RIAs lash out at Schwab hedge fund decision

Mar 3, 2009 @ 1:40 pm

By Jed Horowitz

Saying that Charles Schwab’s recent decision to stop accepting custody of alternative investments has put them in “an untenable position,” a consortium of registered investment advisers told the firm’s top executives they are reluctantly but “actively looking elsewhere” for more-committed custodial partners.

Charles Schwab & Co. Inc., the oldest and largest provider of back-office and other custodial services to RIAs, unilaterally announced in mid-February that it was no longer accepting offshore-fund investments and that as of April 30, it would end acceptance of “any form of alternative assets for custody.” The edict includes hedge funds, promissory notes, privately placed investments, and other stock and bond alternatives that some advisers said have become an increasingly large part of their investment arsenal.

“This precipitous blanket decision during a time of extreme market stress places a crushing burden on your RIA partners at a time when few of us can afford to add more uncertainty to our client relationships,” the group wrote in a Feb. 24 letter to firm founder Charles Schwab, president Walt Bettinger and James D. McCool, head of Schwab Institutional in San Francisco. “We are saddened to hear in our conversations with each other and with other Schwab customers that this single decision by Schwab has many RIA firms, including ours, actively looking elsewhere for a long-term, supportive, full-service broker-dealer partner.”

The letter was signed by executives of 22 RIA firms under the leadership of Steve Disenhof, a partner at Litman/Gregory Asset Management LLC of Larkspur, Calif. (Schwab last year awarded Litman/Gregory, which sponsors the Masters Select family of mutual funds, a "Best in Business" award for practice management excellence.)

“We've received a letter from a group of advisers,” Schwab spokeswoman Alison Wertheim wrote in an email. “We respect their views and are reaching out to them to hear more about their concerns.”

In its initial notice to RIAs, Schwab said its decision was motivated by “recent events and anticipated regulatory changes” that are likely to focus on the role of custodians and the need for greater transparency. Some advisers said they understand Schwab’s anxiety in light of the recent Bernard Madoff and Stanford Group Co. scandals but were stunned by the precipitous way San Francisco-based Schwab made the decision and failed to seek adviser feedback. They also accused the company of hypocrisy, noting that Schwab has actively encouraged RIAs to use alternatives as an investment strategy.

The advisers also were critical of the exception Schwab has made to its new policy: It is continuing to custody assets of 31 hedge funds that Schwab offers on its Alternative Investment Source platform. The 16 companies that sponsor the funds pay a fee believed to be as high as 0.6% of assets that Schwab gathers over the platform.

Schwab has been referring RIAs seeking help with custody and record-keeping of alternatives to San Francisco-based Pensco Trust Co. and Waco, Texas-based Sterling Trust Co. But advisers said those firms charge more than Schwab and are less experienced.

“Some of us are collectively apprehensive about both their customer service relative to Schwab and their respective capacities to take on the responsibilities that would be required,” the letter stated.

Advisers in the consortium are hoping they can use their collective leverage to force Schwab to rescind its decision or to negotiate with rival custodians, said Jason Lina, research director at DCA Global Investment Management, a RIA in Norcross, Ga.

Fidelity Investments of Boston, whose RIA arm is overseen by former Schwab Institutional head Charles Goldman, has been reaching out to DCA and other advisers to discuss accommodating their alternative needs, Mr. Lina said.

“We continue to be focused on helping advisers build their businesses, and offering solutions for their alternative investment and total custody needs,” a Fidelity spokesman said.

TD Ameritrade Holding Corp., an Omaha, Neb.-based discount broker with a large RIA custody practice, is studying the Schwab decision. "We’re taking a good, hard look at it," said Brian Stimpfl, managing director of advisory and industry affairs at the firm's institutional unit. "It's an opportunity."

The letter from the RIAs, many of whom are believed to use multiple custodians, concluded by saying that the advisers are not eager to move assets away from Schwab and hope the company will reverse its decision and work with them on a “long term, in-house Schwab solution.”

At the very least, they are hoping for an extension of the April 30 expiration date for accepting alternative investments.

“Schwab’s decision has put us in an untenable position,” the letter said. “We can’t simply shut down the alternatives portion of our asset allocations while Schwab seeks a third-party solution.”

For more details, please see the upcoming March 9 print edition of InvestmentNews.

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