Morgan Stanley faces Reg BI lawsuit over interest in cash sweep accounts

The firm fell short of its fiduciary duty by paying customers dismal rates compared to what’s available in the market, according to class action.

Morgan Stanley is facing a class-action lawsuit alleging that it breached its fiduciary duty by offering unreasonably low interest rates on client cash sweep accounts.

The suit was filed by the estate of the late Dr. Bernard J. Sherlip, a Connecticut physician who passed away in March 2023, held multiple accounts with Morgan Stanley from November 2012 to August 2022.

The suit also names Morgan Stanley retail customers with cash deposits or balances in the firm’s bank deposit program, individual retirement accounts, Roth IRAs, or SIMPLE IRAs as co-plaintiffs.

The lawsuit, filed in the US District Court for the Southern District of New York, contends that the firm’s cash sweep program pays interest rates as low as 0.01 percent on uninvested cash, far below market rates. Under the program, client cash balances below $500,000 earn just 0.01 percent annually, whereas higher balances yield a maximum of 0.5 percent.

In comparison, other financial firms, such as Vanguard, Interactive Brokers, and Wealthfront, have been advertising significantly higher rates to attract customers. Vanguard’s Cash Plus Account currently offers 4.6 percent and provides FDIC coverage up to $1.25 million for individual accounts and $2.5 million for joint accounts.

“Morgan Stanley breaches its fiduciary duties and its contracts with its customers and violates Reg BI by failing to make adequate disclosures to its customers,” the lawsuit argues.

The disparity in interest rates has been a focal point of the lawsuit, emphasizing how much more customers could potentially earn elsewhere. Citing Reg BI, which requires broker-dealers to act in their customers’ best interests, the lawsuit contended that the firm should offer higher interest rates in its default sweep program.

The complaint highlights that rising interest rates have benefitted Morgan Stanley significantly. In 2023 alone, the firm generated over $8 billion in net interest income from the spread between the low rates offered on sweep accounts and the higher rates earned by the bank from lending out the deposited funds.

“While that growth was, and continues to be, extremely lucrative for Morgan Stanley and its affiliates, Morgan Stanley’s scheme was and continues to be extremely detrimental to its customers,” the lawsuit asserted.

The Sherlip estate’s lawsuit, which also names Morgan Stanley & Co. and Morgan Stanley Smith Barney as defendants, claims that Morgan Stanley engaged in breach of contract, breach of fiduciary duty, and unjust enrichment. The plaintiffs are seeking a jury trial.

Morgan Stanley has declined to comment on the lawsuit.

In an era of elevated interest rates, the way to handle cash sweep account options has been an area of increasing concern for broker-dealers in the past few years.

Late last year, Wells Fargo revealed it was the subject of an “advisory account cash sweep investigation” by the SEC. Before that in 2022, the SEC announced an emphatic $187 million settlement with Charles Schwab, which it said failed to disclose how its robo-advisor used large cash holdings in client portfolios from 2015 to 2018.