Subsidiaries of Charles Schwab have agreed to pay $187 million to settle SEC charges that they misled clients about fees for the broker's robo-advisor product.
The SEC says that between March 2015 and November 2018, Schwab claimed that the amount of cash in the robo-adviser portfolios was determined through a “disciplined portfolio construction methodology,” and that the robo-adviser would seek “optimal return[s].”
However, 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. 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.
"Schwab claimed that the amount of cash in its robo-adviser portfolios was decided by sophisticated economic algorithms meant to optimize its clients’ returns when in reality it was decided by how much money the company wanted to make," says Gurbir Grewal, director, division of enforcement, SEC.
Without admitting or denying the SEC’s findings, three Schwab investment adviser subsidiaries agreed to a cease-and-desist order requiring them to pay approximately $52 million in disgorgement and prejudgment interest, and a $135 million civil penalty.