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Charles Schwab to pay $187mn in settlement to robo-adviser clients

Charles Schwab will pay $187mn in a regulatory settlement after the Securities and Exchange Commission condemned its robo-adviser service for “egregious” allocations of client money that saddled them with “hidden costs”.

The largest publicly traded US investment services company will pay the penalty to clients that were harmed by the practice, settling SEC charges, the securities regulator said on Monday. The charges are the latest sign that the Wall Street watchdog, under Gary Gensler, has intensified scrutiny over the ways in which new technology is being used that puts investors at a disadvantage.

The SEC alleged that three Schwab investment adviser subsidiaries told robo-advised customers they were not being charged fees for the service, but managed their money in a way that extracted hidden profits from high cash balances, hurting customer returns.

The regulator alleged that from March 2015 to November 2018, Schwab did not disclose to customers that its decision to keep a large portion of robo-advised assets in cash — an average of 13 per cent per portfolio — was costing them money because cash holdings would underperform assets such as equities.

Schwab profited by allocating customer cash into an affiliated bank and earned interest by loaning it out, failing to pass along the full interest to clients and creating a “conflict of interest”, the SEC said.

“Schwab claimed that the amount of cash in its robo-adviser portfolios was decided by sophisticated economic algorithms meant to optimise its clients’ returns,” said the SEC’s director of enforcement, Gurbir Grewal. “In reality, it was decided by how much money the company wanted to make.”

The charges point to the risk facing asset managers as robo-advisers grow in popularity and importance as fees from trading disappear. The regulator alleged that the brokerage misled clients and “falsely claimed” that their cash portfolios were allocated through “disciplined portfolio construction”.

Though customers were not charged fees for the advisory service, the lower returns investors received from having their assets held in cash amounted to the same amount as an advisory fee, the SEC noted. “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,” the SEC statement said.

Schwab also agreed to retain an independent consultant to review their robo-adviser’s policies and operations, the SEC added.

Grewal said: “Schwab’s conduct was egregious and today’s action sends a clear message to advisers that they need to be transparent with clients about hidden fees and how such fees affect clients’ returns.”

Schwab neither admitted nor denied the allegations in the claim. “We are proud to have built a product that allows investors to elect not to pay an advisory fee in return for allowing us to hold a portion of the proceeds in cash, and we do not hide the fact that our firm generates revenue for the services we provide,” it said in a statement.

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