Cash Sweep Program Scrutiny

In recent months, many major financial institutions have found themselves under scrutiny due to legal and regulatory challenges concerning their cash sweep programs, including class action lawsuits. This scrutiny underscores a crucial moment for financial firms to reassess their cash sweep compliance practices and enhance transparency to better serve their clients.

Cash Sweep Programs Under Fire

Cash sweep programs have come under fire as clients accuse firms of breaching fiduciary duties by offering minimal returns on cash deposits, while benefiting from substantial revenue streams from program banks. The complaints highlight that these firms have been misleading clients through inadequate or oblique disclosures about the returns and risks associated with these programs. Client complaints highlighted firms’ failure to adhere to fiduciary duties under Regulation Best Interest (Reg BI) and or FINRA Rule 2111 (suitability).

For example, some firms have been criticized for allegedly shortchanging client accounts and concealing the benefits received from cash sweep programs. Clients claim the spread has become more pronounced as the federal funds rate has risen. As of August 30, 2024, that effective rate was 5.33%, up from 2022 when it was as low as .08%. Clients claim they have not received the benefit of the fed funds increase, as the interest rates that the cited financial institutions paid to some customers remained as low as .05%.

Similarly, other firms in the spotlight have been accused of failing to offer competitive returns compared to alternatives available in the market, such as those from other Financial Services firms, which offer higher yields through money market funds.

Clients are making a case that cash sweep accounts were underpaid billions of dollars due to the low rates paid by financial institutions. If firms settle or lose these lawsuits there will be a huge potentially complex remediation effort that could involve a payout of billions of dollars across the industry,

Essential Steps to Address Cash Sweep Scrutiny

In response to the increased regulatory attention around cash sweep programs, firms should review and improve the transparency of their cash sweep programs. This includes providing detailed risk disclosures, ensuring regulatory compliance, clearly outlining fees, and enhancing client communication and education. These steps are critical to safeguarding client interests and maintaining the integrity of their offerings.

Detailed Disclosure of Risks

To address these concerns, firms need to improve how they disclose risks associated with money market funds. This includes:

• Investment Risk Disclosure.  Firms should provide comprehensive details about the potential risks involved, such as the possibility of losing principal, market fluctuations, and liquidity issues.
• Historical Performance and Market Impact.  Offer insights into how these funds have performed under different market conditions and how various events could impact their value to help clients make more informed decisions.

Regulatory Cash Sweep Compliance and Legal Disclosures

Regulatory scrutiny is intensifying, and firms must be proactive in their disclosures:

• Disclosure of Regulatory Actions.  Clearly detail any regulatory fines and the reasons behind them, explaining how they are addressing non-compliance issues with their cash sweep programs.
• Impact on Clients.  Any regulatory actions could lead to changes in fund management or offerings. Clients should be informed about how these changes might affect their investments.
• Review of ADVs and Marketing Materials.  Firms, including introducing firms, need to update their ADV documents and marketing materials to reflect updated information about cash sweeps.

Enhanced Transparency on Fees and Costs

Firms should also focus on providing clear and detailed information about fees:

• Breakdown of Fees. A thorough breakdown of all fees related to money market funds, including those collected from program banks versus what is paid to clients, should be made available.
• Disclosure of Fee Structure Changes. If regulatory actions lead to changes in fee structures, firms must clearly communicate these changes and the reasons behind them.
• Cost Analysis. Provide a detailed analysis of costs associated with supporting the cash sweep business for transparency.

Updated Client Acknowledgements and Consents

Ensuring clients are fully informed and consent to the terms of their investments is crucial:

• New Acknowledgment Statements. Clients should explicitly acknowledge their understanding of the nature of cash sweep money market funds, including fee structures and any related operational expenses.
• Revised Consent Forms. Consent forms should be updated to reflect any changes in terms, conditions, and disclosures resulting from regulatory actions.

Revised Marketing and Promotional Materials

Marketing materials must accurately and transparently represent the nature of cash sweep money market funds:

• Compliance with Marketing Regulations. Ensure all promotional content truthfully represents the cash sweep programs, including detailed information on fees collected from program banks.
• Balanced Presentation of Risks and Benefits. Update marketing materials to provide a fair view of both the risks and benefits associated with these funds, aligning with the latest disclosure documents.

Client Education

Empowering clients with knowledge is a key aspect of enhancing transparency:

• Educational Resources.  Develop comprehensive resources to help clients understand cash sweep money market funds and make informed decisions about their investments.
• Frequently Asked Questions (FAQs).  Update the FAQ section to address common concerns, especially new regulatory developments and fee structures.

Internal Review and Compliance Checks

Provide the following to ensure adherence to regulatory standards and internal policies:

• Legal and Compliance Review. Conduct thorough reviews of all client disclosure documents to ensure they meet regulatory requirements and address any issues raised by recent fines.
• Ongoing Updates and Monitoring. Implement a process for regular updates to disclosure documents and internal policies, ensuring continuous compliance.
• Review of ADV and Marketing Materials. Scrutinize ADV documents and all marketing materials related to cash sweeps to ensure accuracy and compliance.

Communication Strategy for Existing Clients

Maintaining clear and effective communication with clients is vital. Firms should provide clients with:

• Notification of Changes. Proactively inform existing clients about updates to disclosure documents and any implications for their investments in cash sweep programs.
• Helpline and Support.  Provide clients with access to helplines or online resources to address questions and concerns about the changes.

Building Trust Through Transparency and Compliance

As financial firms navigate the evolving landscape of cash sweep programs, enhancing transparency and compliance is more critical than ever. By implementing these changes, firms can help mitigate regulatory risks while reinforcing their commitment to ethical practices and client trust. For clients, this means better-informed decisions and a better understanding of their investments, paving the way for more transparent and trustworthy financial management.

Expert Regulatory Compliance Support

Oyster Consulting’s team of regulatory compliance consultants will review your sweep documents including the Form ADV, client marketing material, along with firm and client disclosures.  Our experts also provide testing of the disclosures and processes, design of the Reg BI conflicts process, remediation of Securities and Exchange Commission (SEC) findings and data analytics.

Compliance Technology To Make Your Job Easier

The Oyster Solutions Fund Analyzer software allows you to compare funds with confidence.  Oyster Solutions provides documentation of compliance with FINRA’s Regulation Best Interest (Reg BI). Identify the lowest cost share class option and reasonably available alternatives when purchasing mutual funds. Using MorningStar Data, our compliance software compares fees and expenses, account types and returns of funds. This comprehensive platform identifies and documents the lowest cost share class that meet the selection criteria.