Schwab Pays Record $187 Million Fine in Robo-Adviser Case (1)

Charles Schwab Corp. agreed to pay a record $187 million penalty to federal securities regulators to settle allegations that it failed to tell clients about the hidden costs of its robo-advising product, which was investing client money in a way that often lowered their returns.

Schwab told investors that the amount of cash held in its robo-adviser portfolios was determined through a “disciplined portfolio construction methodology” when it really was set for business reasons and to compensate for not charging an advisory fee, the US Securities and Exchange Commission said on Monday. The firm’s own analysis of its robo-adviser showed that under most conditions cash in client portfolios was acting as a drag on returns.

While Schwab touted the robo-adviser’s lack of hidden fees, it didn’t disclose the cash drag, the SEC said. Schwab’s product held between 6% and 29.4% of client assets in cash -- a level the company set to ensure it could earn a minimum amount of revenue.

The firm earned money on investor cash by sweeping it to its affiliate bank, loaning it out, and then keeping the difference between the interest earned and what it paid the robo-adviser clients, according to the regulator.

“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,” Gurbir Grewal, head of the SEC’s enforcement division, said in a statement.

The company agreed to pay a $135 million penalty, the largest ever tied to robo-advising product, and about $52 million in disgorgement and interest. Schwab agreed to the penalties without admitting or denying the allegations.

“We are pleased to put this behind us,” the company said in a statement. “The SEC order acknowledges that Schwab addressed these matters years ago.”

The firm introduced its robo-adviser in 2015 -- a product designed to automatically invest client money in exchange-traded funds across different asset classes. Last year Schwab revealed that it had set aside $200 million related to a probe about robo-adviser disclosures.

Robo-advisers, including Schwab’s, have faced criticism for the underlying costs they can carry, which might be opaque to customers. Other smaller robo-advisers have been slapped with SEC fines in recent years.

The SEC brought its first robo-adviser-related enforcement action in 2018. The agency accused two platforms, Wealthfront Advisers and Hedgeable Inc., of misleading investors about their products. Wealthfront, which had $11 billion in client assets at the time, agreed to pay $250,000. Hedgeable, which had $81 million in client assets, agreed to pay $80,000. Neither company admitted nor denied wrongdoing.

(Updates with company comment in seventh paragraph.)

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Annie Massa in New York at amassa12@bloomberg.net

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Ben Bain at bbain2@bloomberg.net

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