Choosing the Right Custodian for Your Firm

Capital introduction is essentially the process of connecting hedge fund managers to potential investors in the form of the prime broker’s asset management and private banking clients. While a hedge fund traditionally holds accounts at different brokerage firms, it commonly instructs these executing brokers to clear all trades through its designated prime broker. Doing so simplifies reporting and operations for the fund since the prime broker also serves as the custodian for the hedge fund’s assets. This broker dealer vs custodian further streamlines the process of borrowing investment securities and capital since the hedge fund’s assets can quickly and easily be shifted to the prime broker as collateral.

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We employ world-class trade-date trust accounting software that provides full tax-lot accounting and reporting as well as a true segregation of principal and income cash. We have experience with accounts of all shapes and sizes, and the https://www.xcritical.com/ technology and expertise to account for client situations today and as their needs evolve. Since client assets are held in their own name with a custody account, the assets do not sit on the custodian’s balance sheet.

Broker-Dealers vs. RIAs: What’s the Difference?

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The likeliest times for custodians to experience distress are during periods of intense financial and economic turbulence. These include providing investment advice to customers, supplying liquidity through market-making activities, facilitating trading activities, publishing investment research, and raising capital for companies. Broker-dealers range in size from small independent boutiques to large subsidiaries of giant commercial and investment banks.

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Bank custodians have always performed tax lot accounting, harkening back to the days when many were founded as local trust companies. The brokerage firms have been late to the cost accounting party, only beginning to do so after successful cost basis legislation made it a requirement. Contrarily, with a custody account, the client’s assets are not on the balance sheet so if the custodian were to go bankrupt, the client’s assets are segregated from bankruptcy proceedings. This means that the account continues to be serviced and the investment manager can quickly and easily redirect any transactions to other financial institutions. Choosing a custodian for your assets in an important decision, and every portfolio has different requirements and objectives. It is important to have knowledge about the various regulations, coverage limits and operational structures of both brokerage firms and banks.

• As a result, a failure of a bank should have no adverse effect on custodial accounts since they remain the property of the account’s owner(s).
• But the fact is that many planners who work on commissions also act very ethically and put their clients’ best interests ahead of their own.
• We have been a trust company for over a century and our record demonstrates a legacy of excellence in fiscal management.
• For example, an investment adviser may work with a client to create an entire wealth management framework, including assisting them through tax, estate, and mortgage planning.
• The Net Capital Rule calculates the brokerage firm’s net worth, adjusted by items such as unrealized profits or losses, illiquid assets and tax liabilities.
• RIAs must register with the SEC if they manage more than $110 million in assets.

Investment Adviser vs. Broker: What’s the Difference?

When considering changing broker dealers or RIAs, ask if the firm you are joining is using a clearing firm or a custodian, and which company they are using. As a general rule, broker dealers will use a clearing firm while an RIA will use a custodian, but there are plenty of exceptions to this rule. It is important to know if  a custodian or clearing firm is being used, as the services, technology, and pricing can all be different and these differences can impact your decision. Custodians also hold onto financial assets at the request of investment advisors also known as RIAs, protecting the assets those advisors manage on behalf of clients.

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These entities may also provide other services such as tax support, account administration, transaction settlements, and interest payments. Citi Private Bank is a business of Citigroup Inc. (“Citigroup”), which provides its clients access to a broad array of products and services available through bank and non-bank affiliates of Citigroup. Not all products and services are provided by all affiliates or are available at all locations.

Investment custodian vs. broker/dealer (revisited)

And just like any other investment, it’s important to do your research before you put any money down. ETF issuers must consider custody when they invest in marijuana-related companies, because some banks may be unwilling to handle securities for an industry that is still illegal on a federal level. However, as the laws change, more banks are willing to accept the risks of banking the pot industry.

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Unless a non-profit has a relatively small amount of assets (i.e., under $25 million) with limited investments in commingled funds (i.e., 1-3 mutual funds), it is highly recommended that the custody bank model be utilized. The opinions expressed in this publication are as of the date issued and subject to change at any time. Nothing contained herein is intended to constitute legal, tax or accounting advice and clients should discuss any proposed arrangement or transaction with their legal or tax advisors. But because the drug is still illegal at the federal level, investors need to take a step back and rein in their excitement. Be sure to watch out for additional fees that cover things like surprise audits.

While this is not true of broker-dealer cash accounts, where the client has paid in full for all assets held, the distinction does not matter in a worst-case scenario where the broker dealer fails. Brokerage firms typically pool client assets and include them on their balance sheet. When assets are held in street name, they are often used for a variety of brokerage activities and are potentially subject to seizure by creditors in the event of the brokerage firm’s insolvency. Financial planners can offer guidance on budgeting, taxes, insurance, and retirement and estate planning. AssetMark is a leading provider of extensive wealth management and technology solutions that help financial advisors meet the ever-changing needs of their clients and businesses.

While both types of institutions satisfy the minimum requirement of being a “custodian,” there are differences in client experience and asset security. If your client base has a number of irrevocable trusts in particular, selecting a custodial provider with a strong core accounting engine capable of principal and income segregation is both necessary and required. If your firm considers itself to have a fiduciary duty to your clients, the safety and security of the bank custody model should be of paramount importance. Although very important, asset safety is only one difference between broker-dealer and bank custodians.

Similar to brokerage firms, national bank custodians must also satisfy regulatory capital requirements. Bank regulatory capital is graded against a risk-based standard and a leverage standard, measuring a bank’s financial health. The OCC analyzes a bank’s capital and assigns it a category, determining if the bank is well-capitalized, undercapitalized or adequately capitalized. In assigning a grade, the OCC considers the potential impact that events, expected or unexpected, may have on a bank’s capital or earnings.

As brokers, they handle transactions, buying and selling securities on behalf of their clients. From generational wealth preservation to asset diversification to philanthropy, PILOTAGE delivers a unique global perspective to capital allocation and risk management in a tax-efficient framework. Our team of experts come together to continuously refine our client’s experience to ensure their values are preserved. When choosing whether to work with a broker-dealer or an RIA, it is important for clients to consider what type of advice they are looking for and what type of fees they are comfortable with. RIAs have a fiduciary duty to their clients, meaning they can only recommend products that serve the client’s interests and goals. A broker-dealer has more flexibility since their products only need to meet the suitability standard.

Before the advent of online trading, accessing a broker was traditionally a luxury reserved for the rich. Individual investors had very little or no direct access to the market and had to place their orders through a licensed broker (usually by phone). However, the advent of web-based discount brokerages has changed the job of the broker.

Selecting a custodian is an important decision, and understanding these differences is a critical step in determining whether bank custody or brokerage custody is more appropriate for your portfolio. By definition, broker-dealers are buyers and sellers of securities, and they are also distributors of other investment products. As the name implies, they perform a dual role in carrying out their responsibilities. As dealers, they act on behalf of the brokerage firm, initiating transactions for the firm’s own account.

As a result, a broker dealer goes through a clearing firm and chooses one or more than one clearing firm to execute their trades. Some broker dealers will self-clear which means they are also a clearing firm and thus won’t need an independent clearing firm. The industries most recognized and largest clearing firms are Pershing and Fidelity’s National Financial Services. Investment advisers and brokers also have different training and licensing requirements. Brokers have to pass the Series 7, otherwise known as the General Securities Representative Exam; the Series 7 also acts as a precursor to further exams in the securities industry. By contrast, future investment advisers are required to pass the Series 65 exam before they can dispense financial advice for a fee.

Outsourced administration and trustee services, along with enhanced leverage enabled by offering lines of credit, are additional features offered by many prime brokerage firms. An investment adviser, by contrast, provides advice to clients on managing their investments. Another difference is that investment advisors have a fiduciary duty to act in the best interests of their clients, while brokers have to follow a “best interest” standard. While much of the focus of fiduciaries is on asset allocation, manager selection and consultant selection, don’t overlook the role of the custodian. A custodian is an institution that provides services including holding, valuing and transferring securities; receiving interest and dividends; and providing notice of corporate actions. These services are most frequently provided by large global custodian banks or through fund companies/brokers.

In both cases, it is important to understand the fee structure and track record of a financial advisor. RIAs can sell insurance products such as annuities, although there are additional regulatory hurdles in doing so. Variable annuities are considered investment securities, so the RIA would need a Series 6 exam, Series 7 exam, or state insurance license. For fixed annuities, the RIA would need a license to sell life insurance from their state. From there, they need a relationship with an insurance company or other provider such as a Brokerage General Agency. A registered investment advisor can help their clients complete their trades, or execute trades on their behalf.

In addition, there are some accounts which are only offered through brokerage. Take the example of U.S.-based ETFMG Alternative Harvest ETF (MJ), the first U.S. cannabis ETF with $241 million under management, as of February 2024. Bank—a federally chartered bank and the custodian of the original fund—ended its relationship with MJ without explanation.