The jig may be up for one of Wall Street’s most lucrative — and hush-hush — revenue streams that could have cost clients hundreds of millions of dollars.

For decades, the largest broker-dealers have shuffled clients’ uninvested assets into higher-yielding accounts, earning profits estimated at 10 times what they paid to customers in the process. The practice, called a cash sweep, is often disclosed to investors in the fine print, but it’s gaining renewed attention after elevated interest rates, high-profile lawsuits, and multiple SEC investigations have motivated clients to find more profitable places to park their cash.

It’s good news for investors who are now making the most out of their money, but not so much for a handful of top brokerage firms, like Morgan Stanley, Wells Fargo, and Charles Schwab. While some of the companies reported solid overall earnings last week, they were tamped down by steep losses inside wealth management divisions. 

“Investors can’t necessarily demand returns they see advertised because a good portion of that money is used for fees or intended for asset purchases,” said Doug Fritz, CEO of the consulting group F2 Strategy. “At the same time, fiduciary advisors should be looking to earn them closer to market rate returns.” 

Wall Street Sweepstakes

Wells Fargo said in its second-quarter earnings call that it would pay customers more in its cash sweep program, and it would likely result in a $350 million hit to interest income in its wealth arm this year alone. CFO Mike Santomassimo said in a call with analysts that the change was not anticipated. Last fall, the wirehouse disclosed an SEC investigation into its advisory cash sweep accounts, although the company did not say if the regulatory scrutiny led to the decision. 

Morgan Stanley, which is facing a class-action suit of its own, was next in line, saying it was also raising rates on clients’ cash in an attempt to lure back customers and their assets. The company announced a loss in revenue in its sweep accounts last week:

• Net interest income for the company topped $1.798 billion for the second quarter, although that was down 3% from the previous quarter and 17% lower than this point in 2023. 
• On the earnings call, Morgan Stanley CFO Sharon Yeshaya attributed the drop to the “seasonality of tax payments,” and expected the metric to “decline modestly” next quarter. She acknowledged “changing competitive dynamics” would also play into interest income moving forward.
• To counteract the losses, Yeshaya said the firm will largely offset higher rates with expected gains from “repricing” the overall investment portfolio.

What’s Up, Chuck? In one of the largest cases of its kind, and arguably most notorious, Charles Schwab was fined $187 million by the SEC in 2022 for failing to disclose its program to clients. While the practice likely helped pay for low-cost, and often free, digital advice it gave customers, the “cash drag” on portfolios helped pad profits at the expense of clients. One study found customer losses could have risen to as much as $500 million over a six-year period.

Registered investment advisors are back in the black in client assets.

Assets under management for RIAs rebounded sharply last year after a dismal 2022, and it wasn’t just because of the markets’ blistering performance, according to Charles Schwab’s latest RIA Benchmarking Study, which surveyed more than 1,300 firms representing $2 trillion in assets. It’s a welcome reset for an RIA industry that has enjoyed massive inflows of client cash over the past decade.

New Clients, New Money

AUM for the median RIA rose nearly 18% in 2023 — a much needed comeback from the 7.1% drop in 2022. Granted, a lot of that was fueled by a booming economy that saw the Dow jump 13% last year, the S&P 500 more than 24%, and the Nasdaq a whopping 43%.

However, RIAs also experienced significant organic growth, which excludes market performance, and translates into new money from new and existing clients. Assets from new clients reached their highest point on record, and assets from existing clients reached their second-highest point over the last five years, the report found:

• Top performing firms — those that rank in the top 20% of Charles Schwab’s index for successful RIAs — added a median of just over $43 million in new assets from 42 new clients in 2023, while the rest gained a median of about $18 million from 23 new clients. 
• Client and business referrals, when an existing customer recommends an RIA to a prospective client, were the leading strategy in organic growth, accounting for 67% of new clients and new assets.

Not Going Anywhere: Like in much of life, being a good listener is a good idea. The study found that firms that collected feedback during client interviews gained 26% more assets from existing clients in 2023. And that type of strategy pays off in the long run, as investors’ attitudes to their RIAs haven’t changed much in the last 10 years. Over the past decade, RIA client retention has remained at 97%. Advisors can rest easy at night, knowing investors aren’t looking to put their money elsewhere anytime soon.

Artificial intelligence may be one of the fastest-growing tools in business, but don’t tell that to the compliance department.

More than 6 in 10 advisory firms have no plans to develop or use client-facing AI applications, according to a new report from the compliance consulting firm ACA Group. In fact, only a small portion of the roughly 600 compliance firms surveyed use the technology at all, and just 1.5% said they frequently depend on AI-equipped robo-advisors to guide investment decisions. About 12% of firms surveyed said they have a ban on all AI tools altogether. Harsh.

Cannot Compute

After “eliminate” and before “delegate,” “automate” is key to completing tasks in the workplace — at least, that’s what all those LinkedIn posts say. But when it comes to managing people’s money, investment firms and the government are careful not to let advisors put all their trust in fast-processing computers just yet:

• When asked what their formal approach to AI tools is like, about 40% of firms, the plurality, said they don’t have one, and are in the midst of or have yet to start evaluating its usage. AI ranked third among the “hottest” compliance topics for 2023, the survey found, with 46% of firms putting it on their list of important issues. The first and second spots were held, respectively, by off-channel communications between advisors and then client and marketing strategies.   
• Earlier this month, the Securities and Exchange Commission suggested that it may take more time to issue regulations on how brokers and wealth managers can use AI, predictive analytics, and large language models when working with clients. The rules, which were proposed last year, would require firms to make sure use of AI doesn’t put their profits ahead of investors’ portfolios. Republican SEC Commissioner Mark Uyeda criticized the proposal as “breathtakingly broad in its reach.”  

Busy Work: Some of the biggest names on Wall Street have already made the plunge into AI tech. Goldman Sachs deployed its first AI tool for code building last month, and Morgan Stanley recently rolled out an application for wealth managers that can take notes during client meetings and draft emails, which is supposed to increase advisors’ productivity. As for now, it seems the grunt work can be handled by robots, but firms are still leaving the important decisions to the professionals.