The Securities and Exchange Commission (SEC) has fined three Charles Schwab investment adviser subsidiaries $187 million for allegedly allocating investors' cash holdings in a way that was less profitable under most market conditions and misleading investors about the strategies involved.
According to the SEC, between 2015 and 2018, the subsidiaries—Charles Schwab & Co., Charles Schwab Investment Advisory, and Schwab Wealth Investment Advisory—allegedly told investors that the amount of cash in their portfolios was determined through a "disciplined portfolio construction methodology," and that the firm's robo-adviser product, Schwab Intelligent Portfolios, would seek "optimal return[s]," according to a press release.
"In reality, 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," the agency said. "Schwab advertised the robo-adviser as having neither advisory nor hidden fees but didn’t tell clients about this cash drag on their investment."
"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," according to the SEC.
According to the SEC's order, the practice netted Schwab nearly $46 million in profits over a three-year period.
Schwab's three subsidiaries agreed to be censured, to a cease-and-desist order that prevents future violations of the antifraud provision in securities law, to pay $52 million in disgorgement and prejudgment interest, and to pay a $135 million civil fine without admitting or denying the SEC's charges. According to a press release from Schwab, the money will be returned to harmed investors through a fair fund account.
Unlike most robo-adviser products, Schwab Intelligent Portfolios did not charge an advisory fee, according to the SEC's order. The robo-adviser would set aside a certain percentage of cash in portfolios, but other assets, such as equities, would outperform that cash. The subsidiaries are accused of making false statements about the robo-cash adviser's allocation strategies and failing to disclose the conflicts of interest to investors.
According to the SEC, one of the subsidiaries, Charles Schwab & Co., also ran advertisements that made false claims about the robo-investment adviser's strategies. According to the agency, some of the advertisements claimed there were no hidden or advisory fees but failed to disclose that the company's internal models showed that when other assets such as equities outperformed cash, the investor's returns would be reduced by "approximately as much as advisory fees would have."
The Schwab subsidiaries agreed to hire an independent consultant within 60 days of the order's date to review their policies and procedures relating to their robo-disclosures, adviser's advertising, and marketing, and to ensure that they are following those policies and procedures effectively. According to the order, Schwab will agree to hire the consultant for two years and will not be able to replace him without the SEC's permission.
By granting access to files, data, and employees, Schwab must fully cooperate with the consultant. Schwab must implement the consultant's recommendations after submitting a report to the SEC, and then follow up with a certification that the recommendations were implemented.
Schwab said it was "pleased to put this behind us" in a statement.
"We believe resolving the matter in this way is in the best interests of our clients, company, and stockholders as it allows us to remain focused on helping our clients invest for the future. As always, we are committed to earning our clients’ trust every day and work diligently to maintain the highest standards for professional conduct throughout our organization," according to the statement.
The robo-adviser product “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," according to the company.
By fLEXI tEAM