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Schwab Faces Class-Action Suit Over Cash Sweeps

By Jeff Berman

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What You Need to Know

  • Three investors allege Schwab violated its fiduciary duties by overconcentrating Intelligent Portfolios accounts in cash.
  • That allegedly caused the plaintiffs and other Schwab clients to lose hundreds of millions of dollars.
  • Schwab disclosed in July it took a $200 million regulatory charge related to a SEC probe of the robo-advisor platform.

Charles Schwab was hit with a class-action complaint by three investors who alleged the firm violated its fiduciary duties by “wrongfully overconcentrating” clients’ Schwab Intelligent Portfolios robo-advisor accounts in cash positions that ended up costing them hundreds of millions of dollars.

The complaint, filed Friday in U.S. District Court for the Northern District of California by Lauren Marie Barbiero, Kimberly Jo Lopez and William Kenneth Lopez, alleged that Charles Schwab Investment Advisory, the subsidiary that manages the firm’s robo-advisor program, kept the plaintiffs’ and other clients’ SIP accounts “overconcentrated in cash positions.”

By doing that, Schwab “could maximize its cash sweeps income — and this caused plaintiffs and the proposed class more than half a billion dollars in damages,” the complaint alleged.

Schwab declined to comment on the complaint on Tuesday, noting it does not comment on active litigation.

The plaintiffs and other Schwab clients enrolled in the SIP program “paid hundreds of millions of dollars in unwarranted and unfair cash sweeps to Schwab and collectively missed out on over $500 million in portfolio growth since the inception” of the robo-advisor program, according to the complaint.

The plaintiffs are seeking a preliminary and permanent order of injunctive relief that will enjoin Schwab from “pursuing the acts and practices” in the complaint.

They are also seeking: the “imposition of a constructive trust and an Order granting restitution, disgorgement of ill-gotten profits, and such other equitable relief as the Court deems just and proper”; actual damages; “reasonable” attorneys’ fees, other legal costs; and additional relief “as the Court may deem necessary or appropriate,” according to the complaint.

Cash Sweep Controversy

Schwab disclosed in July that it took a $200 million regulatory charge related to a Securities and Exchange Commission probe of its robo-advisor platform, representing $0.10 per share, in the second quarter.

The SEC investigation was around past disclosures about the SIP program, according to a regulatory filing. Schwab has been cooperating with the SEC and its ultimate liability may differ from the $200 million charge, it said in July.

In an August blog post, Backend Benchmarking, a research firm that ranks robo-advisors, estimated that Schwab’s “high cash allocations” in the robo-advisor program “cost investors $1.13 billion in total earnings when compared with potential returns if Schwab invested the cash in the fixed income portion of its portfolio.”

Backend went on to estimate that, for the six-year trailing period ended June 30, “clients with SIP earned a total of $531 million less than if Schwab had simply charged a 0.30% management fee and invested the cash into the same fixed income assets that are held in the portfolio.”

In the complaint filed Friday, the plaintiffs pointed to 2015 comments made by analysts at Schwab rival Raymond James about the SIP robo-advisor program, who said in a report: “Although the product itself is free (no advisory fee, no commissions, no service fees), SIP will generate revenue for Schwab in two ways: investments in Schwab exchange-traded funds, from which Schwab will earn management fees, and a net interest margin on the cash by sweeping the cash allocation of client managed accounts into Schwab Bank.”

The complaint also quoted RJ analysts saying ahead of the SIP robo-advisor 2015 launch: “We now understand why Charles Schwab is so excited about the upcoming launch” of SIP.

With a large percentage of managed account assets that can be swept to its bank, “Schwab stands ready to generate substantial revenue from the product despite not charging any advisory fees,” according to the RJ analysts. “From the client’s perspective, however, the potential performance drag from such a high cash allocation may easily exceed the management fee savings relative to competitors.”

(Photo: Bloomberg)

Jeff Berman

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