Another potential hurdle for the plaintiff attorneys is the fact that they filed the lawsuit under common law, not securities law. “What’s unique about this case is that it is rare for investment advisory businesses to be sued like this, in large part because federal securities laws preclude private rights of action, so this case is being brought under common law,” Lundy explained.
“There is not much precedent for this type of action,” he said. “The only actions the SEC has brought to date was one case in August 2020 and several since. But I don’t think there is any other litigated claim. Clearly these attorneys believe in their claim and filed a case.”
What is certain is that this won’t be the last time the industry hears from regulators and litigators about cash sweeps—“a relatively new revenue stream for the industry,” Lundy said.
“Robo-advice is a new business, and firms are trying to figure out appropriate forms of revenues. In most of the work I do with firms, errors are inadvertent. If they had to do it over again, they would likely make changes.”
In this case, the lack of disclosure about the cash sweeps may be what Schwab regrets. “It’s very clear in this complaint that the plaintiff attorneys cite back to disclosure,” Lundy added. It’s also clear that the new SEC chairman, Gary Gensler, will pursue enforcement in this area, as Jay Clayton did before him.
“I think what we will do is create more specificity in disclosures for robots and all RIAs with regard to cash sweeps, because regulatory interest in the area will only accelerate,” Lundy said.
Adam Gana, a New York City-based securities arbitration attorney and professor at New York Law School, agrees. “All of this underscores the fact that we are currently ripe for legal and regulatory action on robo-advisors, which attract investors based on perceived low costs,” Gana said.
The importance of these types of lawsuits “is they set the contour of how courts will interpret best interest going forward. The court will have to opine on whether Schwab met their fiduciary standard and that will set the best interest legal standard for future arbitrations as well. That’s a good thing,” Gana added.
One independent advisory firm that uses Schwab for trades agrees with that assessment.
“What the heck took them so long? Everyone knew this was an issue and I'm glad it will now be rectified,” said Charles Sachs, chief investment officer of Kaufman Rossin in Miami.
“Younger investors are attracted to robo-advisors,” Sachs said, “and unless they tell you different, there is no legitimate reason to park investors in that much cash. You’re locking in 2% to 3% annual losses due to inflation. Investors are on the losing end of this practice.”