Brokerage sweep accounts have been big news all throughout August. We've been reporting on the "Cash of the Titans," the advertising battle between Fidelity Investments and Charles Schwab over the rates paid on brokerage sweep accounts and cash. The two brokerage giants traded full page ads in The Wall Street Journal and New York Times earlier this month, but now Fidelity has begun running TV commercials on its money fund sweep. (We saw them on CNBC starting Thursday and on ABC News Friday night.) While this has drawn attention to the spread between lower-yielding FDIC-insured brokerage sweep rates and money market mutual funds, a new lawsuit is also shedding more light on the space. (Brokerage sweep accounts are averaging yields of 0.26%, according to our Brokerage Sweep Intelligence, while money market funds are averaging 1.94%, according to our Crane 100 Money Fund Index.)

AdvisorHub first broke the sweep lawsuit story in its piece, "Merrill Sued for 'Paltry' Sweep-account Interest Rates," and Crane Data wrote about it Thursday in our piece, "Merrill Sued Over Brokerage Sweep; A Look at Stable Value Lawsuits." The original press release, entitled, "Wolf Popper LLP Files Class Action Complaint Against Merrill Lynch, Pierce, Fenner & Smith Inc. Challenging Merrill's Low-Interest Sweep Account Practices," explains, "Wolf Popper LLP has filed a class action complaint in the U.S. District Court for the Southern District of New York (Case No. 1:19-cv-07998) against Merrill Lynch, Pierce, Fenner & Smith, Inc., a wholly-owned indirect subsidiary of Bank of America Corporation.... The lawsuit challenges Merrill's practice of defaulting customers into its lowest yielding 'sweep account,' which currently pays a paltry 0.05% annual percentage yield on cash balances. Merrill's interest rates are dramatically below competitors' rates of approximately 2.0%. Moreover, Merrill fails to follow SEC rules in initiating client accounts, which require clients' 'prior written affirmative consent' before Merrill sweeps their cash. The lawsuit, among other things, seeks to compel Merrill to adopt transparent disclosure concerning cash investments and pay investors reasonable, market-based interest on cash balances. The lawsuit also seeks payment of back interest."

Fund website ignites weighed in Friday, writing in "Merrill Sued Over Low-Yielding Sweep Accounts," "A brokerage and IRA client recently sued Merrill Lynch over the company's practice of sweeping cash into bank deposit products rather than higher-yielding options such as money market funds. The plaintiff, Sarah Valelly, had more than $1 million invested in four Merrill accounts, including through the firm's Merrill Edge program. The sweep defaults for her accounts yielded as much as 0.14% and as little as 0.06% 'at a time when other Merrill-sponsored accounts yielded as high as 2.07%,' the complaint reads."

Their article states, "In the past several years, brokerages have moved away from using money funds as the default vehicles for sweep cash -- decisions that were made at a time when yields in those funds were low and more comparable to the FDIC-insured bank deposit products that are now more common. However, the spread that banks can retain on the deposit products has given brokerages incentive to keep such products as the default or even prevent money funds from becoming sweep options. Firms that have moved toward bank products, rather than money funds, in their sweep programs include Merrill, Morgan Stanley, Edward Jones and Charles Schwab."

Barron's also covered the news (online only) in, "Investor Sues Merrill Lynch Over 'Paltry' Cash Yields." They write, "With interest rates heading down these days, investors may be wondering what they are earning on cash reserves. If their money is held in a brokerage 'sweep' account, the answer is probably not much. Sweep yields are well below 0.25% at most brokerage firms, according to Crane Data. That pales in comparison with money-market fund yields at around 1.9%. But rather than get mad, one investor is trying to get even: She has filed a lawsuit against Bank of America Merrill Lynch (BAC) over the 'paltry' yields in her sweep and checking accounts held at the firm." (See also, Investment News' "Merrill Lynch client sues over 'paltry' cash yields".)

The full Wolf Popper complaint tells us, "Beginning in the late 1990s, brokerage firms like Merrill began 'sweeping' customer's cash into bank accounts of affiliated entities that were lawfully able to use that cash to generate profits in their operations. The movement of that cash frequently came with only minimal disclosure to customers that their cash was being transferred to affiliated entities. Most times (at least with Merrill) the customer only earned a de minimus return on that cash-- well below the amounts earned by the affiliated entities and paid to Merrill on the use of the cash. In 2005, the NYSE, and subsequently, in 2013, the Securities and Exchange Commission, to counter this abuse in the brokerage industry, promulgated regulations establishing specific procedures for brokerage companies to contract with customers to sweep cash to affiliated entities."

They explain, "The SEC, effective March 3, 2014, adopted a Final Rule amending 17 C.F.R. 240.15c3-3 to add subparagraph (j)(2) requiring that brokerage firms like Merrill first secure a customer's 'prior written affirmative consent' in order to form a binding contract with customers for the use of their cash. See SEC Release No. 34-70072 ('Final Financial Responsibility Rules for Broker-Dealers'), 78 Fed. Reg. 51824 (August 21, 2013).... Merrill Edge is an online brokerage service operated by Merrill beginning in 2010. Merrill has, in its business practices, with regard to Merrill Edge, blatantly failed to secure a customer's 'prior written affirmative consent' to sweeping cash to an affiliated entity (as is required by Rule 15c3-3(j)(2)(ii)(A)). Rather, Merrill employs procedures on its website that intentionally or inadvertently omit and obfuscate disclosures on sweep accounts so that customers do not and cannot give their 'prior written affirmative consent' to the investment of their assets at Merrill's paltry interest rates."

The filing continues, "Since the 2000s, and specifically with respect to the online Merrill Edge accounts, those procedures have been replaced with internet-based account opening procedures and multiple, redundant and voluminous 8-point font PDF files.... Thus, account holders cannot and do not provide prior written affirmative consent to interest rate terms. Although opaque, the online 'Merrill Edge' customers earn the lowest possible interest rate available to Merrill customers ranging from 0.05% to 0.14% -- at a time when market rates on cash investments are approximately 2.0%. Merrill could have designed a website that was compliant with common law requirements to form an online contract and with SEC and NYSE regulations, but (apparently) choose not to out of concern that ... clear, conspicuous disclosure would alert customers that they were being defaulted into Merrill's lowest-yielding sweep accounts.... In either event, Merrill was financially motivated not to make the mandated disclosures."

It continues, "On March 6, 2014, the SEC issued 'Guidance' on compliance with new regulation 15c3-3(j)(2). The SEC emphasized that broker-dealers such as Merrill have the burden of demonstrating compliance with SEC regulations: 'Broker-dealers are reminded that, consistent with other Commission financial responsibility rules, they will bear the burden of demonstrating compliance with paragraph (j)(2)(i) of Rule 15c3-3'.... Comparing the amount of interest that Plaintiff was actually paid at 0.06% and 0.14% APY to the amount of interest that Plaintiff should have been paid at a market-based rate of 2.07% APY yields an astonishing underpayment of approximately $22,400.... Plaintiff also seeks a declaration that NYSE Information Memo 05-11 and SEC Rule 15c3-3(j)(2) are binding on Merrill with respect to procedures for sweep accounts, and injunctive relief compelling Merrill to comply with NYSE Info. Mem. 05-11 and SEC Rule 15c3-3(j)(2)."

Finally, the complaint adds, "The disclosures in the CMA Agreement that relate to Merrill's Sweep Program are not emphasized, but rather are scattered and buried within the 22-page, single-spaced 8-point font document.... Although unexplained on the Merrill website, a 'sweep program' is a 'service provided by a broker or dealer where it offers to its customer the option to automatically transfer free credit balances in the securities account of the customer to either a money market mutual fund product ... or an account at a bank whose deposits are insured by the Federal Deposit Insurance Corporation.' See 17 CFR 240.15c3-3(a)(17). Under SEC Rule 15c3-3, broker dealers such as Merrill are forbidden from using customer's assets to finance any part of their businesses unrelated to servicing securities customers. Brokerages, such as Merrill, however, may lawfully avoid these rules by 'sweeping' cash balances to affiliated banks, such as Bank of America, N.A., a wholly-owned subsidiary of BAC. See SEC Release No. 34-70072, 78 Fed. Reg. at 51839 ('transferring this excess cash to a bank account or money market fund is an alternative to retaining a credit balance in the customer's securities account.')."

For more on Brokerage Sweeps, see these Crane Data News articles: MMF Asset Surge Continues, Govt Funds Hit Record; ignites on Sweeps (8/23), Fitch Reviews French MMFs: Standard Not Really; More Sweep Coverage (8/21), IBD on Brokerage Sweep Accounts (8/20), Cash Stories: Barron's Explains Brokerage Sweeps; Bloomberg on Assets (8/19), Cash of the Titans: Schwab vs. Fidelity; MF Yields Dip Below 2.0 Percent (8/13), Barron's Clarifies Fidelity Sweep Push (8/12), WSJ on Fidelity: Cash's Sweeping Giant (8/9) and Fidelity Now Sweeps to Money Fund (8/8).

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