Long maligned by investors, cash sweep accounts that offer very low interest rates have been getting hit from all sides of late, whether it’s in the form of lawsuits, regulatory fines or the exodus of funds as investors take notice and move those assets to higher paying options.
And with pressure mounting, change seems to be in the air.
On July 12, Wells Fargo used its earnings call to publicize that it is raising the rates on its cash sweep accounts held by advisory brokerage customers (the details are to be determined). Then last week, Morgan Stanley, which registered a $10 billion drop in sweep deposits in the second quarter, did the same thing.
By the firms’ own admission, raising those rates isn’t cheap. “This change was not anticipated in our original guidance, better aligns rates with rates paid in money market funds, and is expected to reduce net interest income by approximately $350 million this year,” said Mike Santomassimo, Wells Fargo’s CFO, during the call.
Morgan Stanley, whose wealth management business is “consistently earning $100 million a day,” according to CFO Sharon Yeshaya, wouldn’t put a dollar figure on the hit. “In the third quarter, we intend to make changes to our advisory sweep rates against the backdrop of changing competitive dynamics,” she said. “The impact of these intended changes will be largely offset with the expected gains from the repricing of our investment portfolio.”
Meanwhile, Bank of America’s CEO Brian Moynihan said in the bank’s earnings call on July 16 that instructions have been given, including to Merrill Lynch, to grow cash deposits a little bit faster than the economy.
“You have to price across the board to achieve that,” he said, adding that the wealth business’s cash deposits were around $280 billion in July when they’d once been as high as $350 billion. “The deposit pricing changes that we made to ensure that they were at a place where they could grow … were made in the [second] quarter.”
Eyes now shift to LPL, which was on the receiving end last week of the latest class action lawsuit claiming breach of fiduciary duty over its sweep account rate (the company's earnings call will take place on Thursday).
Kendra Galante, vice president, public relations, said LPL had no comment at this time.
Historically, sweep accounts were the byproduct of trading, the place where uninvested cash went at the end of the day to be held overnight or until reinvested. Brokerages could make money lending those deposits to other entities.
But that might have worked better for investors when people received monthly paper statements and could clearly see their balance and the interest, said attorney Robert C. Finkel at New York’s Wolf Popper. Finkel has filed two class action lawsuits over sweep account interest rates, one against Merrill Lynch and one against E*Trade.
“Now all that’s delivered electronically, and people don’t really look at account statements anymore,” he said, adding that investors in securities tend to look at their equities holdings, not at the interest rate on the sweep account. “So the banks take advantage of people who aren’t really looking or who don’t understand.”
In the past, lawsuits over the sweep account rates were hard to win, Finkel said, as judges have taken the “caveat emptor” position and said the burden was on investors to know what their accounts were paying them.
But in September, the Securities and Exchange Commission fined AssetMark $18 million for hiding cash sweeps conflicts, perhaps signaling a shift in the assignment of responsibility when a firm is not transparent about the way it handles these accounts.
The most recent class action lawsuit over cash sweep interest rates was filed last week by Michigan resident Daniel Peters, who claimed that LPL had cash sweep programs for uninvested cash in IRA and non-IRA accounts. In both cases, the suit alleged, the sweep accounts generated 3.23% returns to LPL, while paying as little as 0.35% to investors, and did not give investors any other choice if they wanted to open an LPL account.
The lawsuit was filed in U.S. District Court for the Southern District of California and charged LPL with breach of fiduciary duty, unjust enrichment, breach of contract and unfair or fraudulent business practices.
In June, Morgan Stanley was on the receiving end of a class action suit over unreasonably low interest rates on its sweep accounts, and in March it was E*Trade, sued for the same reason.
While the lawsuits might be gaining steam, Finkel said the real incentive for brokerages to raise the rates on sweep accounts is purely economic. “People moving cash out of sweep accounts can move it to a different institution,” he said. “It makes more sense to raise their rates.”
And while there is some public pressure “to do the right thing,” Finkel said that’s not what’s tipping the balance.
“Don’t trust American business to do something because it’s the right thing,” he said. “They do it because it’s the profitable thing.”