How advisors can avoid their own SVB collapse

If you’re not paying close attention to ensure that your clients’ cash is safe, you’re ignoring your fiduciary duty.

Most of us are still stunned by the way Silicon Valley Bank became insolvent seemingly overnight.

I’ve been thinking about what it would take for an advisor to experience a similar event. Three key areas came to mind.

First, there are customer “sweep accounts.” Depending on where an advisor custodies client assets, excess cash is held in either a money market fund or a bank account. If the cash is in a money market fund, the funds are only as safe as that fund is.

Prior to the financial crisis, many independent broker-dealers had agreements with the Reserve Funds, as that firm was willing to share a large chunk of its management fees with the broker-dealers. As the crisis hit, the Reserve Funds were on the verge of “breaking the buck” and all withdrawals were frozen to prevent a run.

Many people who had systematic withdrawals set up on their accounts stopped receiving them. This included much relied upon monthly IRA distributions. Some of the larger broker-dealers stepped up with their own balance sheets to maintain those withdrawals, but for thousands of clients, funds were held up for months, and this created the same personal financial havoc that startups are feeling with the collapse of SVB.

For those custodians and B-Ds that use a bank account instead of a money market fund, the accounts are typically insured up to $250,000 per depositor. Balances above this amount are only as good as the financial health of the underlying bank.

Some custodians’ bank sweep accounts operate an exchange with other banks that effectively deposits uninsured balances into other banks, thus providing FDIC coverage for all deposits up to certain limits, such as $25 million.

Up until this past week, few advisors worried about the soundness of their custodians or B-D sweep accounts. But if you’re not paying close attention to ensure that your clients’ cash is safe, you’re ignoring your fiduciary duty.

One way financial advisors could have an SVB-type collapse is with brokered certificates of deposit. My assumption is that no advisor would be foolish enough to purchase CDs above their insured limits. The bigger risk lies in not having the proper controls in place and purchasing multiple CDs from the same bank.

I witnessed an advisor who did just this with CDs from IndyMac bank prior to its collapse.

Another way an advisor could end up in hot water would be due to an esoteric circumstance. Let’s say that in a quest to help a client achieve greater investment performance, an advisor allocates clients’ money into investment products that are restrictive and contain unique risks. This does happen, and should one of these blow up, an advisor could find their practice has its own “run” as a mass of clients move their relationship.

While there’s nothing financial advisors can do to reverse the fate of SVB, there are precautions that we can take. For the benefit of your clients and your firm, this would be a good time to review the safeguards you have in place.

Scott Hanson is co-founder of Allworth Financial, formerly Hanson McClain Advisors, a fee-based RIA with about $14 billion in AUM.