Charles Schwab to pay $187 million to settle SEC charges that it misled robo-advisor clients on fees

Personal finance

The U.S. Securities and Exchange Commission headquarters in Washington on Feb. 23, 2022.
Al Drago/Bloomberg via Getty Images

Charles Schwab agreed to pay $187 million to settle an SEC investigation into alleged hidden fees charged by the firm’s robo-advisor, Schwab Intelligent Portfolios, according to an agency announcement on Monday.

“Robo-advisor” is shorthand for a digital investment service that uses algorithms to judge how to allocate individuals’ money among asset classes such as stocks, bonds and cash.  

From March 2015 through November 2018, Schwab didn’t disclose to clients that its robo-advisor allocated funds “in a manner that their own internal analyses showed would be less profitable for their clients under most market conditions,” the SEC claimed.

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As part of the settlement, three Schwab subsidiaries — Charles Schwab & Co., Charles Schwab Investment Advisory and Schwab Wealth Investment Advisory — agreed to pay a $135 million civil penalty and an additional $52 million in disgorgement and interest to affected clients.

In a statement issued Monday, Schwab neither admitted nor denied the allegations and said the firm 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,” according 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.”

Cash drag

Robo-advisors are getting more popular. They began appearing around 2008, during the advent of the iPhone and an ascendant digital culture. They may soon hold more than $1 trillion of Americans’ wealth.

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.”

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