Know Your Brokerage Firm's Cash Sweep Account
by James J. Eccleston, Esq.
he New York Stock Exchange (NYSE) has issued an "Informed Investor" publication alerting investors to important issues surrounding so-called "cash sweep" accounts. These accounts are used when investors have excess cash balances in their brokerage accounts.
Investors need to understand that brokerage firms offer many ways to manage these excess cash balances. According to the NYSE, some firms offer money market mutual funds. Others offer accounts either at an affiliate bank or at a third party bank. Moreover, some firms give investors a choice; other firms do what they wish in their discretion.
Investors should know what kind of account they have because their brokerage firm is not required to seek the highest interest rates available. Indeed, the NYSE reports that an investor's brokerage firm may receive payments for introducing his or her cash sweep account to a bank, which, in turn, may pay a lower interest rate on the investor's funds.
Here are five key questions and answers that the NYSE has published on the cash sweep accounts.
First, what choices are available for investment of cash balances? The answer is that an investor can let his or her brokerage firm manage the cash balance, or he or she can take a more active approach. If the latter, then the investor's selection depends upon his or her investment objectives and liquidity needs. Then the investor should explore the choices offered by the brokerage firm. Is the choice limited to a bank account? Is a money market account available? Are there any other choices? Then, the investor should determine the rates being paid on these accounts. Sometimes, the rates are published on a website or can be accessed through a toll-free number. Finally, the investor should comparison shop at other brokerage firms.
Second, are there introductory rates and what is the longer-term rate? This is an important question as "teaser" rates may exist for a limited duration to induce investors to open accounts at a particular brokerage firm. The NYSE urges investors to determine the longer-term rates in order to make an educated investment decision.
Third, is there any benefit to selecting a bank account instead of a money market fund? Bank deposits feature FDIC insurance, meaning that the first $100,000 of funds is not subject to bank credit risk. On the other hand, money market funds have no such insurance, and do invest in securities that may have interest rate and/or credit risk. As a practical matter, however, the NYSE alert states that money market fund managers attempt to keep the value of the funds at a stable price. But there is no guarantee that they will be able to do so.
Fourth, can an investor take advantage of more than $100,000 in FDIC protection? There are two possible ways to do this. First, investors should search for a brokerage firm that sweeps cash balances to not one, but multiple banks, each with separate FDIC coverage. Alternatively, when a brokerage firm uses just one bank, investors should consider establishing accounts in different capacities (individual account, joint account, trust account, and so forth). The NYSE does caution investors that whichever method they choose, it is the investors' responsibility to monitor his or her accounts to make sure that they do not exceed the $100,000 limit for FDIC insurance.
Fifth, does the brokerage firm need an investor's consent to move his or her cash balance from one investment to another? Probably not. According to the NYSE, some brokerage firms have contractual language in their customer agreement which gives the firm authority to adopt or amend their cash sweep plans without further consent from the investor. The NYSE reports that "often" firms publish changes to existing plans in newsletters, or with monthly statements. If an investor wants to revoke his or here consent to a sweep, he or she needs to speak with the broker or customer service representative.
In a separately issued memorandum to brokerage firms, the NYSE urged the "best practice" of full disclosure to investors and their consent. While the NYSE has not issued new rules, it clearly delivered the message to brokerage firms that it would do so in order to "safeguard investor interests for the programs currently in place." Meanwhile, investors should be on guard for cash sweep programs that benefit more the brokerage firms than themselves.
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James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.
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