SEC fines Charles Schwab $135 million for “egregious” conduct in robo-advisery

Rick Steves

“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.”

The Securities and Exchange Commission charged three Charles Schwab investment adviser subsidiaries for misleading customers and agreed to pay $187 million to harmed clients to settle the charges.

According to the SEC, the firms did not disclose that they were allocating client funds in a manner that their own internal analyses showed would be less profitable for their clients under most market conditions.

Schwab’s investment adviser subsidiaries, Charles Schwab & Co., Inc., Charles Schwab Investment Advisory, Inc., and Schwab Wealth Investment Advisory, Inc., agreed to pay approximately $52 million in disgorgement and prejudgment interest, and a $135 million civil penalty.

Schwab made money from the cash allocations in the robo-adviser portfolios

Allegedly from March 2015 through November 2018, their 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,” and that the robo-adviser would seek “optimal return[s].”

However, 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, said the SEC.

The robo-adviser advertised it had neither advisory nor hidden fees, but didn’t tell clients about this cash drag on their investment, and 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.

“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”, said Gurbir S. Grewal, Director of the SEC’s Division of Enforcement.

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