Three Charles Schwab subsidiaries have agreed to pay $187 million in fines to settle charges they related to inadequate disclosures to robo-advisor clients regarding advisory fees on certain cash allocations, the Securities and Exchange Commission announced today.
The SEC order, which was part of a consent agreement with Schwab, said from March 2015 through November 2018, Charles Schwab & Co., Inc., Charles Schwab Investment Advisory, Inc. and Schwab Wealth Investment Advisory, Inc. misled investors on their Form ADV filings about the cash component of their robo-advisor service, Schwab Intelligent Portfolios (SIP).
The SEC said each of SIP’s model portfolios held between 6% and 29.4% of clients’ assets in cash, which was preset so that the affiliate bank of the subsidiaries would earn at least a minimum amount of revenue from the spread on the cash by loaning out the money. Schwab did not charge investors an advisory fee for the SIP service because of the revenue spread received from the SIP cash allocations.
“But [Schwab] did not disclose that, under market conditions where other assets such as equities outperform cash, the cash allocations in the investors’ portfolios would lower clients’ returns by approximately the same amount as an advisory fee would have,” the SEC order noted.
The SEC said the Schwab entities also falsely claimed that the cash allocations were based on a “disciplined portfolio construction methodology” and that the robo-advisor would seek “optimal return[s].” But the truth is they were preset to compensate the Schwab entities for not charging an advisory fee, the SEC said.
Over the last year, the SEC has embarked on a campaign to discipline investment advisors, including several robo-advisors, for charging fees on cash balances. The SEC said Schwab's campaign implied that investing in SIP allowed investors to keep more of their money than other advisory services that charged a fee. But Schwab’s own internal models showed that clients would make less money even while taking on the same amount of risk.
“Because of the disclosure failures in Respondents’ Form ADV filings and the misleading advertisements, investors were unable to make a fully informed decision regarding whether the lack of an advisory fee benefitted them,” the SEC said.
In a statement released today, Schwab said, “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 said that in November 2018 Schwab published a revised ADV brochure that removed misleading statements and ceased publishing misleading advertisements about its fees. By then, the company had gained “significant assets from individual retail investors and profited by almost $46 million from the spread on the SIP cash allocations,” the SEC said.
“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,” the SEC said.