Regulators are currently investigating Morgan Stanley's program for transferring investment advisory clients' surplus cash into affiliated bank accounts, according to a recent regulatory filing.
In the same document filed on Monday with the Securities and Exchange Commission, Morgan Stanley disclosed it is facing two class-action lawsuits targeting its cash-sweep program.
Despite these developments, shares of Morgan Stanley were trading 1% higher at $93.04 midday Tuesday. This reaction suggests that investors may not yet be overly concerned about the potential impact of these investigations and lawsuits, but the situation is worth monitoring closely.
Cash-Sweep Programs Under Scrutiny
The spotlight on cash-sweep programs comes amid growing dissatisfaction with the low-interest rates wealth management firms often offer on clients' uninvested cash. This has become a contentious issue following the Federal Reserve's rate-hiking campaign, which has made it more evident that many firms have not passed along increased returns to their clients. In response, some firms, including Morgan Stanley, have pledged to enhance these returns, yet this area continues to attract attention from both investors and regulators.
The cash-sweep programs have also led to legal and regulatory scrutiny across the industry. Multiple firms, such as Wells Fargo and Ameriprise, are dealing with lawsuits and regulatory inquiries regarding their cash management policies. For instance, Wells Fargo, which has announced plans to raise rates on sweep accounts, is facing similar regulatory challenges.
Morgan Stanley’s Regulatory Challenges
Morgan Stanley revealed in its latest filing that it has been engaged with the SEC's Enforcement Division since April, responding to requests for information about its policies on "advisory account cash balances swept to affiliate bank deposit programs and compliance with the Investment Advisers Act of 1940." This inquiry underscores the importance regulators are placing on ensuring that firms adhere to fiduciary standards and act in clients' best interests.
A spokeswoman for Morgan Stanley declined to comment further on the matter, leaving questions about the firm's specific steps to address these concerns unanswered.
Details of the Lawsuits
Beyond the regulatory inquiry, Morgan Stanley is facing two lawsuits that allege it has failed to offer reasonable returns on clients' cash-sweep accounts. These lawsuits could have significant implications for the firm, particularly if they gain class-action status.
The E*Trade Lawsuit: The first lawsuit targets E*Trade and Morgan Stanley, claiming that the discount online brokerage firm, and the combined entity following its acquisition by Morgan Stanley in 2020, failed to pay reasonable rates on cash accounts held by IRA clients. Morgan Stanley has stated that a motion to dismiss this lawsuit is currently pending, which indicates that the company is actively contesting the allegations.
The Federal Court Lawsuit: The second lawsuit was filed in June in a federal court in New York. It alleges that Morgan Stanley failed to pay reasonable rates on cash balances held by brokerage, advisory, and retirement account holders. Like the first lawsuit, this case is seeking unspecified damages and aims to have the plaintiffs certified as a class. If successful, this could lead to significant financial and reputational consequences for Morgan Stanley.
Implications for Wealth Advisors
For wealth advisors and RIAs, these developments highlight several critical considerations:
Client Communication: It's essential to communicate transparently with clients about how their cash is managed, including explaining cash-sweep programs and how interest rates are determined. Clear communication can help manage expectations and build trust.
Review Cash Management Policies: Advisors should regularly review their cash management strategies to ensure they align with clients' best interests and adhere to regulatory standards. This includes evaluating the interest rates offered and exploring alternatives that may better serve clients.
Monitor Industry Trends: Staying informed about industry trends and regulatory developments is crucial. As scrutiny on cash-sweep programs intensifies, being proactive in addressing potential issues can position advisors to better navigate the evolving landscape.
Evaluate Third-Party Relationships: Advisors should assess their relationships with custodians and banks involved in cash-sweep programs to ensure they meet fiduciary obligations. This includes understanding how these partners determine interest rates and whether they align with clients' expectations.
Potential Impact on Morgan Stanley
The outcome of the regulatory investigation and lawsuits could have significant implications for Morgan Stanley. If found non-compliant with fiduciary standards, the firm may face financial penalties, reputational damage, and a potential shift in how it manages client cash.
Moreover, these cases could set a precedent for how wealth management firms handle uninvested cash, leading to industry-wide changes. Advisors should be prepared for potential regulatory reforms and shifts in client expectations regarding cash management practices.
Conclusion
The investigation into Morgan Stanley's cash-sweep program and the accompanying lawsuits underscore the growing scrutiny on how wealth management firms handle client cash. For wealth advisors and RIAs, this serves as a reminder of the importance of transparency, adherence to fiduciary standards, and proactive client communication.
As the situation unfolds, advisors should stay informed and be prepared to adapt to any changes in the regulatory landscape. By doing so, they can continue to uphold their commitment to serving clients' best interests while navigating the challenges and opportunities within the wealth management industry.
