The manipulation of cash to generate more has often carried a sketchy reputation.
Hundreds of years ago in England, the crime of "coin clipping" — shaving the edges off gold and silver currency to melt them together for sale — led to the punishment of
Less likely to make the news or the big screen, the brokerage industry's widespread and lucrative practice of cash sweeps has drawn extensive regulatory scrutiny and
The "sweep" refers to investors' cash assets moving back and forth from a brokerage to one or more bank accounts that never individually go above the Federal Deposit Insurance Corporation limits and remain immediately available to financial advisors and clients. The money comes from the leftover sums after trades in an account or liquid holdings in a client's portfolio. For banks and brokerages, those assets add up to a reliable source of deposits and profits.
Some argue that the sweeps help pay for commission-free trades, boost access to capital and expand FDIC coverage of cash deposits. Others question whether advisors and their clients are aware that there is an estimated $1 trillion in brokerage cash sweeps that they could move into money markets, certificates of deposit and other higher-yielding accounts to tap into those climbing interest rates themselves.
In an effort to better understand an asset class of growing importance to investment portfolios and industry profits but rarely discussed publicly by wealth management executives with anyone besides stock analysts, Financial Planning compiled an advisor's guide to cash sweeps — how they work, the firms' explanations for their existence and the increasingly available alternatives.
The fractions of gains received by clients, in contrast to their brokerages, stand out the most in a time of elevated interest rates that most experts expect
There's "nothing nefarious" about cash sweeps, according to Josh Siegel, the founder of New York-based StoneCastle Partners, whose subsidiary, StoneCastle Cash Management, offers one of the other options for a better yield on clients' liquid assets,
"When you stop and think about it, lazy cash is everywhere. A lot of times, we just don't want to waste the time. There are more important things in life to do," Siegel said in an interview. "It's the customer's responsibility to be responsible. If you're fine earning zero, then I'm not going to argue with you. If you want to earn more, it's actually quite easy to earn more now."
By the numbers
The statistics show the huge stakes to clients and the industry alike from cash.
Liquid assets in general may not receive enough attention, even in times of low or zero interest rates. Americans lost more than $600 billion in yields over the past eight years on their holdings in savings and checking accounts by keeping cash with mega-bank "money center" institutions like Bank of America and Wells Fargo,
Cash sweeps deal clients out of the mix for the value to be gained on those assets, as evinced by the disparity between them and money market funds or certificates of deposit. As of April 19, money-market research service Crane Data's
In contrast, the "everyday cash" at Schwab — meaning uninvested assets in brokerage and retirement accounts — paid a rate of 0.45%. Edward Jones' sweeps give customers
LPL Financial uses two types of sweeps, one called the
As part of its "
That impact shifts based on the changing conditions after the Fed's moves and higher interest rates can hurt Schwab's business, too.
Regardless, cash sweeps represent "a big issue" for client advocates, said Micah Hauptman, the
"Oftentimes you'll see that the broker or advisor puts the client in a very low-yielding account that makes the broker's firm or the advisor's firm more money than the reasonably available alternatives," Hauptman said. "That is a fundamental conflict of interest that harms the client."
The cash sweeps display "why, as a firm, we proactively try to keep as little in cash as possible," said advisor Catalina Franco-Cicero of Plantation, Florida-based
"We do understand that they need to have money in their checking account, maybe one or two months of living expenses," Franco-Cicero said. "There's no set percentage. It really depends on upcoming needs."
FP asked Schwab, LPL, Raymond James, UBS, Edward Jones and seven other big wealth management firms and custodians a series of five questions about their level of business from cash sweeps, the amount they make on the accounts and the returns clients received. Schwab was the only firm that sent on-the-record answers to all five questions.
"We make it easy for clients to manage their cash in line with their financial goals and we think investors should understand there's two kinds of cash: cash for everyday use that needs to be easily accessible; and there's savings and investment cash that should be earning higher returns," spokesman Joseph Giannone said in an emailed statement.
The sweeps, which come with protection from the FDIC above the standard $250,000 limit, are "only the starting point for cash at Schwab," since they're intended to "help clients meet their everyday cash needs," Giannone added. "From there, we proactively work with clients and encourage them to find the best fit and optimal rate for their longer-term savings and investment cash. With just a few clicks, clients can move their cash into the many high-yielding money market funds, fixed-income funds or FDIC-insured certificates of deposit we offer."
However, brokerages are "absolutely addicted and dependent on those flows" into cash sweep accounts, and "right now, the hottest game in town is cash harvesting," said Tim Welsh, the CEO of
"Cash should be simple, but, guess what, it's extremely complex, and it's also the root of all the money and profits for these broker-dealers because they've moved everything to free," he said.
Competitors to the brokerage firms and analysts covering them say that cash will only get more important as the year goes on. Even with many investors moving into higher-yield vehicles, there's still "a big, big chunk of cash sitting in people's bank accounts," said Ravi Kumar, the head of First Citizens Bank's
The industry's revenue from cash sweeps will be "incrementally positive versus last year," said Bain Rumohr, the senior director of financial institutions at
Following the January interview and
In an "issuer in-depth" report from February on Schwab, Raymond James, LPL and Oppenheimer & Company,
Rate hikes generated "significant additional revenue for the four firms over the last two quarters," from a business line that "typically has no associated operating expense, meaning that the bulk of benefits will boost bottom-line profitability and expand profit margins," Hack wrote.
"Interest revenue accretes substantially to the firms' bottom line because of the general rate-insensitivity of clients' transactional cash balances and the exclusion of net interest revenue from most advisor payout calculations," he added. "This supported the strong pretax margins for all firms during the [fourth] quarter. However, periods of higher interest rates can lead to outflows of client cash balances into higher yielding alternatives, reducing the magnitude of this benefit as the interest rate cycle deepens."
How it works
Like much of wealth management, the business depends on the participation of multiple parties that have been subject to consolidation in recent years. Cash sweeps emerged out of the combination of brokerages seeking new sources of revenue and FDIC insurance for customers and banks looking for deposit assets, with technology firms in the middle to distribute the cash across many different institutions while paying back the yield generated on the holdings.
The brokerages can pass those yields on to clients at any rate, and they pay the technology firm an administrative fee for the sweeps. The banks get deposits on their balance sheets, which in turn allows them to extend more loans and other capital to their customers for a healthy spread return. Brokerages, such as the wirehouses, Raymond James and Ameriprise can generate even higher profits by using the banks operating under their own companies' umbrellas.
Two of the largest technology firms providing cash sweep services to brokerages,
"With IntraFi Sweep, your firm can: significantly increase profit margins over those earned from short-term investment accounts, like money-market mutual funds; control the margin earned from the service; tier the rate offered to various customer segments, if desired; fund affiliate banks, if desired or applicable — and switch back and forth between placing funds with affiliated and unaffiliated banks based on the affiliated bank's liquidity needs."
IntraFi, which declined interview requests for this story,
Out of a deposit network spanning 3,000 member banks, 95% of the institutions are community banks using the money to extend more capital in their areas, FP sister publication
A pair of the biggest competitors to IntraFi, Reich & Tang Deposit Networks and Total Bank Solutions,
The combined firm's sweep programs have reached more than $200 billion in assets under administration in a network of 100 wealth management firms as clients and 350 banks and other institutions, according to Kevin Bannerton, R&T's head of wealth management.
In an interview, Bannerton described the setup as "seamless and smooth for both sides," with banks picking up the deposits and brokerages able to offer their clients up to $50 million in FDIC-insured deposits by spreading the assets across multiple institutions.
"Cash as an asset class is more nuanced than some people think about it. … There are tradeoffs, even with something as conservative as cash," Bannerton said. "In many cases, the sweep function meets a convenience and operating need as opposed to an investment need."
Bannerton and Siegel of StoneCastle each noted that the brokerage cash sweep business now represents a market of $1 trillion in assets across the industry. Siegel's firm
The parties didn't disclose the financial terms, but interLink had a "platform administering over $9 billion of deposits from FDIC-insured cash sweep programs between banks and broker-dealers and clearing firms," according to
"They bought it as a deposit acquisition strategy," Siegel said. "They now have an engine to go find billions and billions of deposits."
How we got here
Experts credit Merrill as the first firm to launch cash sweeps in 2000, according to separate respective news reports a few years later in the
Customer demands for lower commissions and other fees led the industry to the idea for cash sweeps, according to Peter Crane, whose company,
"It's not like they're holding clients hostage," Crane said. "Anyone with a brokerage account who doesn't know how to buy another mutual fund or stock is in the wrong place."
Welsh, the industry consultant, started his career with Merrill's Private Client Group in 1994 when stock trades cost $600 each, he recalled in an interview. During his tenure, the wirehouse began charging clients $100 for new "cash management accounts" to sweep the liquid assets into money market funds that also enabled users to write checks from the accounts, Welsh said.
The accounts would eventually blossom into some $300 million in revenue when 3 million clients signed up, helped along by a production contest named "The Masters" after the golf tournament and awarding 10 points to a broker for every new cash management account.
"That was really the first time they had taken a brokerage account and added checking to it," Welsh said. "It was revolutionary at the time."
In the current time of low expense ratios and zero-fee trades, even some critics of cash sweeps have altered their approach. When Bill Hamm of Tampa, Florida-based
Hamm had always "had an issue" with brokerages taking most of the yield for themselves, he said in an interview. He has since pushed that limit up by as much as 20 basis points in search of a "happy medium" in the yields to the firm and its clients.
"There is a need for that revenue into the firm. It's a matter of degree," Hamm said. "It's never going to be a perfect system, but you just try to make it make sense for everyone, because if we're not in business we're not doing anybody any good."
The alternatives
Advisors and their clients can choose among an array of methods to secure the higher yields available to them, according to Bruce Bent II, the CEO of
"The last thing an advisor wants is to feel afraid to talk to their customer because they know that the rate on the cash is underperforming," Bent said. "They know if they have bad news, they don't want to talk to the client."
Besides his firm, advisors could explore their options among such competitors for the assets including Ally Bank, Synchrony, Marcus by Goldman Sachs, MaxMyInterest, CIT Bank, FICA for Advisors and Flourish Cash.
As of this month,
He views cash sweeps as "a tremendous opportunity" for advisors because "there are people who just have far too much money sitting in those accounts," he said. Brokerages are also navigating how to respond to being told by clients that "we don't want to pay for anything," Cruikshank noted.
"You've got to make your money somewhere," he said. "The unfortunate thing is, it's a penalty on the people who don't pay attention. It is not a level playing field by any means."
If you're fine earning zero, then I'm not going to argue with you. If you want to earn more, it's actually quite easy to earn more now
SEC actions and the outlook ahead
Representatives for the SEC declined a request for an interview or comment, although Wall Street's regulator has been speaking through guidance and enforcement actions.
In a
With at least seven enforcement actions
In the latest significant settlement from earlier this year, the SEC found that Boston-based
"Moors & Cabot did not fully and fairly disclose to advisory clients with discretionary nontaxable accounts that, by default, all of their uninvested cash would be placed in the cash sweep option that was consistently least profitable to clients and most profitable to Moors & Cabot, rather than in other available options that were consistently more profitable to clients and less profitable to Moors & Cabot," the document said.
The case charged the firm with breaching its fiduciary duty to put its clients' interests first by failing to properly explain the conflict. Moors & Cabot settled the case, which also involved disclosures about margin loans and postage and handling fees, for $1.9 million. The regulator stopped short, though, of calling on the firm or the industry to eliminate the conflict completely.
That's troubling to investor advocates, who have been criticizing cash sweeps for nearly as long as they've existed. In 2005, Hauptman's predecessor at the Consumer Federation, Barbara Roper,
Hauptman praised the SEC enforcement cases but said he would like to see the SEC take a broader approach to cash management. At the very least, firms should make "a colorable argument as to why they put the investor in the product that doesn't perform as well as a reasonably available alternative," he said.
"Firms need to make money, they're for-profit entities," Hauptman said. "I would much rather see them charge in more transparent, express and direct ways and then add values on top of that, rather than doing it in indirect and opaque ways where its very difficult to decipher how they're charging and what incentives those revenue-generating actions are creating, because those could come to the detriment of the investor."
The larger regulatory implications remain outside of advisors' control, though. Their clients' cash holdings are another matter, especially in a time of rising interest rates amid concerns about a recession in the economy.
"Cash, on multiple fronts, is getting more important by the day as the yields get higher and as other markets show more vulnerability or volatility," Crane said.
Advisors should not underestimate cash, according to Bent.
"It's a great way to consolidate the relationship with the customer," he said. If the client's cash holdings are only in sweeps under an advisor, "I guarantee that your customer has a bank account somewhere," Bent added. "How much is in it? You don't know."
