Morgan Stanley Sued Over Low Interest Rates on Client Cash

Morgan Stanley violates its duties to act in clients’ best interests by paying brokerage and advisory customers unreasonably low interest rates on balances in its cash sweep program, a proposed class action lawsuit alleges.

“This case concerns a simple ruse: in violation of its fiduciary duties and contractual obligations and a regulatory mandate to act only in the ‘best interests’ of its customers, Morgan Stanley … fails to secure for its brokerage and advisory customers reasonable interest rates on its customers’ cash balances,” the lawsuit alleges.

The financial services firm’s net interest income — the spread between what it secures from customers and makes in the market — has grown exponentially during the rising-interest-rate environment since March 2022, according to the lawsuit brought in U.S. District Court for the Southern District of New York earlier this month.

While that growth has been “extremely lucrative” for Morgan Stanley and its affiliates, with net interest income surpassing $8 billion in 2023 alone, the scheme is “extremely detrimental to its customers,” who could receive higher rates elsewhere, according to the suit, filed by the estate of the late Bernard Sherlip, a Connecticut physician who died last year.

“The rates offered by Morgan Stanley through its Bank Deposit Program (BDP) — essentially Morgan Stanley’s account sweep program — are significantly lower than sweep programs at other brokerage and advisory firms,” the complaint, which seeks a jury trial, says.

The lawsuit includes a a chart alleging that Morgan Stanley’s cash sweep program pays from 0.01% to 0.50% in interest, depending on the cash balance, while Vanguard’s pays 4.7% or 2%, depending on balance, and Fidelity’s 2.69%.

“Thus, other brokerage and advisory financial institutions that use sweep programs pay or secure significantly higher rates than Morgan Stanley,” the lawsuit alleges.

The suit alleges the firm breaches its fiduciary duties, contracts with customers and the Securities and Exchange Commission’s Regulation Best Interest by failing to secure reasonable interest rates for clients.

Morgan Stanley also violates Reg BI and contractual obligations by failing to make adequate disclosures to customers, elevate its customers’ interests above its own, avoid or at least disclose its conflicts of interest, disclose other viable options that may benefit customers, and demonstrate loyalty to customers, the lawsuit alleges.

As Sherlip’s investment advisor, the company owed him the highest fiduciary duty for personal and IRA accounts, and Reg BI compliance for other accounts, the complaint says. The suit, on behalf of the proposed class, alleges breach of fiduciary duty and unjust enrichment, and for those with IRAs, breach of contract.

For customer cash balances under $500,000, Morgan Stanley secures an interest rate of 0.01%, or one basis point, while paying its brokers 0.15%, or fifteen basis points, for that same customer cash balance. “In other words, the broker makes fifteen times more than the customer on that customer’s cash balance,” the suit says.

Unlike its brokers, Morgan Stanley does not pay its investment advisors directly for customer cash balances in the Morgan Stanley sweep program, the complaint contends. Morgan Stanley and its advisors charge a management fee on the cash balances. A typical annual advisory fee is approximately 1%, or 100 basis points.

“In this scenario, the investment advisor makes 100 times the amount of interest on the customer’s cash balances. Morgan Stanley has devised a scheme in which Morgan Stanley, its affiliated banks and its advisors make significant profits on advisory customer cash balances whereas the advisory customer, to whom a fiduciary duty is owed, literally loses money on his cash balances,” the lawsuit alleges.

The plaintiffs seek damages and restitution.

Morgan Stanley declined to comment on the lawsuit, a spokesperson said by email Monday.

Photo: Bloomberg