Charles Schwab (NYSE: SCHW) will pay $187 million to settle charges that the company misled investors through its "Robo-advisor," an algorithmic, automated asset manager.
According to a release put out by the U.S. Securities Exchange Commission (SEC), the "Robo-advisor" was marketed as only holding enough cash as determined by "disciplined portfolio construction methodology" and that the advisor would seek the most profitable returns using this reserve. As the regulator would later find, this was not the case, with the cash left in these portfolios creating a drag on client returns.
Charles Schwab sent the cash in these portfolios to an affiliated bank, loaned it out, and pocketed the difference between the loan's interest and the interest guaranteed to clients. In addition to this low return, around one-fifth of each client's portfolio is held in cash that remains unused for any other investment. This not-insignificant fraction of idle funds creates the "drag" identified by the SEC.
"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 S. Grewal, Director of the SEC's Division of Enforcement, explains. "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."
While certainly highlighting the need for greater transparency regarding algorithm-powered "Robo-advisers," it is worth noting that functionally no issues were highlighted by the SEC. Given the growing popularity of Robo-advisors and the growing share of American investments tied up in automatically managed portfolios, brokers more clearly explaining the procedures their Robo-advisers use and the risks of investing with them only seems beneficial to investors.
Charles Schwab didn't get off to the best start this year, stumbling briefly after a Q4 earnings miss, and the possibility of a looming recession already unsettles most markets, though the near future looks just fine for the bank. Settling with the SEC and paying compensation to misled investors likely won't put too much downward pressure on the bank's shares past this week, a small silver lining for investors. Shares of Charles Schwab slipped into the red as the week began, sliding 3.1% on Monday but recovered 4% by the time of writing on Wednesday.