Your Custodian Doesn’t Owe You AnythingYour Custodian Doesn’t Owe You Anything

There has been a lot of backlash pointed at the major RIA custodians of late, primarily around two issues:

The criticism seems misplaced, however, considering our industry’s universal love for “free” custody services.  When custodians eliminated commissions for trades of stocks, ETFs and options in late 2019, it represented a big shift in our industry.  While RIAs cheered the fact that their custody costs were dropping significantly, this change also meant the custodians were eliminating the primary revenue driver for their own businesses.  Once commissions for trades were eliminated, only three other areas for custodians to earn revenue remained:

Custody did not become “free.” The industry simply transitioned the cost from direct, transparent costs—commissions that appear on a client statement—to indirect, non-transparent costs that exist in the background. The custodians still need to make money. And as someone who works at an RIA who relies on our custodians every day, I want our custodians to make money. I need them to continue to invest in cybersecurity for our clients’ assets; I want them to have enough profits to staff their service teams appropriately so our questions and service requests are addressed in a timely manner. I hope they continue offering training resources to our industry, with valuable benchmarking studies, compelling conferences and consulting resources.

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Without the infrastructure and the safety of assets provided by the major custodians, independent RIAs cannot thrive. When I hear advisors lament that they feel it is their God-given right to have access to free custodial services, I shake my head in disbelief. That is the equivalent of launching a widget-making business and expecting the universe to hand you the factory for free—where would you make your widgets if you didn’t have a factory or a warehouse to produce them? What business owner assumes they have no cost of goods sold?

Clients demand asset safety, record keeping, lending solutions, mobile deposits and banking products such as checks, debit cards and credit cards. RIAs themselves don’t offer these solutions. It’s the custodians that make that possible. How does the $500 million RIA with 13 employees compete with the publicly traded international wealth management firms like Merrill Lynch, JP Morgan and Goldman Sachs?  It simply couldn’t happen without the resources provided by the custodians. Those resources aren’t “free,” and none of us should expect them to be.

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Now, do custodians have an obligation to provide a competitive interest rate on money market vehicles? Absolutely. Many financial institutions have rightly been levied fines for paying below market rates of interest to retail clients. That is clearly wrong. But there is no obligation for the custodians to make the automatic cash sweep vehicle the highest-yielding money market fund they offer to clients.

According to Jeff Schmitt, a research analyst at William Blair, “(RIAs) can continue to shift sweep cash into money market funds to earn higher yields, although this lowers the convenience of trading as this money would have to move back into sweep accounts if it were to be used to purchase another security. This can be cumbersome for independent advisors.”  Cumbersome and inconvenient? Yes. Illegal or morally wrong? No.

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Since entering the RIA industry in 2008, I have never understood the custodial referral programs. As mentioned above, the custodians provide vital services to RIAs and their clients, but who determined that one of those services was to solve our client acquisition problem? We all left the bulge bracket firms because we felt “smaller was better.” We felt our value proposition could be delivered to clients in a more efficient manner without the limitations put on us by the large firms. We felt the value of that large brand didn’t outweigh the bureaucratic nature of those firms. Did we really start RIAs simply because we assumed the custodians would be our primary source of new clients? I don’t think so.

With each custodian’s enormous retail presence, the revenue generated by the RIA portions of their business are rather insignificant. We need them far more than they need us. The next time you speak with your custodial relationship manager, consider expressing gratitude instead of demanding more. At the end of the day, custodians don’t owe us anything.