Custody and custodians:  Where is your money?

As the ‘wealth management’ industry moves from the old ‘stock broker’ model to the fee-based Registered Investment Advisor structure, one question seems to be a little less straight-forward:  “Where is my money held?”

In the ‘good old days’, the answer was pretty simple:  “My broker works for E.F. Hutton” implies: “My money is at E.F. Hutton.”[1] Ditto for Merrill Lynch, Drexel Burnham, Goldman Sachs… all the big names of their day.

One big movement that took place in the 80s and 90s was that insurance companies started to play a bigger role in managing the wealth of their clients.   While they had fairly substantial ability to hold and manage assets, most insurance companies outsourced the trading and custody of investment assets to some of these larger investment firms.  For a fee, these firms would execute trades, collect commissions and fees and pass them along to the ‘broker dealer’ firm created by the insurance company or any of a number of other groups, big and small.

Another trend that gained a lot of traction in the 90’s and ‘00s was the emergence of a type of wealth manager who did NOT buy and sell stocks, bonds, and mutual funds, and did not, as a result, get paid commissions on these products.  Rather, the ‘Registered Investment Advisor’ would charge for advice on and oversight of investments, acting in the capacity of a fiduciary for the investor.

Some of the brokerage houses took note of the fact that many of their investors actually weren’t managing their own assets, but were rather assigning a Registered Investment Advisor, using a limited power of attorney, to conduct the management of their assets.  Seeing an opportunity to attract advisor-managed funds, some of the brokerage houses took steps to improve the access these advisors have to their investment platforms, and developed tools to help advisors in managing client assets on their systems.

Fast-forwarding to today, Registered Investment Advisors manage over $82.5 Trillion dollars of client assets.  By far, it’s the fastest growing segment of the asset management marketplace, with ‘Wirehouses’, banks, and insurance companies falling far behind in growth.


One decision an RIA firm needs to make is whether or not they will take custody of client assets.  Not surprisingly, a very significant number of these firms opt NOT to take custody.  The reason for this is pretty simple:  It is very onerous to maintain the supervisory procedures, higher insurance costs, and overall administrative burden to actually hold onto client assets.  Madoff Investments was a custodial RIA.  Enough said.

As big RIA-friendly custodians like Schwab, TD Ameritrade Institutional and Fidelity have come onto the scene, the need for an Investment Advisor to hold assets is more the exception than the rule.

Big RIA custodians provide invaluable services to Registered Investment Advisors, including facilitating trades and providing investment banking and research services, but perhaps the most significant factor in what drives an RIA to work with one custodian over another comes down to technology.

Since trading has become somewhat commoditized, with all three big custodians (TD, Schwab and Fidelity) all dropping commissions on stock trades to zero, the big questions for RIAs are:  How will this custodian interface with my accounting and reporting platforms?  How easily can the data be integrated with my Financial Planning and investment modeling software?  How effectively can investment models be applied over a varied range of investors?  Should the investor wish to interface directly with the custodian, how user-friendly are the custodians’ platforms and client-facing apps?

In other words, from an advisor’s point of view, a custodian is primarily a technology company.

Beyond technological considerations, questions about how well-insured these firms are against liability because of any mishandling of client accounts or financial insolvency is a central issue.  Pretty much all big custodial firms are members of the Securities Investors Protection Corporation (SIPC), which provides $500,000 of coverage for investors ($250,000 for cash).  Most of these firms purchase investor protection far above this level.

Given the importance of these institutions, and the trillions of dollars in assets and millions of clients who use these firms to custody assets with, it’s really big news to us that Charles Schwab is reportedly in talks, as of this morning, to purchase TD Ameritrade Institutional (the custodian we use primarily).   TD was impacted significantly by the move to zero commissions, with about 36% of their revenue coming from trading commissions.  Schwab, on the other hand, only makes 7% of their revenue on trading commissions.  For both companies, securities lending, cash float (aka banking), and, in the case of Schwab, proprietary investment products, make up the majority of their income.

Given the amount of gravity we attribute to the selection of a custodian for our client assets, you can be assured we’ll be watching this development VERY CLOSELY!

[1] For those who are old enough to remember, it also means that everyone around you will lean in to intently hear the nuggets of wisdom your EF Hutton broker has imparted.