protection laws for failing to pay reasonable interest rates on sweep account assets, presenting yet another risk for financial firms that employ a cash sweep program."
Investment News also wrote again last week on sweeps in, "After UBS earnings, is cash sweep drama over?" They comment, "UBS Group ... became the latest wealth management firm to declare it was increasing yields on clients' cash held in advisory accounts, joining Wells Fargo & Co., Morgan Stanley and others who also recently raised rates due to competitors paying substantially better yields on cash. Todd Tuckner, UBS Group's chief financial officer, said during a conference call with investors to discuss company earnings that by the middle of the fourth quarter the wirehouse and global bank intends to adjust the sweep deposit rates in U.S. advisory accounts, with the company expecting a reduction in pretax profits by around $50 million annually."
This article says, "Ever since interest rates began rising in 2022 post the Covid-19 pandemic, wealth management firms have faced questions about low interest rates they continued to pay clients on cash deposits.... `The broader wealth management industry, which for decades has toggled back and forth between charging clients commissions in brokerage accounts and fees in advisory accounts, has been wrestling with rate of interest in pays clients for cash for some time now, most recently for the past month during this recent earnings season."
It adds, "These events do not 'permanently remove the overhang' facing brokerage firms, particularly as risk from litigation about the interest rate issue remains, [analyst] Chubak noted. 'But it does bolster the case made by bulls that the IBDs could be largely insulated from this risk,' he added. Another analyst echoed the positive sentiment for Schwab. 'As we look ahead, we continue to believe we are close to stabilization in sweep cash,' wrote Jeff Schmitt, an analyst with William Blair Equity Research ... particularly as the Federal Reserve appears to be on the verge of easing interest rates."
UBS's Tuckner says on their latest earnings call (see transcript here, "The outlook for net interest income in our U.S. wealth business is expected to be influenced by competitive dynamics affecting the pricing of sweep deposits. By the middle of 4Q '24 we intend to adjust the sweep deposit rates in our U.S. Advisory accounts, which net of offsetting factors, are expected to reduce pretax profits by around $50 million annually."
Tuckner comments, "Advisory is about a third of the total that we have in sweeps ... and then as far as the pricing goes ... it's a function of interest rates.... So we have to see also where interest rates are, so in terms of an absolute price that I can offer."
See also Reuters' "Cash sweep scrutiny threatens wealth managers' credit ratings, Moody's says," which states, "The spate of regulatory investigations into wealth managers' cash sweep programs could hurt their credit ratings, Moody's warned on Thursday, underscoring the threat to the high-margin business for firms like Morgan Stanley and Wells Fargo."
For more on recent Brokerage Sweep News, see too these CraneData.com stories: "Law Firm Says Bolster Disclosures, Rates on Sweeps; Crane Index 5.11%" (8/13/24), "Barron's: BofA Cites Risk from Sweeps" (8/8/24), "Tradeweb Completes ICD Acquisition; AdvisorHub on Wells Sweep Suit" (8/2/24), "IN: Ameriprise Sued Over Sweeps" (7/31/24), "Federated Hermes' Donahue, Cunningham Call Hits Sweeps, Flows, Rates" (7/29/24), "Ameriprise, Raymond James Discuss Sweeps Issues on Earnings Call Q&As" (7/26/24), "Barron's Writes on Pressure on Sweeps" (7/25/24), "WSJ, Investment News on Brokerage Deposit, Advisory Sweep Pressures" (7/19/24), "Schwab, BlackRock Q2 Earnings: Cash Migration Slowing, But Continues" (7/17/24).
