The Securities and Exchange Commission (SEC) has charged three Charles Schwab subsidiaries for not disclosing that they allocated client funds in a way that was less profitable for clients under most market conditions.
The subsidiaries have agreed to pay $187m (£155m, €179m) to the clients involved to settle the charges.
According to the US regulator, from March 2015 to November 2018, Schwab’s mandated disclosures for its robo-adviser product, Schwab Intelligent Portfolios, stated that the sum of cash in the robo-adviser portfolios was determined through a “disciplined portfolio construction methodology,” and that the robo-adviser would seek “optimal return[s]”.
But the SEC said that “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”.
Schwab advertised the robo-adviser as having neither advisory nor hidden fees “but didn’t tell clients about the cash drag on their investment”, according to the SEC.
The watchdog added: “Schwab 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 robo-adviser clients.”
Settlement
Without admitting or denying the SEC’s findings, Schwab’s investment adviser subsidiaries, Charles Schwab & Co, Charles Schwab Investment Advisory and Schwab Wealth Investment Advisory agreed to a cease-and-desist order.
They are required to pay approximately $52m in disgorgement and prejudgment interest and a $135m civil penalty.
The 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 effectively following those policies and procedures.
Gurbir Grewal, director of the SEC’s division of enforcement, said: “Schwab claimed that the amount of cash in its robo-adviser portfolios was decided by sophisticated economic algorithms meant to optimise 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.”
Response
Charles Schwab said in a statement: “Schwab has resolved a matter with the SEC regarding certain historic disclosures and advertising related to Schwab Intelligent Portfolios between 2015-2018, and we are pleased to put this behind us. The SEC order acknowledges that Schwab addressed these matters years ago.
“In entering the settlement, Schwab neither admits nor denies the allegations in the SEC’s order. We believe resolving the matter in this way is in the best interests of our clients, company, and stockholders as it allows us to remain focused on helping our clients invest for the future.
“As always, we are committed to earning our clients’ trust every day and work diligently to maintain the highest standards for professional conduct throughout our organisation.”
