A proposed class action alleges the “Intelligent Portfolios” robo-advisory program offered by Charles Schwab Investment Advisory, Inc. is not free to use as some marketing materials suggest, but rather reaps for the firm hundreds of millions in revenue through what amount to undeclared fees charged to retail investors.
The crux of the 26-page lawsuit hinges on Charles Schwab’s digital Schwab Intelligent Portfolios, an ostensibly free-to-use, algorithm-based program designed to provide financial advice and/or manage investments with moderate to minimal human interaction. According to the case, Charles Schwab Investment Advisory charges Intelligent Portfolios users undeclared fees by way of a “cash sweeps arrangement,” whereby the firm sweeps a cash portion of a client’s portfolio into an FDIC-insured, interest-earning Schwab Bank account.
The lawsuit alleges Charles Schwab, since the launch of Intelligent Portfolios in 2015 and amid an increasingly competitive, highly lucrative robo-advisor services marketplace, has made “at least hundreds of millions of dollars” by skimming earned interest, i.e. “cash sweeps,” away from retail investors’ cash accounts linked to the robo-advisory program.
“As one industry commentator put it when Schwab launched ‘Intelligent Portfolios,’ the ‘devil is truly in the details’ when it comes to Schwab’s fees here,” the complaint reads. “While Schwab indeed charges its retail investor clients no investment advisory fees in connection with the [Schwab Intelligent Portfolios] program, the program is not free for anyone to use, as certain Program marketing suggests.”
In light of the foregoing, Charles Schwab, in order to generate the alleged “bumper crop” of cash sweeps income for itself and its corporate parent, systematically kept proposed class members’ Intelligent Portfolios accounts over-concentrated in cash in the recent “white-hot boom years” of the stock market, the lawsuit alleges. The effect of this, the suit contends, is that Intelligent Portfolios clients foreseeably missed out on market gains they would have enjoyed had Charles Schwab Investment Advisory instead managed their accounts loyally, prudently and without placing its own interest and those of its parent before the interests of clients:
“CSIA’s self-dealing directly caused Plaintiffs and the proposed Class more than half a billion dollars in losses here: ‘based on a simulated portfolio return using the equity-only and fixed income-only returns of its Schwab Intelligent Portfolio account, which is invested in a moderately aggressive portfolio, Backend Benchmarking is reporting that for the six-year period ending June 30, , clients with Schwab Intelligent Portfolios missed out on $531 million in portfolio growth [that they would have earned] if Schwab had [instead] charged a 0.31% management fee and invested the cash into the same fixed-income assets that are held in the portfolio.”
The lawsuit alleges Charles Schwab Investment Advisory has breached its fiduciary duty to clients by wrongfully overconcentrating Intelligent Portfolios accounts in cash positions. Per the case, the firm’s “cash sweeps” arrangement can potentially create a conflict of interest in that Schwab Bank earns income on the sweep allocation of each investment strategy.
“The higher the Sweep Allocation and the lower the interest rate paid the more Schwab Bank earns, thereby creating a potential conflict of interest. The cash allocation can affect both the risk profile and performance of a portfolio,” the case says, citing a February 2015 disclosure brochure for the Intelligent Portfolios program.
The lawsuit goes on to detail that Charles Schwab reported in early July 2021 that it took a $200 million hit in the second quarter of the year due to an ongoing Securities and Exchange Commission probe that the company couched as “largely concern[ing] historic disclosures” related to the Intelligent Portfolios program while providing no other details on the SEC inquiry. According to the case, industry observers have been able to read the tea leaves, signaling that the SEC must have uncovered something significant for Charles Schwab to pay a $200 million accounting charge.
The suit looks to represent all Intelligent Portfolios account holders during the last four years and through the date of trial.
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