Schwab Robo-Advisor Hidden Fees Case Moves to Federal Court

A stockholder lawsuit alleging Charles Schwab Corp. hid fees in its robo-advisor program, Schwab Intelligent Portfolios, moved to federal court in California this week.

Schwab falsely claimed its SIP robo-advisory charged no advisory fees, which attracted investors because most of its competitors did impose such charges, according to the shareholder derivative lawsuit — a complaint that a stockholder makes on behalf of the corporation.

The complaint (4:23-cv-02938), filed by the Reynolds Family Revocable Trust, a Schwab shareholder, against the company and several executives and directors, alleges SIP hid fees by using preset cash allocation amounts. Schwab had to start programs like SIP to compete after online upstart Robinhood disrupted the brokerage industry by introducing no-fee stock trades years earlier, the lawsuit states.

These preset cash allocations “created a ‘cash-drag’ that would allow Charles Schwab to earn at least a minimum amount of revenue from the spread on the SIP cash by loaning out the money,” according to the complaint, which was removed from California Superior Court to U.S. District Court in Northern California.

“Effectively, SIP was structured so that the portfolios would cause the company to receive the same amount from clients as if Charles Schwab charged them an advisory fee,” the complaint alleges.

“These wrongs resulted in significant damages to Charles Schwab’s reputation, goodwill and standing in the business community, as well as exposing the company to potential liability for violations of state and federal law,” the complaint says.

The lawsuit notes that a year ago, the U.S. Securities and Exchange Commission entered into a cease-and-desist order with Schwab that “detailed how from March 2015 through November 30, 2018, the company had misled investors regarding the hidden fees and the effects of the cash allocations.”

ThinkAdvisor reported last year that the SEC ordered Schwab to pay $186.5 million related to false and misleading statements its subsidiaries made in filings and advertisements. Schwab’s statements that SIP had no hidden or advisory fees were misleading because its cash allocation models would lower returns by about the same amount as advisory fees when other assets outperformed cash, the SEC noted at the time.

Schwab neither admitted nor denied the SEC allegations by agreeing to the order. That 2022 order closely followed a Northern California District Court judge’s ruling to dismiss a putative class-action client lawsuit alleging that by over-investing clients in cash, SIP violated its fiduciary duty. The 9th U.S. Circuit Court of Appeals affirmed the district court ruling last week.

The Reynolds trust suit alleges “breach of fiduciary duty, waste of corporate assets, unjust enrichment and violations of law.”

On the company’s behalf, the suit seeks amounts for damages the company sustained, corporate governance reforms, and restitution and profit disgorgement from defendants, among other demands. While the complaint doesn’t specify a dollar figure for the relief demand, the court’s docket cites an $18.8 million demand.

Schwab provided a statement ThinkAdvisor today: “This lawsuit rehashes matters resolved with the SEC last year about disclosures from nearly half a decade ago. There is nothing new about this case other than the filing date.

“As we have said time and again, we stand firmly behind the design and construction of Schwab Intelligent Portfolios. We are committed to earning our clients’ trust every day and work diligently to maintain the highest standards for professional conduct throughout our organization.”

Photo: Bloomberg