SEC Charges Investment Advisers for Compliance Failures Relating to Cash Sweep Programs

Who may be interested: Registered Investment Companies; Investment Advisers; Broker-Dealers Compliance Staff

Quick Take: Indicative of a recent SEC focus on bank deposit sweep programs (BDSPs) offered to advisory clients through broker-dealers, the SEC recently settled charges against three dually registered investment advisers and broker-dealers (Advisers) for failing to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act related to the firms’ bank deposit sweep programs and the setting of interest rates on advisory client cash held by the programs.

The SEC orders (Orders) relate to BDSPs, through which a broker-dealer automatically deposits, or “sweeps,” cash awaiting investment in an advisory client’s securities account into deposit accounts at one or more depository institutions (IDIs) whose deposits are insured by the Federal Deposit Insurance Corporation.

According to the Orders, two affiliated Advisers (Affiliated Advisers) and another, unrelated Adviser offered their BDSPs as the only uninvested cash management option for most advisory clients. The BDSPs deposited client cash into deposit accounts at IDIs affiliated with the Advisers and unaffiliated IDIs, and the Advisers each received significant financial benefits from advisory client cash in the BDSPs, including advisory fees from clients, fees from affiliated and unaffiliated IDIs, or intercompany credits paid by the affiliated IDIs.

The Orders found that the Advisers, with input from their respective affiliated banking entity, set the interest rates offered in the BDSPs and that, during periods of rising interest rates, the yield differential between the BDSPs and other cash sweep alternatives (such as money market funds, treasuries and CDs) varied but at times exceeded five percent for the Affiliated Advisers and almost four percent for the other, unrelated Adviser.

The Orders indicated that, while the Advisers disclosed to clients that they received financial benefits from holding client cash in BDSPs, the Advisers failed to adopt and implement reasonably designed policies and procedures (1) to consider the best interests of clients when evaluating and selecting which cash sweep program options to make available to clients, including during periods of rising interest rates, and (2) concerning the duties of the firms’ financial advisors in managing client cash in advisory accounts. More specifically, the Orders noted that the Advisers’ policies and procedures failed to address, among other things, whether advisory client cash was appropriately allocated according to the client’s goals and objectives.

The Orders found that, as a result of the conduct described above, the Advisers violated Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, which require, among other things, that an adviser adopt and implement written policies and procedures designed to prevent violations of the Advisers Act and the rules thereunder. Without admitting or denying the findings, the Affiliated Advisers agreed to pay a total of $35 million in civil penalties, and the other, unrelated Adviser $25 million. In addition, the Advisers agreed to cease-and-desist orders and to be censured. The Orders acknowledged the prompt remedial action promptly undertaken by the Advisers to address shortcomings in the BDSPs and cooperation afforded to the SEC staff.

Incidentally, there are a number of outstanding related private lawsuits against firms for offering significantly lower interest rates through their BDSPs than the rates of BDSPs offered by other brokerage and advisory firms, particularly during periods of rising interest rates.

The Orders announcing the settled charges can be found here.