SEC scolds Schwab over robo disclosures

A trio of subsidiaries of retail brokerage firm Charles Schwab have settled allegations that they misled robo-advisor clients about the economics of their portfolios.

The U.S. Securities and Exchange Commission (SEC) charged three Schwab subsidiaries for promising they’d seek “optimal returns” for investors on the cash in their robo portfolios when, in fact, they were allocating client funds in a way that, under most market conditions, would make less money for clients for the same risk.

The SEC alleged that Schwab made money from the cash allocations in its robo portfolios by sweeping clients’ cash to its affiliate bank and profiting on the lending spread.

“Schwab advertised the robo-adviser as having neither advisory nor hidden fees, but didn’t tell clients about this cash drag on their investment,” the regulator said.

Without admitting or denying the SEC’s findings, the firms — Charles Schwab & Co. Inc., Charles Schwab Investment Advisory Inc. and Schwab Wealth Investment Advisory Inc. — agreed to pay approximately US$52 million in disgorgement and prejudgment interest, and a US$135-million penalty.

They also agreed to a censure and to retain an independent consultant to review their policies and procedures relating to their robo-advisory disclosures, advertising and marketing.

“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,” said Gurbir Grewal, director of the SEC’s enforcement division, in a release.

“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,” he said.

Commenting on the settlement, Charles Schwab Corp. issued a statement saying it was “pleased to put this behind us” and noting that it resolved the issue “years ago.”

“We are proud to have built a product that allows investors to elect not to pay an advisory fee in return for allowing us to hold a portion of the proceeds in cash, and we do not hide the fact that our firm generates revenue for the services we provide. We believe that cash is a key component of any sound investment strategy through different market cycles,” the statement said.

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.