Robo Advisers And Conflicts of Interest

Conflicts of interest are a key issue for investment advisers and others. The Commission has brought a number of actions alleging that investment advisers failed to disclose conflicts which could impact clients. For example, the agency filed a series of cases centered on the failure to disclose fees paid to a broker affiliated with the adviser in connection with the selection of certain mutual fund shares.

The Commission’s most recent case involving an investment adviser and conflicts centered on a different type of conflict. In that case the adviser failed to advise clients about hidden Robo Adviser fees. In the Matter of Charles Schwab & Co. Inc., Adm. Proc. File No. 3-20897 (June 13, 2020).

Respondents in the proceeding include the dual registered investment adviser and broker-dealer; Charles Schwab Investment Advisory, Inc, a registered advisory which is a subsidiary of Schwab Holdings, Inc., a subsidiary of The Charles Schwab Corporation; and Schwab Wealth Investment Advisory, Inc, an investment adviser formed for the firm’s Schwab Intelligent Portfolios or SIP product – a robo advisor.

Over a three-year period, beginning in early 2015, certain adviser subsidiaries of The Charles Schwab corporation made false and misleading statements regarding its SIP product. The robo advisers were based on model portfolios that held between 6% and 29.4% of client assets in each case. The amount was preset so the affiliated bank would make at least a minimum amount of revenue from the spread on the cash by loaning the money. Investors were not charged a fee for the SIP service. The firm did not disclose the fact that under certain market conditions other assets such as equities outperform cash.

Respondents were also alleged to have made false statements in their Form ADV filings regarding the conflict of interest in setting the cash allocations at levels that would generate a certain amount of revenue. For example, firm clients were told that the allocations were created through a “disciplined portfolio construction methodology.” In fact, they were set for business reasons. The difficulty was compounded by the fact that the firm launched an advertising campaign informing investors that the SIP program permitted them to keep more of their money than other advisers who charged a fee.

Respondent cooperated with the Commission’s investigation. The firm also agreed to implement certain undertakings which included the retention of an independent consultant. The Order alleges violations of Advisers Act Sections 206(2) and 206(4).

To resolve the proceedings, Respondent consented to the entry of a cease-and-desist order based on the Sections cited in the Order and a censure. The firm will also pay disgorgement of $45,907,541 and prejudgment interest of $5,629,320. The firm will pay a penalty of $135 million. A Fair Fund will be created.

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