Schwab ends custody of alternative investments

The Charles Schwab Corp., concerned about liability related to hedge funds, is telling registered investment advisers that it will no longer accept custody of alternative assets.
In calls to selected RIAs and in a notice on its Schwab Advisor Services website, the company said it has immediately stopped accepting custody of offshore funds, promissory notes and new investments requiring issuer setup.
Advisers can add positions to existing domestic alternative ac¬counts until April 30, at which time “we will no longer accept additional purchases of any form of alternative assets for custody,” said the online notice, which was signed by Trish Cox, Schwab Advisor’s chief operating officer, and by its sales head, Bernie Clark.
“Recent events and anticipated regulatory changes in the financial markets have caused us to review … our areas of custodial focus,” the notice said. “Emerging reform efforts are likely to focus on the role of custodians and the need for more transparency in this segment of the market.”
The notice did not specifically mention recent frauds related to Bernard Madoff or R. Allen Stanford, well-known financiers who wrested many billons of dollars from investors in alleged Ponzi schemes. Such frauds have led to calls for more-intense scrutiny of hedge fund advisers and their gatekeepers, such as custodians.
San Francisco-based Schwab, the largest custodian of RIA assets, said it will continue to offer a limited number of hedge funds through relationships with 16 issuers on its Alternative Investment Source and Alternative Investment Access platforms, and will facilitate transfer of alternative investments to other custodians specializing in the asset class.
Jason Lina, research director of DCA Global Investment Management in Norcross, Ga., said the decision must have been made quickly.
“We challenged them, but they were pretty vague,” said Mr. Lina, whose firm manages $200 million of client assets, about 40% of which are tax-free retirement investments in hedge funds.
“It’s not a good time to disrupt our clients,” he said.
Mr. Lina said his firm got little comfort when asked if Schwab would rescind its decision if advisers began transferring other assets to rivals. They told DCA that it’s “hard to get the genie back into the bottle once the decision has been made,” he said.
“It’s one less arrow in the quiver for Schwab, but they’re not making money holding the assets, and they probably don’t want to be held liable for securities values on their books that they can’t necessarily validate,” said Shannon Eusey, president of Beacon Pointe Advisors in Newport Beach, Calif.
“It’s not a huge issue, but we have to find an alternative or not record the performance of the assets on our systems, which won’t make clients happy.”
She and others said Schwab charges a minimal account fee of about $100 a year per account to custody hedge fund assets and show the balances on Schwab-generated statements.
Beacon Pointe, which has about $3.5 billion under management with Schwab and TD Ameritrade, has about 25 clients affected by the policy change.
Officials at Schwab’s major rivals either declined comment or said they were closely following developments.
“We are rethinking how we use alternative investments, just as advisers are, but will continue to improve our alternative-investment capabilities,” Charles Goldman, president of institutional platforms at Fidelity Investments in Boston, said through a spokesman.
Mr. Goldman was formerly head of Schwab’s institutional businesses for RIAs.
A spokesman at Pershing Advisor Solutions said the company would not comment. TD Ameritrade’s institutional arm has not made changes in its alternatives policy but is monitoring events, said Brian Stimpfl, a managing director. Both custodian firms are located in Jersey City, N.J.
Schwab’s website notice ac¬knowledged the operational bind the firm may be creating for RIAs in forcing them to develop new servicing relationships and working with end clients on transfers.
“Our intent is to develop capabilities for efficient account opening and data transmission between Schwab and these custodians,” the notice said.
“We have decided that instead of building highly specialized systems that fully respond to anticipated and emerging regulatory requirement, it is more efficient and effective to rely on third-party custodians,” it continued.
A Schwab spokeswoman said the company is referring clients to San Francisco-based Pensco Trust Co. and to Sterling Trust Co. of Waco, Texas, both of which specialize in the custody of self-directed assets held in individual retirement accounts.
“It’s increasingly clear that the environment is rapidly evolving, and regulatory changes are likely to occur, making an outsourced model that draws on specialized expertise the right way to go,” the spokeswoman wrote in an e-mail.
Schwab receives payments from the sponsors of the 31 hedge funds that will remain on its alternatives platform. Many of the funds use futures strategies or are 1940 Act registered funds that are characteristic in many ways of mutual funds open to a wide number of investors.
“It’s not that they’re bad funds, but more sophisticated advisers don’t want to be limited to them” Mr. Lina said.
Ms. Eusey said her firm will continue to use some of the funds on the platform, such as Hatteras Investment Partners’ multi-strategy funds.
The 31 hedge funds Schwab will continue to custody on its platform are of limited use to advisers since many duplicate futures funds or are registered funds similar to mutual funds. “It’s not that they’re bad funds, but more sophisticated advisers don’t want to be limited to them” Mr. Lina said.
Ms. Eusey said her firm will continue to use some of the funds on the platform, such as Hatteras Investment Partners’ multi-strategy funds.

Related Topics: Charles Schwab Institutional