SEC proposes rules on cash sweep practices

Mar 26, 2007 @ 12:01 am

By Dan Jamieson

IRVINE, Calif. — The Securities and Exchange Commission has proposed that firms beef up their disclosure of cash sweep policies.

The proposal, part of a little-noticed package of rules floated by the SEC this month, would require broker-dealers to provide a quarterly notice to customers telling them that they can opt out of a default sweep option and choose another vehicle for their cash.

Sweeping customer cash into low-paying bank accounts — a growing industry practice — has caused concern among regulators.

The SEC also wants clients to get a 30-day notice before their sweep option is changed, and it wants new customers to agree beforehand that a firm can switch their cash investment options.

“There may be consequences to changing [sweep] options, and [we] believe that customers should have a sufficient opportunity to make an informed decision,” the SEC’s proposal stated.

The SEC is taking comments on the rule until May 18.

If approved, the proposal will create the first industry rule specific to cash sweep disclosure.

Two years ago, the New York Stock Exchange recommended that firms improve disclosure of cash sweep options. The NYSE didn’t call specifically for notice of an opt-out option.

Firms disclose now

The SEC’s proposed rules may formalize some industry practices adopted in the wake of the NYSE’s recommendations.

“Where NYSE guidelines are in effect, industry firms should be in compliance,” said Travis Larson, spokesman for the Securities Industry and Financial Markets Association of New York and Washington.

The trade group will file a comment letter on the proposal, he said.

“We’ve always disclosed [that clients] can opt out by calling their [financial adviser] and having [their adviser] put them in a money market,” said Smith Barney spokesman Alexander Samuelson.

Smith Barney, the brokerage unit of New York-based Citigroup Inc., changed to a tiered bank deposit sweep program in September. Prior to that, it had been paying money market rates on its deposit accounts, regardless of client size.

Most large firms require at least $100,000 in assets before a customer begins to earn a higher rate on bank deposits.

Merrill Lynch & Co. Inc. of New York requires $250,000. The firm was recently paying a starting rate of about 1.4% on its deposit account, versus nearly 5% on a money fund.

Firms say that clients can always check rates online.

A Merrill broker, who asked not to be identified, said that the firm’s account-opening forms require brokers to indicate whether they have discussed money market options with clients.

The NYSE said in its 2005 notice that registered reps “would be expected ... to determine the appropriate money market choices.”

Mr. Samuelson said Smith Barney makes it clear to clients that its bank deposit sweep is more profitable for the firm.

Requiring disclosure of an opt-out option might encourage more clients to use money funds, the Merrill broker said.

“It might start that conversation,” he added.

Some brokers said they already use higher-yielding money funds, especially if a client keeps significant cash holdings for extended periods.

The drawback is that in most cases, if a customer opts out of the default sweep, brokers must manually move cash into a money fund.

Important business

Using lower-yielding bank deposits for customer cash boosts profits at brokerage firms’ affiliated banking operations.

Charles Schwab & Co. Inc. in San Francisco, Morgan Stanley of New York and Wachovia Securities LLC of Richmond, Va., also use bank deposit programs with tiered rates.

Merrill has been the most successful in directing assets into its bank accounts. It reported $84 billion in deposits at the end of last year.

The practice of sweeping client cash into lower-paying accounts has also attracted the attention of plaintiff’s attorneys.

In January, a class action was filed against Citigroup, Merrill, Morgan Stanley and Schwab. The suit, filed in the U.S. District Court for the Southern District of New York, alleged that the firms’ sweep programs weren’t adequately disclosed to customers under state law.

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