Amid AI threat, LPL reviews reliance on 'cash sweeps'

While some brokerages seem unconcerned that AI could eat into their hefty profits from managing client cash, LPL Financial is forging ahead with a full-scale review of its pricing options.

In an earnings call in April, CEO Rich Steinmeier responded to an analyst's question about possible business risks caused by artificial intelligence by saying LPL is considering reducing its reliance on income made from clients' uninvested cash. Steinmeier said he doesn't view the perceived threat from AI as anything new, noting that "we've heard variations of this question over time."

At the same time, he said, "You should know we're doing the work to properly assess the opportunities and risks of reducing our reliance on cash sweep economics over time."

Cash sweeps generally refers to firms' practice of taking uninvested cash sitting in brokerage accounts and moving it over to banks to be lent out. Broker-dealers like LPL typically offer clients a far lower return on that cash than they make from lending it and pocket the difference.

Visualization created with AI assistance based on original reporting.

The practice can be lucrative. In the second quarter, LPL made $443.5 million on its holdings of $57 billion in client cash.

READ MORE: SEC to RIAs: You also have to worry about cash sweeps

AI and other risks to cash sweeps revenue

Analysts have warned that AI threatens that revenue because digital agents might one day manage client assets and automatically ensure uninvested cash is producing the highest possible returns. Sweeps accounts are often touted as temporary holding places for investors to park their cash before finding better ways to invest it. But some clients leave substantial parts of their portfolios in cash for the long term.

Executives at many of LPL's industry rivals have generally pooh-poohed the notion that AI could undermine their own substantial cash-sweeps profits. Speaking at a conference for institutional investors in March, Schwab CEO Rick Wurster noted that firms like Max (formerly MaxMyInterest) have for more than a decade offered automated systems to make the most of uninvested cash. Raymond James CEO Paul Shoukry has similarly said he views AI's potential ability to help clients make better use of cash as only an "incremental threat."

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Schwab made nearly $3.4 billion in net interest revenue in its latest quarter, much of it on nearly $485.7 billion held in sweeps accounts. Raymond James, meanwhile, reported making $656 million in its latest quarter on nearly $42.2 billion swept over to its own banking division, as well as various outside banks. 

AI isn't the only source of liability for the practice. Recent lawsuits have taken LPL, Raymond James, Raymond James and many of their rivals to task for failing to make sure clients receive a "fair share" of the money made from cash sweeps. Shoukry noted in Raymond James' latest earnings call that the firm's spending on professional fees was up by $27 million mainly because of legal costs in the cash-sweeps lawsuits.

READ MORE: Cash sweeps: Checking the fine print on a conflict of interest 

Arguments for platform, custodian fees

So far, LPL is the only firm to publicly state it is looking into reducing its reliance on client cash. Without specifying if his firm is responding to AI, litigation or something else, Steinmeier reconfirmed in LPL's latest earnings call that he and fellow executives are reviewing the firm's pricing options.

LPL's size is a barrier to moving quickly. The largest independent broker-dealer by almost any measure, LPL has to make sure any changes it adopts are suited to its more-than 32,000 advisors, 1,000 institutional clients and 8 million end investors.

"The levers are very clear to us," Steinmeier said. "But as we go through the work, we have to make sure that it works for those constituents."

LPL Financial

Analysts have proposed firms respond to the perceived threat from AI by adopting platform or custody fees for safeguarding client assets and providing other services.  Devin Ryan of the investment bank Citizens JMP wrote in a research note following LPL's second-quarter earnings report that "a thoughtful shift toward platform-based economics could broaden the revenue model and reduce sensitivity to client cash balances and interest rates." 

"Importantly, we believe LPL's scale and market position give it considerable flexibility to shape the evolution of industry economics, rather than simply react to external pressure," he added.

Industry experts like XY Planning Network founder Michael Kitces have long called for the widespread adoption of custodial fees. Advisors often struggle with their fiduciary duty to do what's best for their clients when confronted with the labyrinthine array of custody and support fees charged by broker-dealers.

Among the more obscure sources of revenue, according to the Kitces.com blog by Adam Van Deusen and Kitces, is money made from cash sweeps. Advisors who are keenly aware of their fiduciary duty are having to spend a good deal of time "on activities like moving client cash to higher-yielding money market funds and incurring their own time costs to avoid RIA custodians undermining the RIA's fiduciary fulfillment," they wrote.

READ MORE: What do RIAs pay for Schwab as custodian? It all depends 

New fees, perhaps needed for transparency, are far from adoption

Tim Welsh, the president and founder of the wealth management consultant Nexus Strategy, agreed there's a need for greater simplicity in what investors and RIAs pay for brokerage services.

"Just tell me: How much does it cost?" he said. "We understand it's not free. It costs money. But don't take a huge rate on our cash on the back end to pay for it. Just be transparent."

Even while contemplating larger changes, LPL has started making tweaks to how it makes money from client cash. In the firm's latest earnings call, Chief Financial Officer Matthew Audette announced LPL plans to modify its practice of paying a yield on client's total asset holdings in sweeps accounts the firm calls insured cash accounts. With the goal of lowering expenses, LPL will instead follow the example of many other brokerages and just pay on cash holdings. 

Audette said LPL clients keep around $5,000 in cash on average.

"When you look at the price tiering — to perhaps state the obvious — you pay less on smaller balances and more on the larger balances," he said. 

Meanwhile, any bigger changes await the completion of LPL's pricing review.

"We're doing the work, which we know is extremely important," Steinmeier said in the firm's first-quarter earnings call. "However, I would note, it's going to take some time as we work closely with our clients to ensure any potential changes would work for them."