RIA Compliance Blog
On June 13, 2022, the Securities and Exchange Commission (“SEC”) issued an order instituting administrative and cease-and-desist proceedings against Charles Schwab & Co., Inc. (“CS & Co.”), Charles Schwab Investment Advisory, Inc. (“CSIA”), and Schwab Wealth Investment Advisory, Inc. (“SWIA”), (collectively, “Schwab subsidiaries”) who submitted an offer of settlement without admitting or denying the findings of the order, except as to jurisdiction and subject matter. The order alleges that these investment adviser subsidiaries of The Charles Schwab Corporation (“Schwab”) listed before made false and misleading disclosures on Forms ADV Part 2A and published false and misleading advertising regarding Schwab Intelligent Portfolios (“SIP”), a robo-adviser service.
The Schwab subsidiaries did not charge an advisory fee for the SIP service and instead made money by allocating a fixed percentage of a client’s portfolio to cash and depositing that cash with Schwab Bank. Schwab Bank then loaned the cash out at a higher interest rate than the interest rate paid to clients in order to make a profit.
From March 2015 to November 2018, the disclosures published by the subsidiaries of Schwab in their respective Forms ADV Part 2A stated that the cash allocation in the SIP portfolios was determined by “disciplined portfolio construction methodology.” However, Schwab’s internal data showed that these pre-set cash allocations created a “cash drag” in some market conditions where other assets outperformed cash. The SEC determined that this disclosure was false and misleading and failed to adequately disclose corresponding conflicts of interest because the cash allocations were actually pre-set.
In addition to the disclosure issues identified by the SEC, it was determined that corresponding advertising regarding SIP was misleading. When the SIP service began in 2015, CS & Co. published advertisements that there were “no hidden fees [and] no advisory fees” for the SIP service. The SEC determined that these statements were misleading because they did not disclose the “cash drag” on their investment.
In November 2018, the subsidiaries ultimately revised their ADV Part 2A to remove these misleading statements and stopped publishing the misleading advertisements. By this time, however, Schwab had profited almost $46 million based on the SIP service.
The SEC found that the Schwab subsidiaries violated anti-fraud provisions of the Investment Advisers Act and the rules thereunder. Accordingly, they were censured, ordered to pay approximately $52 million in disgorgement and prejudgment interest, and received a $135 million civil penalty. In addition to these penalties, the Schwab subsidiaries agreed to retain an independent consultant to review policies and procedures related to the IP disclosures and advertising.
Investment advisers with robo-adviser services should take note of this order and ensure that all disclosures and advertising are consistent with SEC guidance, specifically related to hidden fees.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our Investment Adviser Group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our Investment Adviser Practice Group page for more information.