(City Wire USA) - A group of investors last week filed a class action lawsuit against Charles Schwab Investment Advisory, accusing the business unit of allegedly overweighting cash allocations for clients of its robo-advice product Schwab Intelligent Portfolios, leading to hundreds of millions in lost potential gains.
The complaint was filed in a district court in Northern California. It accuses Schwab of breaching its fiduciary duty, violating local state laws and breach of contract.
Schwab Intelligent Portfolios, launched in 2015, is unlike other robo-advisors in that it does not generate revenue through recurring fixed subscription or asset-based fees. Rather, it makes money two ways. One is by placing client assets in Schwab ETFs, from which Schwab earns management fees. The other is by sweeping cash holdings into Schwab Bank and pocketing the difference between the interest rate it pays out and the rate it receives. Between 7% and 30% of any given client portfolio is held in cash, depending on the client’s selected time horizon, risk tolerance and investment strategy. Clients are unable to opt out of the cash sweep program.
Plaintiffs Lauren Barbiero, Kimberly Lopez and William Lopez allege in their complaint that ‘in order to generate this bumper crop of cash sweeps income for itself and its corporate parent, Schwab, CSIA systematically kept the “Intelligent Portfolios” accounts of plaintiffs and the proposed class over-concentrated in cash during the white-hot boom years of America’s recent stock market.’
It’s true that compared to equity and bond markets in the last several years, cash has been a relatively costly investment. The suit pegs the opportunity cost of Schwab’s heavy-handed cash allocations at ‘more than half a billion dollars,’ citing a report published last month by researchers at Backend Benchmarking.
According to that report, ‘for the 6-year trailing period ending June 30th, 2021, we estimate that 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.’
The suit argues that while Schwab markets its lack of management fees as a competitive advantage over other robo-advisors, ‘the potential performance drag from such a high cash allocation may easily exceed the management fee savings relative to competitors.’
Most numerical details of the plaintiffs’ Schwab Intelligent Portfolios accounts were redacted from the public version of their complaint, but their cash allocations were disclosed at between 9% and 25%, including for Barbeiro’s son, who is under 21 years of age. The complaint calls such a high cash holding ‘imprudently high’ for someone with such a long time horizon.
The suit aims to force Schwab to pay damages and restitution comprising ‘all monies wrongfully obtained’ to the proposed class, which consists of anybody who held a Schwab Intelligent Portfolios account during the last four years.
Attorneys representing Schwab declined to comment on the matter.
The complaint comes just two months after the Securities and Exchange Commission charged Schwab $200m in relation to an ongoing probe concerning ‘historic disclosures’ about Schwab Intelligent Portfolios. It is unclear whether the probe is related to the robo-advisor’s cash allocations.
Schwab Intelligent Portfolios had roughly $64bn in assets as of the end of the first quarter of 2021.
By Andrew Foerch
14 September 2021
