LPL's cash tweak slashes client yields while boosting firm's profits

LPL Financial is tweaking its largest client cash sweep program to generate an even higher yield for the company and a much lower one for its customers. As interest rates boost the company's profit, LPL is slashing the amount clients can earn on certain cash holdings.

The adjustment — which is effective Aug. 15 — will reduce the yields that clients get on the so-called overflow cash that's above banks' insurance limits by moving customers' dollars out of a Goldman Sachs money market fund and into LPL's primary sweep program. Wealth managers collect tens or even hundreds of millions of dollars in revenue each quarter through such sweep accounts at banks that pay better interest rates to the companies than their clients.

Clients or even some financial advisors may not notice those low yields as much as they would if they were seeking to tap into the current rising interest rates through a money market fund. LPL's cash sweeps amount to about $5,000 to $8,000 per client account on average, according to the firm, which noted in the "key metrics" of its second-quarter earnings that the money is usually used for rebalancing, fees and withdrawals. Those amounts can add up across millions of clients, though: overflow balances in LPL's primary sweep program, the Insured Cash Account, were $1 billion at the end of the first quarter, the last time the firm disclosed the figure. 

Under the subtle shift in LPL's handling of that overflow money, clients will get a yield of 0.01%, compared to 0.32% from the Goldman fund, according to an update for investors that the firm posted on its website in June listing the rates as of the end of the previous month. The company sent notifications to clients in the past quarter about the change.

"We previously told you that we would move overflow balances from [the Goldman money market fund] back to bank deposits only when deposit capacity in the banks was sufficient for all overflow balances," the document said. "In an effort to move overflow balances back into banks more quickly, effective August 15, 2022, we're changing our approach and will instead move overflow balances back to the ICA banks as capacity becomes available."

Those details carry big implications for LPL and all giant wealth managers, whether in terms of potential compliance cases or their business. Free credit — another term used to describe this overflow cash — reached more than $249 billion across FINRA member brokerages in June, the regulator's data shows. The SEC also mentioned cash sweeps by name in an Aug. 3 bulletin warning wealth managers and advisors to disclose it and other conflicts of interest. The sweep accounts and other cash allocation methods have come up frequently in recent SEC cases, including Charles Schwab's $187 million settlement and Avantax's $17 million matter.

The amount of money to be gained and rise of technology enabling cash sweeps has made them "a very attractive strategy" for all of the large wealth managers, according to Arbitration Insight's Louis Straney, a former regulator who often serves as an expert witness. Clients and advisors can opt out of the sweeps in favor of higher-yielding funds, but the companies have added more hurdles to altering cash accounts over the years, Straney said.

"It's not something that clients want to understand or pay much attention to," he said. "It's a way of increasing income without having to, one, hear complaints from clients and, two, there are no payouts to financial advisors."

Representatives for Goldman declined to comment on the change to LPL's cash sweeps, noting a policy against discussing the firm's clients. Representatives for LPL declined to comment as well.

The firm included a note about the shift as a "key update" in bullet points at the top of the press release on its second-quarter results earlier this month. Snippets of the company's cash-sweep disclosures and earnings call with analysts offer some explanation for the move.

LPL picked the Goldman Sachs Asset Management Government Square Fund for the overflow cash last year after it made the decision to find "a temporary solution to address systemic bank deposit capacity constraints" during the time of low interest rates, the investor briefing states. The alteration gives LPL, its clients and advisors "a new long-term process for cash holdings that exceed cash sweep programs' capacity," according to the document. 

With the stock slump prompting investors to allocate more money to cash, LPL's revenue from sweep accounts soared by 73% year over year to $156.2 million in the second quarter — 22% of its gross profit.

An analyst asked LPL Chief Financial Officer Matt Audette on the Aug. 2 earnings call whether the company has seen "any incremental signs of more yield-seeking behavior, whether that's demand for money — treasury or short-duration fixed income instruments?"

Audette noted that client cash balances have risen to 6.5% of their assets, which is above their usual 5% share. But he answered "no" while noting that the sweep accounts are "largely operational" for clients, the transcript shows.

"We tend to have some of the lowest cash as a percent of AUM in the industry," Audette said. "The primary factor that tends to move that up and down is really market sentiment as opposed to rate-seeking behavior. And I think when you look at just the last couple of quarters and especially this quarter, I think you're seeing that play out."

That behavior would likely lead clients and advisors to move their accounts back to a money market fund or another cash vehicle. With the adjustment to overflows, LPL said the balances will get the same interest gains as other money held in its main sweep accounts. For those Insured Cash Accounts as of Aug. 10, clients with up to $150,000 at LPL got 0.10% yields; followed by 0.12% for clients between $150,000 and $750,000; 0.20% for between $750,000 and $5 million; 0.25% for $5 million to $10 million; and 0.30% for those above $10 million.

In contrast, LPL generated an average yield of 1.34% on Insured Cash holdings of $40.8 billion in the second quarter. It had disclosed in its first-quarter earnings that, if the Fed raises interest rates by as much as 1% this year, LPL will make $330 million in additional gross profits.

Other comparisons for potential uses of the cash display an even wider disparity: As of Aug. 11, a one-month treasury bill was yielding 2.13%. Money market research firm Crane Data's 100 Money Fund Index showed a seven-day average of 1.92% on Aug. 10.

For any clients or advisors taking time to read LPL's update to clients on the shift in its overflow cash, the company expressly states that those seeking a better rate should look at their other potential options. 

"Our cash sweep programs, including ICA, are designed to provide operational convenience for investors, such as automated transfers to enable cash deposits/withdrawals, trade settlements, and other cash movements, while providing the opportunity to earn interest income at a competitive rate for similar programs," according to the update to clients. "Investors who prioritize higher yields over operational convenience should discuss other options, such as traded money market mutual funds, with their financial professional."

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