There is a common and understandable misconception that clearing firms and custodians are one in the same.  In reality, clearing firms and custodians are distinctly different entities with unique roles.  Here’s an in-depth look at the differences between clearing firms and custodians.

What are Clearing Firms?

Clearing firms, also referred to as clearing brokers, are members of exchanges that serve as a bridge between broker dealers and investors.  The role of a clearing broker is to guarantee trades are properly settled and transactions prove successful.  Furthermore, clearing brokers are tasked with maintaining the paperwork associated with the clearance and execution of transactions.

How Clearing Firms Work

Clearing firms are essentially the security markets’ supportive pillar.  A broker dealer works in tandem with a clearing firm to ensure the trades are executed and transferred exactly as they should be.

Part of the difference between clearing firms and other broker-dealers is the fact that broker dealers lack the authority necessary to clear transactions.  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.

What Are Custodians?

Custodians, also referred to as custody providers, are financial institutions that retain the securities of clients. They provide protection against threats and the potential for funds to be lost.  Custodians hold stocks as well as additional assets within both physical and electronic form on behalf of clients.

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. In other words, custodians serve as a metaphorical lockbox that only authorized individuals or institutions can access with the express consent of a client.

Custodians are not individuals or small businesses.  Rather, custodians are institutions that proactively secure valuable assets and securities worth hundreds of thousands, millions, or even billions of dollars.  As a result, custodians are almost always sizable firms with a proven reputation for unparalleled security.  Some of the industry’s largest custodians include Charles Schwab, Fidelity’s Institutional Wealth, and Bank of New York Mellon (Pershing).

The Role of Custodians vs Clearing Firms

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.

Evaluating a clearing firm or custodian is more than just comparing the categories; it is also about comparing firms within a firm.  For example, Fidelity and Pershing can both act as either a clearing firm to broker dealers or a custodian to RIAs.  Even within the same parent firm, the services and the pricing may be different.  You will want to ask questions related to technology integrations, client account fees, or even the cost of trading. To add to the complexity of the decision, the RIA or broker dealer you are evaluating may neutralize any pricing differences between a clearing firm and custodian negating or even inverting the differences.

When considering changing firms, you should evaluate the Feel, Fit and Financials® and your service provider, which isn’t just the broker dealer or RIA, but can also include the clearing firm or the custodian. The challenge comes when comparing many different choices and prioritizing them. While a custodian or clearing firm may seem like a small part of the overall process, it is one area that can have some of the greatest impact on clients. A clearing firm or custodian’s name is on the statement the clients will be receiving, so make sure this decision is thoroughly evaluated.

Contact Bridgemark Strategies

Bridgemark Strategies is a recruiting, consulting, and M&A firm.  We help advisors assess, evaluate and negotiate their search for a broker dealer, RIA, or strategic partner.  Our experience and success is unparalleled in the industry in helping advisors find their next firm. Reach out to us today at (866)266-8823 or on the web through our contact form for a confidential discussion and more information about our services.