Keep sweep accounts clean and transparent

In “olden” days, or at least up until the mid-1990s, the Glass-Steagall Act prohibited commercial banks from owning or operating brokerage firms, and equity trades required five days to settle.

[More: Advisers in a pickle over low-yielding cash sweep accounts]

Since then, much has changed. Banks and brokerage firms now operate under one roof. And settlement — the process of going from transaction to receiving payment or securities — has shrunk to two days. But concerns remain about whether brokerage firms are giving investors a fair deal on cash — whether it’s the cash received when securities are sold or the cash that must be available for securities to be purchased.

Unlike in the past, when idle cash sitting in a customer’s brokerage account typically received no interest, cash today usually is swept into a money market mutual fund or into a money market bank account, typically at a bank that is a unit of the same parent as the broker-dealer.

As noted in a recent report by Mark Schoeff Jr., the Financial Industry Regulatory Authority Inc. will be making brokerage firm cash sweep programs one of its examination priorities this year, citing its own worries and those of the Securities and Exchange Commission. Essentially, Finra is concerned that brokerage firms may be encouraging customers to use in-house bank sweep accounts without informing them of other alternatives for cash management, namely money market mutual funds.

To be sure, the bank sweep accounts offered by brokerage firms come with several user conveniences, including debit cards and ATM withdrawals. At the same time, bank sweeps often pay far less interest than money market funds — about 175 basis points less, on average, according to Bankrate.com.

[More: Finra probes brokerage bank sweep accounts as commissions dwindle]

What’s left unstated by Finra is that it is clearly in a broker-dealer’s financial interest, and not necessarily in the customer’s, to avoid money market mutual funds and instead steer idle cash to a bank sweep account controlled by the brokerage firm’s parent. This creates an ethical and business conflict for firms: Do the right thing for the customer by enabling them to earn a higher return on their cash, or do the right thing for the firm by keeping those returns in-house?

With brokerage commissions falling to zero at many of the largest firms, interest earned on idle cash — or in this case, the spread between what brokerage firms pay customers on bank sweep account balances and what their parent firm earns on those funds as an institutional investor — is a significant profit center for broker-dealers. It is not likely one they will want to cede.

Finra said it will take several factors into consideration when looking at firms’ sweep practices, most of which involve clear and complete disclosure of where the cash is going and the alternatives available to the investor. Among the many specifics it will be reviewing are whether firms omit or misrepresent material information concerning the relationship of the brokerage accounts to partner banks, the nature and terms of the arrangements, and the amount of time it may take for customer funds to reach the bank accounts.

[More: Mariner Wealth Advisors gets into the cash management business]

In the old days, there was little investors could do to speed the settlement process or share in part of the sizable interest earned by brokerage firms on the cash that coursed leisurely through customer accounts on the way toward settlement. In those days, too, brokerage firms were often less than diligent about making sure idle cash was moved promptly into customers’ hands — prompting complaints about “dirty sweeps.”

In today’s faster, interconnected world, there is no reason for anything other than clean sweeps. Let’s hope that Finra’s efforts result in more transparency and greater cleanliness in the cash sweep process.