Regulators Increase Focus on Conflicts in Cash Sweep Programs
Broker-Dealers
Regulatory Exams and Oversight
November 30, 2024
The Case
Cash sweep programs, which automatically transfer uninvested cash in brokerage accounts to higher-interest accounts, are facing increased scrutiny from regulators like the SEC and FINRA, and investors. These programs often involve conflicts of interest, particularly regarding how interest income is allocated between the firm and the client and whether the firm prioritizes its profits over client benefits. Regulators are examining whether firms adequately disclose these conflicts, how they select sweep options, and if they ensure clients receive reasonable returns.
This scrutiny has led to several SEC enforcement actions and lawsuits alleging inadequate disclosures, breaches of fiduciary duty, and violations of Regulation Best Interest. Firms are now expected to be transparent about the features, risks, and financial details of their cash sweep programs, including how interest is allocated and what alternatives are available. They also need to ensure their programs suit each client's needs and that their policies and procedures effectively address conflicts of interest.
Regulatory Implications
The heightened scrutiny of cash sweep programs by the SEC and FINRA underscores the importance of addressing conflicts of interest and providing transparent disclosures. Key regulatory implications include:
Disclosure Requirements:
Firms must clearly disclose any compensation or revenue-sharing arrangements related to cash sweep programs and explain how these arrangements impact clients’ returns.
Conflict of Interest Management:
Broker-dealers and investment advisors are expected to identify and mitigate conflicts of interest, particularly those arising from financial incentives tied to sweep options.
Compliance with Reg BI:
Broker-dealers must demonstrate that their cash sweep program recommendations are in clients’ best interests, aligning with the standards set by Regulation Best Interest.
Practical Guidance for Firms
To address increasing scrutiny, broker-dealers and investment advisors should consider the following steps:
Clarify the nature of conflicts, compensation arrangements, and interest allocation practices in all client-facing materials.
Identify and document any conflicts arising from cash sweep programs and develop strategies to manage or mitigate these conflicts.
Periodically audit cash sweep programs to assess whether they align with regulatory expectations and fiduciary obligations.
Analyze whether cash sweep options are appropriate for clients’ needs, considering market conditions and available alternatives.
Train employees on the regulatory requirements and ethical considerations related to cash sweep programs and conflicts of interest.
Stay informed on SEC and FINRA guidance and enforcement trends related to cash sweep programs.
InnReg’s expertise supports firms in adopting transparent practices and aligning with SEC and FINRA expectations. Contact us today to learn more about how we can help your firm mitigate regulatory risks.
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