On August 5, a prominent investment brokerage firm disclosed in a quarterly filing that it has been responding to requests from the SEC since April related to the firm’s practice of sweeping uninvested customer account balances into interest-bearing deposit programs at affiliate banks in order to generate income. This disclosure comes on the heels of the firm being named in two separate class action lawsuits earlier this year, both alleging that the firm breached customer agreements and its fiduciary duties to account holders by failing to pay reasonable interest rates on cash balances swept to affiliate bank deposit programs.
These cases are representative of the broader wave of recent class action litigation accusing several large brokerage firms of unlawfully profiting off of their “cash sweep” programs. The class actions generally allege that defendant firms breached their fiduciary duties to account holders by failing to adequately disclose that customers could realize greater returns if they moved their cash into other accounts or cash-alternatives like money market funds with higher interest rates. In addition, certain of the class actions also involve contractual claims alleging that the failure to pay reasonable interest rates to account holders in connection with cash sweep programs constitutes a breach of the firms’ brokerage agreements with customers.
While class actions based on breach of fiduciary duty in connection with cash sweep programs date back as far back as 2007, the number of such cases brought in recent months, along with the mounting scrutiny from regulators, indicate a more discernable trend than has been seen in the past.
Putting it into Practice: Given that the current wave of class action litigation aimed at cash sweep programs is relatively new, it is difficult to assess the plaintiffs’ likelihood of success, especially given the many meritorious defenses that exist. However, considering the scope of the legal theory being advanced in support of the plaintiffs’ claims, other brokerage firms employing similar cash sweep programs face a potential risk as the class action suits continue to snowball. Although the theories of liability are different, a similar phenomenon occurred with the countless fiduciary-duty based ERISA class actions that proliferated in recent years. In light of the potential exposure, firms should be proactive in considering mitigation strategies, such as bolstering disclosures made to customers and increasing the interest rates paid back to account holders on swept funds.
