On June 13, 2022, the Securities and Exchange Commission (“SEC”) entered a settled order (“Order”) against three of The Charles Schwab Corporation’s investment adviser subsidiaries (collectively, “Schwab”) on charges that Schwab made false and misleading statements in its Form ADV filings and in its advertisements about the cash component of its robo-adviser service, Schwab Intelligent Portfolios (“SIP”).1
Launched by Schwab in March 2015, SIP provides automated, software-based investment portfolio management services to clients. Schwab did not charge investors an advisory fee for the SIP service. Rather, according to the Order, Schwab allocated a fixed percentage of SIP accounts to cash and deposited the cash with its affiliate bank, Charles Schwab Bank (“Schwab Bank”). Schwab Bank loaned the cash out at higher interest rates than it paid to SIP clients. By 2018, Schwab had profited by almost $46 million from the spread on the SIP cash allocations.
The SEC found that, while Schwab stated in its ADV brochures that the SIP portfolios’ cash allocations were “set based on a disciplined portfolio construction methodology,” Schwab’s management would pre-set the SIP accounts’ cash allocations in order to reach minimum revenue targets. Schwab stated in its ADV brochures that the SIP accounts’ cash allocations were higher than competitors’ cash allocations because SIP investors did not pay a fee. Meanwhile, Schwab’s internal models showed that these pre-set cash allocations would reduce SIP returns under most market conditions. This would result in investors’ returns being lowered by approximately the same amount as an advisory fee would have lowered them. However, Schwab also published advertisements stating that SIP had “no hidden fees [and] no advisory fees.”
The Order stated that, due to Schwab’s disclosure failures and misleading advertisements, investors could not make fully informed decisions regarding whether the lack of an advisory fee benefitted them. Schwab’s disclosures surrounding the SIP accounts’ cash allocations violated § 206(2) of the Investment Advisers Act of 1940 (“Advisers Act”), and its misleading advertisements violated § 206(4) of the Advisers Act and Rule 206(4)-1(a)(5) thereunder. Without admitting or denying the SEC’s findings, Schwab consented to the Order and will pay a total of $187,000,000, comprised of $45,907,541 in disgorgement, $5,629,320 in prejudgment interest, and a $135,000,000 civil penalty.
S&K Observations
The Order evidences the SEC’s ongoing scrutiny of robo-advisers and their fiduciary duties to provide clear and adequate disclosures and to act in their clients’ best interests.2 The charges against Schwab are also a reminder that the SEC continues to focus on fees and expenses charged to clients by investment managers. Please contact your primary attorney at Seward & Kissel if you have any questions or seek assistance in reviewing your firm’s disclosures or policies and procedures concerning fees and expenses or potential conflicts of interest.
