Finra probes brokerage bank sweep accounts as commissions dwindle

Expert: Interest rate discussions with clients ‘can be problematic’

As commissions drop precipitously, brokerages have to make money somehow, and regulators are zeroing in on one way they’re trying to do it – profiting from managing client cash.

In its recently released examination priorities, the Financial Industry Regulatory Authority Inc. emphasized that it would probe bank sweep programs in which brokers put uninvested customer money into accounts at affiliated banks or into money market funds.

These accounts sometimes offer services such as checking, debit cards and ATM withdrawals. But they have generated criticism because they often pay minuscule interest rates. The average yield of a sweep account is about 25 basis points, according to, while money market funds draw about 2%.

Finra added exams of sweep practices to its priority list for this year, citing worries by the broker-dealer regulator and the Securities and Exchange Commission.

“While these bank sweep programs may offer useful features to customers – and in some, but not all, cases offer higher-than-average interest rates – they have also raised several concerns about firms’ compliance with a range of Finra and SEC rules,” the Finra priority letter states.

Basically, Finra doesn’t want brokerages passing sweep accounts off as the equivalent of bank accounts or stashing customer cash there without telling customers about other alternatives for cash management. In the priorities letter, Finra listed eight questions brokers should cover when talking about sweep accounts.

In its effort to monitor brokerages’ alternative methods for making money, Finra also said it would review potential conflicts of interest in decisions on how to route customer trade orders.

Recently, Charles Schwab Corp., TD Ameritrade and ETrade announced that they would offer commission-free trading. That has focused attention on their use of sweep accounts.

“Finra scrutiny of bank sweep accounts is a big deal and
could present a serious issue to broker-dealers from wirehouses to discount
brokerage firms that all have increasingly relied on this conflicted model of
defaulting investors to low-yield ‘in-house’ cash options to generate revenue,”
Michael Kitces, director of wealth management at Pinnacle Advisory Group, wrote
in an email.

With Finra peering over their shoulders, brokerages will
have to do more than automatically put customer cash into a sweep account, according
to Brent Burns, owner of the Law Offices of Brent A. Burns.

“Not one size fits all,” Mr. Burns said. “Each broker should
look at their clients’ needs because they may not fit the default.”

Providing transparency about available cash options and
where customer money is going will be the key to meeting Finra’s expectations,
said Greg O’Gara, a senior research analyst for wealth management at Aite Group.

But having a frank conversation with customers about the low interest rate they will earn on cash in their sweep accounts could be awkward.

“If you’re going to talk about bank sweep programs, the rate
discussion is not far behind,” Mr. O’Gara said. “Rate discussions can be
problematic, especially if they’re not offering the highest rates.”

The attention Finra is giving to sweep programs won’t
necessarily cause brokers to back off of them, said William Jannace, a consultant
at Bates Group, a legal and compliance consulting firm.

“I don’t think it should have a chilling effect,” Mr. Jannace said. “Given the interest rate environment, it’s a good opportunity for firms to step back and review policies and procedures and update them where warranted.”

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