Charles Schwab agreed to pay $187 million to settle an SEC investigation into alleged hidden charges charged by the agency’s robo-advisor, Schwab Clever Portfolios, in accordance to an company announcement on Monday.
“Robo-advisor” is shorthand for a digital funding service that makes use of algorithms to choose how to allocate people’ cash amongst asset courses reminiscent of shares, bonds and money.
From March 2015 by November 2018, Schwab did not disclose to purchasers that its robo-advisor allotted funds “in a manner that their own internal analyses showed would be less profitable for their clients under most market conditions,” the SEC claimed.
As a part of the settlement, three Schwab subsidiaries — Charles Schwab & Co., Charles Schwab Funding Advisory and Schwab Wealth Funding Advisory — agreed to pay a $135 million civil penalty and one other $52 million in disgorgement and curiosity to affected purchasers.
In an announcement issued Monday, Schwab neither admitted nor denied the allegations and mentioned the agency is “pleased to put this behind us.”
“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,” in accordance to the statement. “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.”
Money drag
The dynamic outlined by the SEC was due to an undisclosed “cash drag” on Schwab client portfolios, the agency said.
Cash generally yields lower returns than stocks, for example, during periods of low interest rates and a rising stock market, as was the directional trend over 2015-2018.
Schwab advertised that clients’ cash allocations were determined by strict portfolio methodology that sought optimal returns, according to the SEC. But the firm’s data showed that the cash allocations would lead clients to make less money for the same amount of risk in most circumstances, the SEC said.
The firm profited by sweeping cash to an affiliate bank, loaning the money and pocketing the difference between the loan interest it received and the cash interest it paid to robo-adviser clients, according to the SEC.
“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,” Gurbir S. Grewal, director of the SEC’s enforcement division, said Monday.
However, Schwab highlighted that its Schwab Intelligent Portfolios Service lets investors elect not to pay an advisory fee in exchange for allowing the firm to hold some proceeds in cash.
The firm said it “[does] not hide the fact that our firm generates revenue for the services we provide” and thinks cash is a “key component of any sound investment strategy through different market cycles.”