Charles Schwab to Pay $187 Million After Robo-Advisor Mishap

Is your advisor looking out for you -- or the company?

When you give your money to a financial advisor or stockbroker, you do so with the expectation that it will do its best to make that money grow. This applies whether you're entrusting your money to a human advisor -- or a digital one.

So-called robo-advisors use sophisticated algorithms designed to use your risk tolerance and investment goals to allocate and rebalance your portfolio. In theory, robo-advisors, like human ones, should focus on maximizing your return within your risk tolerance.

In practice, this isn't always the case.

Recently, Charles Schwab got into hot water with the SEC over its robo-advisor looking out for Schwab's interests, rather than its clients. In the end, Schwab must pay $187 million to those clients to settle the charges.

Robo-advisor clients lost money so Schwab could make it

According to the press release from the SEC, Schwab misled robo-advisor clients about how the amount of cash in their portfolios would be determined. Schwab's marketing claimed the robo-advisor used a "disciplined portfolio construction methodology" for an "optimized return."

Instead, Schwab's data showed essentially the opposite -- clients were actually losing money under most market conditions, without any minimization to their risk. The extra cash was then funneled into Schwab's affiliated bank, where it was used to generate loan interest. The difference between the loan interest and the interest paid out to investing clients was pocketed by Schwab.

In the SEC's release, Gurbir S. Grewal, Director of the SEC's Division of Enforcement, had this to say:

"Schwab claimed that the amount of cash in its robo-advisor portfolios was decided by sophisticated economic algorithms meant to optimize its clients' returns when in reality it was decided by how much money the company wanted to make. Schwab's conduct was egregious and today's action sends a clear message to advisors that they need to be transparent with clients about hidden fees and how such fees affect clients' returns."

The settlement doesn't include admitting fault

Despite the evidence against them, Schwab's investment subsidiaries -- investment advisor subsidiaries, Charles Schwab & Co., Inc., Charles Schwab Investment Advisory, Inc., and Schwab Wealth Investment Advisory, Inc. -- did not admit fault or outright deny the SEC's findings.

However, it agreed to a cease-and-desist order both censuring them and prohibiting them from (further) breaching the antifraud provisions of the Investment Advisers Act of 1940. (The Investment Advisers Act of 1940 outlines the responsibilities of financial advisors. Specifically, it states that they must act primarily on behalf of their clients, not their own -- or their company's own -- interests.)

Additionally, Schwab's subsidiaries must pay $52 million in disgorgement and prejudgment interest, as well as $135 million in civil penalties. The company also agreed to an independent review of their policies and procedures for the disclosures, advertising, and marketing of its robo-advisor product.

Choose a brokerage with a reliable reputation

One of the hardest parts of beginning investing is choosing a brokerage. You need to be able to trust your brokerage implicitly; many people are quite literally handing over their life savings.

As such, you should thoroughly research each company before opening a new brokerage account. This includes checking for SEC censures and penalties, which can be indicative of a company that doesn't follow regulations.

SEC regulations are often there to protect you, the client, rather than the company. Brokerages that don't follow them may not be looking out for your best interests. If you do find that your current brokerage isn't maintaining your -- or the SEC's -- standards, consider transferring your account to a more reliable company.