Charles Schwab SIP Robo-Adviser Cited In FINRA Arbitration

July 5, 2022

Schwab Intelligent Portfolios ("SIP") was advertised as a robo-adviser that didn't charge advisory fees; however, from March 2015 through November 2018, Schwab profited on its clients' cash holdings by arbitraging the difference between was was earned by Schwab lending out those balances and what Schwab paid to the clients -- and, SIP had allocated relatively high levels of cash rather than investing those amounts. SIP clients were were not fully informed about the interest earned on the cash balances in their portfolio, which prompted the SEC to order Charles Schwab & Co. to pay a $52 million in disgorgement and prejudgment interest, and a $135 million civil penalty. In one of those troubling quirks of Wall Street regulation, while the SEC was finalizing its multi-million dollar settlement against Schwab, the firm was battling it out in a FINRA arbitration with a SIP customer, who was complaining about transaction errors. Read about that arbitration in today's blog.

Case in Point

In a FINRA Arbitration Statement of Claim filed in August 2020, public customer Claimant Covell, representing himself pro se, asserted that Respondent Charles Schwab had committed an account transfer execution error. Claimant Covell initially sought $75,000 in damages but in February 2022, the sole FINRA Arbitrator granted Claimant's motion to increase the damages sought to $235,000. 
In the Matter of the Arbitration Between Kenneth L. Covell, Claimant, v. Charles Schwab & Co., Inc., Respondent (FINRA Arbitration Award 20-02414)
https://www.finra.org/sites/default/files/aao_documents/20-02414.pdf 

Respondent Charles Schwab generally denied the allegations, asserted affirmative defenses, and sought the expungement of the matter from an unnamed party's Central Registration Depository record ("CRD"). 

The FINRA Arbitration Award characterizes the nature of the dispute as involving the unnamed party's failure:

to follow Claimant's instructions to "dollar cost average" $500,000.00 that Claimant invested in a portfolio managed by a robo-advisor called Schwab Intelligent Portfolios ("SIP").

Award

The sole FINRA Arbitrator found Respondent Charles Schwab liable to and ordered it to pay to Claimant Covell $79,249.93 in compensatory damages, based on Claimant's losses as of March 16, 2020, plus interest, and $300 in filing fees. The Arbitrator denied the requested expungement of the unnamed party's CRD by Respondent Charles Schwab. The Arbitrator assessed solely against Respondent Schwab:
  • $450  in Postponement Fees
  • $600 in Last-Minute Cancellation Fees;
  • $2,700 in Hearing Session Fees
Bill Singer's Comment

Compliments to pro se Claimant Covell on a job well done! 

Durrances v. Schwab FINRA Arbitration

While we're on the topic of Schwab's failure to follow customer Covell's instructions, let's not forget that only recently, in "Unhappy Customers Pull Out All The GameStops In FINRA Arbitration Win Against Charles Schwab" (BrokeAndBroker.com Blog / April 12, 2022)
https://www.brokeandbroker.com/6399/durrance-schwab-arbitration/ , we reported in part that: 

In a FINRA Arbitration Statement of Claim filed in May 2021, public customer Claimants asserted negligence; breach of contract and covenant of good faith and fair dealing; and breach of fiduciary duty. Claimants sought compensatory and punitive damages, interest, fees, and costs. 
In the Matter of the Arbitration Between Chad Durrance and Leslie Durrance, Claimants, v. Charles Schwab & Co., Inc., Respondent (FINRA Arbitration Award 21-01181) 
https://www.finra.org/sites/default/files/aao_documents/21-01181.pdf

As asserted in the FINRA Arbitration Award:

[T]he causes of action relate to Claimants alleging that Respondent: failed to maintain an adequate infrastructure and trading platform; prevented Claimants from entering orders to sell Claimants' entire GameStop Corporation ("GME") position; failed to timely place Claimants' trades; did not provide proper support and resources; did not have an adequate risk management system or controls in place; and did not satisfy industry standards. 

Respondent Schwab generally denied the allegations and asserted affirmative defenses. 

Award

The FINRA Panel of Arbitrators found Respondent Schwab liable and ordered the firm to pay to Claimants $214,640.00 in compensatory damages. . . .

In Covell, the public customer Claimant had alleged that Schwab was guilty of an account transfer execution error. In Durrances v. Schwab, Claimants alleged that Schwab was guilty of inadequate infrastructure, trading platform, trading execution, support, and other shortcomings. 

June 13, 2022 SEC Order

Okay, sure, Schwab's a big firm with lots of accounts. Something's likely to go wrong on any given day. It happens. On the other hand, as reported in the "Securities Industry Commentator" https://www.rrbdlaw.com/6499/securities-industry-commentator/#schwab:

https://www.sec.gov/litigation/admin/2022/34-95087.pdf
Without admitting or denying the findings in an SEC Order
https://www.sec.gov/litigation/admin/2022/34-95087.pdf, Charles Schwab & Co., Inc., Charles Schwab Investment Advisory, Inc., and Schwab Wealth Investment Advisory, Inc., agreed to a cease-and-desist order prohibiting them from violating the antifraud provisions of the Investment Advisers Act of 1940, censuring them, and requiring them to pay approximately $52 million in disgorgement and prejudgment interest, and a $135 million civil penalty. Further, the Respondents agreed to retain an independent consultant to review their policies and procedures relating to their robo-adviser's disclosures, advertising, and marketing, and to ensure that they are effectively following those policies and procedures. As alleged in part in the SEC Release:

[F]rom March 2015 through November 2018, Schwab's mandated disclosures for its robo-adviser product, Schwab Intelligent Portfolios, stated that the amount of cash in the robo-adviser portfolios was determined through a "disciplined portfolio construction methodology," and that the robo-adviser would seek "optimal return[s]." In reality, Schwab's own data showed that under most market conditions, the cash in the portfolios would cause clients to make less money even while taking on the same amount of risk. Schwab advertised the robo-adviser as having neither advisory nor hidden fees, but didn't tell clients about this cash drag on their investment.

Schwab made money from the cash allocations in the robo-adviser portfolios by sweeping the cash to its affiliate bank, loaning it out, and then keeping the difference between the interest it earned on the loans and what it paid in interest to the robo-adviser clients.

How wonderful Wall Street regulation is!  On June 13, 2022, when the SEC ordered Schwab to pay $52 million in disgorgement and prejudgment interest, and a $135 million civil penalty, FINRA was conducting two arbitration sessions between Covell and Schwab. And then FINRA held another two arbitration sessions on June 14, 2022. 

Just tossin' this out there but why would Schwab be allowed to contest the customer's allegations involving its robo-adviser after it had entered into $187 million in sanctions involving, well, you know, its robo-adviser. Where was the SEC's concern for investor protection? Where was FINRA? Of course, you could also scratch your head an ask why Schwab itself didn't just pull the plug on Covell and pay the unhappy customer given the attendant SEC settlement. 

In the end, SIP-py just couldn't hang on.

Sippy, I don't care what your daddy do. Hang on Sippy, Sippy hang on. Hang on Sippy, Sippy hang on.