As Charles Schwab faces a class action lawsuit filed by investors alleging the company breached its fiduciary duty with its robo-advisor’s cash sweeps, one ex-Securities and Exchange Commission attorney says the company is likely going to pull out all the legal stops to defend itself.
“I’m sure that Schwab will vigorously defend against the claims,” said James Lundy, a partner at Faegre Drinker and a former SEC attorney who worked with the Division of Enforcement and the Office of Compliance Inspections and Examinations. Lundy who works with financial advisors on enforcement matters but who is not involved in the suit, spoke with Financial Advisor about Schwab’s position.
Schwab faces a suit by three investors who say that robo-advisor Charles Schwab Investment Advisory put its own interests before those of investors by making cash sweeps to parent company Charles Schwab, causing investors to lose out on as much of $500 million in portfolio growth.
The investors in Schwab’s robo-advisor Intelligent Portfolios accounts claim the firm breached its fiduciary duty to clients by purposely allocating an “imprudent and excessive” amount of investor money into cash—as much as 30%—which cost investors stock market returns while allowing the bank to loan out the money to margin borrowers at interest rates that earned Schwab 5% to 7%. They also said Schwab advertised Intelligent Portfolios as having zero cost to investors without disclosing the firm’s cash sweep practice or the significant revenues it generated.
A Schwab spokesperson declined to comment on the lawsuit.
The class action suit plaintiffs include all Intelligent Portfolios account holders for the four years preceding September 10, 2021 (the filing date for the suit) up until the trial date. In addition to the charge of breach of fiduciary duty, the suit accuses Schwab of breach of contract, unjust enrichment, negligent misrepresentation and unfair business practices.
The case was triggered by Schwab’s disclosure in July that it had set aside $200 million to cover an SEC investigation, Lundy said. “It’s very clear in the class action complaint that they cite the disclosure” as the genesis of the case, he said.
Schwab disclosed that it had incurred a “nondeductible charge of $200 million” and noted that the firm’s actual liability may be different “depending on the outcome of the matter.”
“The SEC has not brought an action against Schwab, nor has there been a settlement yet. Whether or not that happens remains to be seen,” Lundy noted.
But if Schwab does settle with the SEC, it may take the steam out of the class action suit, he added. The plaintiff attorneys, he said, have “hurdles to overcome, such that there may not be customer damages once there is an SEC settlement and reimbursement” for any customers who may have suffered losses due to Schwab’s cash allocations.