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Schwab executive says rivals will follow its lead on alternatives

Date: Monday, May 4, 2009
Author: Jed Horowitz, Investment News.com

The head of sales at The Charles Schwab Corp.'s adviser services unit expects its competitors to adopt the same restrictions it is putting on the custody of alternative assets, and urged clients to “interrogate” the companies on their “end-game solutions.”

Bernie Clark, a Schwab senior vice president, made the remarks during an April 23 webcast in which he and other officials defended the company's controversial decision to stop holding hedge funds and other alternative assets, according to several people who monitored the webcast.

Jim McCool, Schwab's executive vice president in charge of institutional services for RIAs and corporate-retirement-plan providers, acknowledged on the webcast that advisers found the San Francisco-based firm's initial communications surrounding its February decision “lacking in detail and support.” He also acknowledged the firm's shortcomings in explaining a viable transition process to other custodians.

The two executives outlined Schwab's still-developing plans for helping advisers remove the assets from its platform without interrupting service to end clients, a process the company ex-pects to complete by early next year.

The issue is of major importance to advisers because many in recent years have turned to hedge funds, promissory notes, real estate investment trusts and various partnership structures as alternatives to conventional stocks, bonds, mutual funds and exchange traded funds. Some of them manage the products directly. Schwab is the biggest custodian of assets for registered investment advisers,

Mr. McCool acknowledged the significance of the issue by saying some that 900 people had registered for the webcast, and about 36% of RIAs who use Schwab as a custodian are involved in alternatives. Together, they keep about 47,000 positions in 12,000 unique alternative securities worth about $5 billion on the company's platform, up from almost nothing six years ago.

That rampant growth has be-come a problem because the Securities and Exchange Commission and Congress are stepping up scrutiny of broker-dealers such as Schwab in the wake of the Bernard Madoff scandal to ensure that the custodians can verify that the assets exist, are accessible and can be valued.

Assets kept with banks and trust companies aren't subject to such possession-and-control requirements, which is why Schwab has requested proposals from about 10 such firms on how they would operate to assure that service levels remained high and that end clients could see the holdings on Schwab-produced statements. Schwab hopes to make a decision on choosing a new custodian in June, according to those who listened to the webcast.

Mr. Clark and Mr. McCool, trying to defend a decision that triggered threats from some advisers to move all their assets to rival custodians, said that Schwab made the hard and long-considered choice on alternative assets because it is a leader and would be irresponsible if it continued to rubber-stamp acceptance of any asset.

At that point in the webcast, Mr. Clark said that he expects competitors such as Fidelity Investments, TD Ameritrade Holding Corp. and the Pershing Advisor Solutions LLC unit of Bank of New York Mellon Corp. to make similar moves. Although competitors may be talking about accommodation, he urged advisers to “interrogate” the firms on their plans.

Fidelity has no plans to change its alternatives custody policy, said Stephen Austin, a company spokes-man. “We plan to continue to custody alternative assets for our advisers,” he wrote in an e-mail.

TD Ameritrade of Omaha, Neb., said that it isn't planning to change its acceptance policy on alternative investments, which are handled on a case-by-case basis.

“We welcome any questions advisers might have regarding our policy on alternative investments,” J. Thomas Bradley Jr., president of the firm's institutional businesses, wrote in an e-mail. Less than 3% of the firm's total adviser assets are invested in alternatives, a spokeswoman said.

“Pershing already processes selected alternative investments where it can meet the appropriate operational controls and requirements,” Michael Geller, a spokesman for Jersey City, N.J.-based Pershing, wrote in an e-mail. “We continue to actively explore opportunities to expand our capabilities and solutions in a controlled manner that will serve the best interests of our customers and their investors.”

Some advisers said that a transfer from Schwab's brokerage platform would be operationally easier if it simply moved the assets to its own bank, an option that Mr. McCool said is being considered. But the firm appears reluctant to keep the assets in-house, advisers said.

Mr. Clark indicated that the value of alternative assets now in custody at Schwab gives the firm leverage as it negotiates with a new custodian on behalf of advisers.

But he warned that the cost to advisers is almost certain to rise because Schwab has been holding the assets as an “accommodation,” charging about $100 annually per account, according to advisers.

Alison Wertheim, Schwab's spokes-woman, declined to discuss whether the firm will share in any fees charged by a new custodian. She said that clients who need in-formation on transitional procedures or final plans for transferring assets can get them by calling their relationship manager.

Schwab no longer is accepting additions to offshore alternative investments, but will allow advisers to supplement domestic-securities positions already in place from existing or new clients.

As of May 1, however, the firm imposed new acceptance rules requiring advisers to submit substantially more documentation from issuers of alternative assets and, in some cases, from their own clients.

The review process, it said during the webcast, will take a minimum of three to four weeks, meaning that advisers must give Schwab as much advance notice as possible if they know they have to meet capital calls from general partners of a fund.

“The acceptance process seems fairly onerous on the surface, but it's probably something they should have had all along,” said R. Jeffrey Young, chief operating officer of WealthStone Inc., a Columbus, Ohio, adviser with about one-fourth of its $275 million of assets under management in alternatives.

E-mail Jed Horowitz at jhorowitz@investmentnews.com.