Advisers Settle SEC Charges for Disclosure Failures on Robo-Services

Three affiliated investment advisers settled SEC charges for making false and misleading statements in their Form ADV filings about the cash component of their robo-adviser services. The SEC also found that the advisers failed to disclose "conflict of interest in setting the cash allocations at a level that would earn a minimum amount of revenue, as well as the effect of the cash allocations."

In the Order, the SEC found that the advisers did "not disclos[e] that they were allocating client funds in a manner that their own internal analyses showed would be less profitable for their clients under most market conditions." The SEC stated that while the advisers did not charge a fee to use the robo-adviser services, they did not disclose that they "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."

Further, the advisers failed to disclose that under market conditions where equities outperformed cash, the cash allocations in the investors' portfolios would lower clients' returns. The SEC determined that the advisers did not disclose to customers that the cash allocations of the portfolios were pre-set to compensate for the fact that customers did not incur a fee when using the robo-adviser services. The SEC determined that the advisers communicated to investors that the robo-adviser service was a "no-advisory-fee product," which offered a competitive advantage over other robo-advisers, but falsely implied that the true overall costs were lower.

As a result, the advisers were found to have violated Section 206(2) and Section 206(4) of the Advisers Act ("Prohibited transactions by investment advisers"), as well as Advisers Act Rule 206(4)-1(a)(5) ("Investment Adviser Marketing") and Rule 206(4)-7 ("Compliance procedures and practices").

To settle the charges, the advisers have agreed to (i) a cease-and-desist, (ii) a censure and (iii) a fine of $186,536,861, which includes disgorgement of $45,907,541, pre-judgment interest of $5,629,320 and a civil monetary penalty of $135,000,000.