-- Say you have $20,000 idling in a money-market account at my bank. Your cash earns 5 percent while you decide how and when to invest it.
The year is 2001, and my bank wants to move your money to a deposit account earning a paltry 1 percent.
You would make less. We -- the bank, that is -- would make more. We would lend out your money and get, say, an 8 percent return, while we pay you a pittance.
Would you have said yes?
You probably did if you are a longtime brokerage client of Merrill Lynch & Co., Citigroup Inc., Morgan Stanley, Charles Schwab Corp. or Wachovia Corp. If you've been keeping cash in a trading account valued at less than $1 million, your balance was moved out of money-market funds and into lower-rate accounts years ago.
True, those low-rate deposits are better than nothing, which is what balances in trading accounts earned before Merrill Lynch came up with the idea of automatic sweeps decades ago.
The idea at first was to give clients a high return on their dollar.
Now, the sweeps give the broker-banks a high return on their clients' dollar.
Led by Merrill in 2000, the firms began telling clients their money would no longer sweep into money-market funds but would instead go into deposit accounts in the brokerages' affiliated banks. The banks could lend out the money or invest it, which was impossible when it was in money-market funds.
Hefty Accounts
Clients with heftier accounts get more options and higher interest rates. This is called tiering, and it leaves the smaller investor with few options and a lousy interest rate.
To the banks, the switch has been a windfall. Merrill, Citigroup, Morgan Stanley, Charles Schwab and Wachovia, which are being sued by shareholders for the practice, last year took in a combined $186 billion in deposits swept from broker customers, according to their clients' lawsuit.
So why would investors go along? Maybe it's because the brokerage houses make the deal sound so fabulous.
``Keep your money working with an automatic sweep,'' urges Merrill in an online pitch.
``Make your money work harder,'' suggests Morgan Stanley. ``Your excess funds are never idle.''
Right. They are working hard for Morgan Stanley.
And yet, the firms pitch the notion that their brokers are so focused on their clients' interests that they don't call themselves mere brokers anymore. They are financial advisers, and the client's needs rank above all else.
Defending the Accounts
This week Merrill, Citigroup, Morgan, Schwab and Wachovia defended their sweep accounts in court, saying the lawsuit has no merit and asking the judge to toss it out. Merrill is a passive minority investor in Bloomberg LP, the parent of Bloomberg News.
In their court filings, the firms say they have no obligation to pay the highest possible return on idle funds, nor did they ever promise to.
``Broker-dealers are not -- and never have been -- required to sweep idle cash from brokerage accounts or pay any interest at all on cash balances,'' the accused firms say in a joint court filing.
They say they fully informed their clients as to the changes in the sweep accounts.
``Effective June 6, 2001,'' reads one such disclosure, ``the Merrill Lynch Banks will set interest rates based on economic and business conditions,'' and no longer link them to money-market fund rates.
`Financially Beneficial'
It also says the changes ``will be financially beneficial'' to Merrill and its bank.
Merrill doesn't actually say, ``We will make billions at your expense.'' The plaintiffs say it ought to.
``For them to not disclose the enormous windfall, or give any kind of quantification, really doesn't give the client any sense of the disparity between what they're getting as a client as opposed to what the financial adviser is getting,'' says Joel Laitman, a lawyer for the plaintiffs with the firm Schoengold Sporn Laitman & Lometti in New York.
True, the basics are disclosed. And any halfway astute investor would notice the drop in interest rates listed on the monthly statements.
Nothing stops the investor from putting idle funds elsewhere, the banks point out. If you want a money-market rate of return, fine. Go out and plunk your funds into a money-market account.
Getting Swept Up
But unless that fund is linked to your investment account, your money won't be handy when you want to trade. And if you use the money-market fund at your brokerage's bank, your balances won't be automatically swept into the fund regularly, unless you're a high-tier client.
``We use plain language to give our clients clear and full disclosures about our cash sweep program,'' Merrill says in a statement about the lawsuit.
That's one of many lines of defense for the firms. They offer a long list of procedural errors in the suit that should kill it, they say. Plus, there's no claim of false statements, intent to defraud or even a properly articulated breach of fidiciary duty claim.
The banks get help from a 1998 court decision.
``The practice of a financial institution using money deposited with it to obtain earnings is neither unknown nor unexpected, much less nefarious,'' the Second U.S. Circuit Court of Appeals in New York ruled.
Regardless of the outcome, perhaps this case could at least persuade the brokerage houses to skip the claims that their first priority is their client's wealth, and replace it with reminders that their first job is to make money for themselves.
As for a disclosure about the benefits of its cash sweep program, how about this one: ``For us, it's fabulous. For you, it's better than nothing.''
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