Commentary June 13, 2022 at 07:44 AM Share & Print
What You Need to Know
- In ads and Form ADV filings, Schwab claimed its Intelligent Portfolios platform had ‘no hidden fees [and] no advisory fees.’
- The SEC found these statements misleading, saying high cash allocations in the portfolios reduced returns while making money for Schwab.
- The fine was announced days after a judge dismissed a class-action lawsuit alleging that SIP over-invested clients in cash.
The Securities and Exchange Commission on Monday ordered Charles Schwab to pay $186.5 million related to false and misleading statements made by its subsidiaries in their Form ADV filings and in advertising about the cash component of Schwab’s robo-advisor service, Schwab Intelligent Portfolios.
According to the SEC order, from March 2015 through November 2018, certain investment advisor subsidiaries of The Charles Schwab Corp. made false and misleading statements in their Form ADV filings about the cash component of Schwab Intelligent Portfolios (SIP).
The subsidiaries also published misleading advertisements about SIP.
The SEC order comes on the heels of June 7 ruling by a Northern California District Court judge dismissing a class-action lawsuit that alleged SIP violated its fiduciary duty by over-investing clients in cash.
Starting around the time of the SIP launch in March 2015, Schwab published advertisements stating that there were “no hidden fees [and] no advisory fees” for SIP, the order states.
“These statements were misleading because, based on Schwab’s own internal models, the cash allocations in SIP would, when other assets such as equities outperform cash, reduce investors’ returns by approximately as much as advisory fees would have,” according to the order.
Certain other advertisements were misleading “because they implied that SIP investors would end up with more money as a result of not being charged an advisory fee—even though internal models showed that the cash allocations would reduce returns by a similar amount when other assets such as equities outperform cash,” the SEC said.
According to the order, each of SIP’s model portfolios held between 6% and 29.4% of clients’ assets in cash.
“The amount of cash that each SIP model portfolio contained was pre-set so that Respondents’ affiliate bank would earn at least a minimum amount of revenue from the spread on the cash by loaning out the money,” the SEC said.
In significant part because of the revenue received from the spread on the SIP cash allocations, “the Schwab subsidiaries did not charge investors an advisory fee for the SIP service,” the SEC states.
“But Respondents 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 states.
The subsidiaries “made false and misleading statements in their Form ADV filings regarding both their conflict of interest in setting the cash allocations at a level that would earn a minimum amount of revenue, as well as the effect of the cash allocations,” the SEC said.
Also, “they falsely claimed that the cash allocations in the SIP portfolios were determined through a ‘disciplined portfolio construction methodology’ when in fact they were pre-set for business reasons, and to compensate Respondents for not charging an advisory fee,” the order states.
The disclosure failures were compounded by the fact that, around the same time, the Schwab subsidiaries “launched a marketing campaign that included advertising stating that SIP was a no-advisory-fee product, which Respondents viewed as a strong competitive advantage over other robo-advisers, and falsely implying that investing in SIP allowed investors to keep more of their money than other advisory services that charged a fee.”
But because of the disclosure failures in the Form ADV filings and the misleading advertisements, “investors were unable to make a fully informed decision regarding whether the lack of an advisory fee” benefited them, the SEC said.
In a Monday statement, Schwab said that it “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 Order acknowledges that Schwab addressed these matters years ago.”
In entering the settlement, Schwab neither admits nor denies the allegations in the SEC’s order.
“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,” Schwab said in 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.”
The SEC ordered Charles Schwab & Co., Charles Schwab Investment Advisory Inc., and Schwab Wealth Investment Advisory Inc. to pay disgorgement, prejudgment interest and a civil penalty totaling approximately $186.5 million as follows: disgorgement of $45.9 million and prejudgment interest of $5.6 million, and a civil money penalty of $135 million.