The Securities and Exchange Commission (SEC) charged three Charles Schwab investment adviser subsidiaries for allocating client funds in a manner that their own internal analyses showed would be less profitable for their clients under most market conditions. Schwab has agreed to pay $187 million to impacted clients to settle the charges.
Schwab has paid the penalties without admitting or denying the SEC’s findings, agreeing to a cease-and-desist order prohibiting them from violating the antifraud provisions of the Investment Advisers Act of 1940, censuring them, and requiring them to pay approximately $52 million in disgorgement and prejudgment interest, and a $135 million civil penalty.
The SEC said the Schwab subsidiaries also agreed to retain an independent consultant to review their policies and procedures relating to their Robo-adviser’s disclosures, advertising, and marketing, and to ensure that they are following those policies and procedures.
According to the SEC, from March 2015 through November 2018, Schwab’s mandated disclosures for its Robo-adviser product, Schwab Intelligent Portfolios, stated that the amount of cash in the Robo-adviser portfolios was determined through a “disciplined portfolio construction methodology.” The SEC’s complaint says Schwab claimed the Robo-adviser would seek “optimal return[s].” In reality, Schwab’s own data showed that under most market conditions, the cash in the portfolios would cause clients to make less money even while taking on the same amount of risk. The SEC added that Schwab advertised the Robo-adviser as having neither advisory nor hidden fees, but didn’t disclose to clients how their money was impacted.
Schwab allegedly made money from the cash allocations in the Robo-adviser portfolios by sweeping the cash to its affiliate bank, loaning it out, and then keeping the difference between the interest it earned on the loans and what it paid in interest to the robot-adviser clients.
Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, commented on the SEC action:
“Schwab claimed that the amount of cash in its Robo-adviser portfolios was decided by sophisticated economic algorithms meant to optimize its clients’ returns when in reality it was decided by how much money the company wanted to make. Schwab’s conduct was egregious and today’s action sends a clear message to advisers that they need to be transparent with clients about hidden fees and how such fees affect clients’ returns.”
