As smaller rivals keep quiet, Axos opens up on custody fees

When it comes to RIA custody, silence is part of the structure, industry experts said. That seemed to be borne out in this latest installment of Financial Planning's series on industry custodians, which focuses on three smaller players: Hilltop Securities and Innovayte, which declined any form of interview about their fees and business models, and Axos Advisor Services, which initially declined but reversed course this week.

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That apparent reluctance, however, does not reveal "anything firm-specific," according to William Trout, director of the securities and investments practice at consulting firm Datos Insights, and Gregory O'Gara, a strategic advisor with Datos' wealth management practice. Instead, they argued in an email that it reflects custodians' general dependence on cash sweeps, which also came up in a "risk alert" issued by the Securities and Exchange Commission in June.   

"Reticence here is structural by nature: Silence is the default posture in this segment of the business. Pricing is negotiated firm by firm, and cash sweep arrangements are under regulatory scrutiny," Trout and O'Gara said. "SEC examiners flagged advisers that failed to disclose revenue they receive from 'some custodians' based on client cash balances. For example, a clearing firm or custodian sweeps uninvested client cash into money market funds or bank deposit products. It then pays the adviser, or the adviser's affiliated broker-dealer, a share of the resulting revenue based on how much cash the adviser's clients hold. Where these arrangements exist, the custodian is the paying party, and custody executives rarely discuss pricing or cash sweep revenue on the record."

The 3 firms, at a glance

Las Vegas-based Axos, Dallas-based Hilltop and Dallas-based Innovayte may not be the first firms that come to mind for registered investment advisory firm owners and financial advisors when thinking about the industry's custodians. But they each operate substantial clearing and custody businesses. 

Axos' serves hundreds of RIAs and other wealth management firms. Hilltop's publicly traded parent company reported more than 90 clients for its custody and other services. And after ending its outsourced vendor relationship with Axos to start its own custody business in 2023, Innovayte reported $3.4 billion in assets, largely in alternative investments, through predecessor firms that provided custody for self-directed individual retirement accounts. 

When Innovayte broke into the business, CEO Catherine "Cat" Davies said the firm aimed to work with RIAs that had between $100 million and $800 million in assets under management. Earlier this month, Davies' team appointed former Apex Fintech Solutions Chief Operating Officer Fritz Louis-Charles to be Innovayte's COO.

"Innovayte has built a strong foundation, and I look forward to working alongside this talented team to scale our operations, strengthen our risk and controls environment and continue delivering an exceptional experience for our clients," Louis-Charles said in a statement.

The other Dallas-based custodian, Hilltop, is part of the broker-dealer segment of Hilltop Holdings, a banking, mortgage, municipal investment, insurance and asset management company that also owns a midsize broker-dealer. In the second quarter, the unit housing Hilltop's clearing and custody business generated pretax profit of $12.4 million on net revenue of $124 million for a margin of 10%.

At the end of last year, Hilltop's custodian provided "trade execution and clearance as well as back office services such as recordkeeping, trade reporting, accounting, general back-office support, securities and margin lending, reorganization assistance and custody of securities" to "93 financial organizations, including correspondent firms, correspondent broker-dealers, registered investment advisers, discount and full-service brokerage firms and institutional firms," according to its parent firm's last annual report.

Axos' custody strategy and fees

Axos Financial, a publicly traded bank and digital wealth management firm, has expanded its custody line to a larger size than the other two firms. It bought the business — previously known as Trust Company of America and E-Trade Advisor Services — from Morgan Stanley in 2021 for $55 million. 

In the end, Axos was more willing to talk about its fees and business models than not only the silent Hilltop and Innovayte, but also two giants of the industry, Fidelity Investments and BNY Pershing, whose representatives answered questions via email but didn't agree to live interviews. 

Axos also shared its standard fee schedule. 

Mike Watson, executive vice president and head of Axos Clearing and Advisor Services, compared the schedule to the "rack rate" or the costs displayed on the back of the door in a hotel room. RIAs and other wealth management clients negotiate asset-based fees or transaction prices, with the talks beginning "with understanding what they're paying today, what's important to them," and an evaluation of how working together could benefit both parties, Watson said.

"It really depends on the firm and how they want to utilize us as a custodian," Watson said. "A lot of it has to do with what they're paying where they're at." 

He added that Axos is having "lots of conversations with prospects," particularly in the wake of Fidelity's looming move to drop RIAs with less than $100 million on its custody platform. 

Axos' figures show its custody business has grown since leaving Morgan Stanley. When the business changed hands five years ago, Axos listed $23 billion in assets under custody or administration across 200 client RIAs, advisory practices and other wealth management firms. As of the end of the second quarter this year, the firm had $47.8 billion and 300 clearing and custody clients. Compared to the second quarter of 2020, the clearing and custody firm's net revenue has soared by more than 350% to $41.4 million, according to Axos' investor presentation from August. The "secular" trends in the industry including fee compression, advisor independence, succession planning challenges and the onslaught of digital technology "provide opportunities for Axos," the presentation said.

The firm's ideal clients fit into one or more of "three buckets," according to Watson. The first revolves around firms that have "an orientation toward planning" that could go "deeper" with banking and other Axos capabilities. The second stems from firms with mass affluent to "single-digit millionaire" customers, and the third is among RIAs with less than $500 million in AUM, he said.

"That segment feels underserved and underappreciated," Watson said. "So we think we have an opportunity." 

Nevertheless, the firm also faces some of the same compliance challenges as many companies operating in wealth management. 

Earlier this year, a FINRA arbitration panel ordered Axos Clearing to pay $49.4 million in damages and attorney fees to the former clients of a defunct brokerage that used its clearing and back-office services. Axos is seeking to vacate the decision in federal court. The judge hasn't ruled yet on its motion to toss the arbitration decision or the filing by the clients seeking confirmation of the award. 

Custodians often face litigation from former clients of brokerage or other wealth management firms who say they were harmed by fraud or faulty recommendations using the clearing and custody firms' infrastructure. At Axos, the expenses from the case helped cut pretax profits in half for the last fiscal year for the segment of its business that includes the clearing and custody firm.