The cost-slashing by the $65-billion AUM San Francisco RIA is meant to streamline and improve process, according to the company

April 24, 2015 — 4:40 PM UTC by Lisa Shidler

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Brooke’s Note: What exactly represents the best interests of an RIA client? Is there an identifiable protocol of ethical actions or can you do what you like so long as you disclose it to the SEC? The answer seems to depend on which ADV you look at. Case in point: The top of the freshly published ADV brochure for Schwab Private Client reads as if it was written by a Dow Jones Newswire writer. Schwab is going to purge expensive share classes from Private Client portfolios in favor of cheaper ones. Why they were pushing pricier funds in the first place and why it took so long to jettison them isn’t crystal clear, although the fact that the exchanges are happening on a tax-free basis seems significant and to Schwab’s credit. But it is harder to understand how Schwab can continue to steer the “majority” of assets to its proprietary or OneSource-listed funds, according to the same ADV brochure. This practice of encouraging in-house products, or at least well-remunerated in-house distribution, has the feel of what an Ameriprise or a JPMorgan does with their brokers. See: The New York Times exposes JPMorgan’s brokers, yet again. Investors, too, may be harder pressed to find where that practice is disclosed at those firms. As we looked around the industry for compliance experts to help us sort through this, we were challenged. Many work closely with Schwab and chose to recuse themselves. It shows you how difficult it is to analyze these gray areas.

Charles Schwab & Co.'s Private Client Investment Advisory Inc. will reduce what RIA clients pay for the underlying mutual fund management in their portfolios.

“Beginning in June 2015, Schwab will periodically review Schwab Private Client (SPC) accounts to identify mutual fund shares that may be eligible for a tax-free exchange with a lower-cost share class of the same fund and may initiate such exchanges as detailed in the SPC agreement,” SPC’s ADV states.

Schwab spokesman Greg Gable explains what prompted the change: “An improved capability we’ve constructed to streamline the process of inter-class exchanges. The amended service agreement makes it easier to implement the process.”

With discretion

But here’s the twist: In implementing this policy, Schwab will make an exception to its policy of asking client permission to make switches in mutual funds in order to expedite the process.

Schwab spokesman Greg Gable explains this way in an e-mail: “Schwab Private Client is a non-discretionary advisory service, and as such, we need permission ahead of every trade. That can be slow and cumbersome — for us and our clients — when it comes to switching out a fund at each instance for which there is a lower-cost share-class fund. That’s why we’re amending the terms of service to allow for interclass exchanges on a periodic basis without seeking permission in advance. Since the impact is beneficial, we believe that the advance blanket permission should be well-received as a convenience for clients.” See: How Schwab is calling out wirehouses with its 'accountability’ blitz and what collateral effects could hit RIAs.

Finger stays on scale

One policy, however, that may result in Schwab Private Client investors paying higher mutual fund management fees will remain constant: Schwab Private Client advisors will still recommend its Schwab OneSource funds heavily to clients. See: Starting 2012 with a bang, Schwab will place its private client business under a new RIA.

“Although, compensation to Schwab and its affiliates was not directly considered in the selection of funds for any recommendable list, by design, the majority of mutual funds on the recommendable list are no-load, no transaction fee-funds that are part of the Schwab mutual fund OneSource service with some prominence given to Schwab affiliate funds,” the ADV states.

Acknowledging the revenue from the OneSource funds, the ADV adds: “Schwab and its affiliates Charles Schwab Investment Management generally earn more money when clients purchase and hold OneSource and Schwab affiliate funds.” See: Schwab and T. Rowe Price finally strike a OneSource deal with help from an ex-Fido exec.

This begs the question of why Schwab Private Client prefers Schwab OneSource funds when its robo-advisor, Schwab Intelligent Portfolios, focuses on a quantitative analysis.

Gable explains the two efforts are very different.

“Private Client and Schwab Intelligent Portfolios are completely different service models, with SPC providing a highly customized non-discretionary advisory relationship that incorporates a wide variety of investment vehicles including individual equity and fixed income securities and mutual funds, not just ETFs, and Schwab Intelligent Portfolios is an automated algorithmic service using ETFs.” See: Schwab tells the SEC its robo-advisor has a 30 basis-point fee and big-time cash allocations held by Schwab Bank.

Summary conclusions

This sort of inside ADV baseball may make it hard for clients to absorb the changes, cautions Peter Mafteiu of Sound Compliance Services in Gig Harbor, Wash. Schwab’s ADV information is compiled in several documents including one document that details changes in Schwab Managed Portfolios, Schwab Private Client and Windhaven. Readers need to go to each specific ADV to read about the specific changes, he says. See: Schwab adds $2 billion of assets from Windhaven, with RIA help, and another $2 billion of assets from 41 new RIAs.

“Schwab appears unable to distinguish one RIA entity to another RIA entity they own, inserting material amendments for all form ADVs of all Schwab RIAs,” Mafteiu says. “This is like overwhelming a reader (prospective client, client, sales person, etc.) so they really cannot map out the changes that might affect a particular customer.”

But Gable points out that the summary is meant to summarize the material changes in concise form in accordance with regulatory requirements.

“The Summary document you’ve seen is a completely separate document from the ADV itself and is designed to alert clients to important changes in the ADV, but in summary fashion (as required), so they may look into it further if they are interested (either by contacting us with questions or to get the revised ADV or accessing the document at the SEC),” he writes. See: How suitable are your investment strategies? The SEC cares, a lot..

And Gable contends that SPC clients are savvier and less easily confused than Matfeiu makes them out to be. “We find that clients are aware of the name of the service they are using and can very quickly and easily hone in on the changes to the service that they participate in. In many cases it is multiple services they use and the compilation is very convenient from that perspective.”

Other costs

The ADV in the summary also spells out additional fees that investors pay if they follow Schwab Private Client’s advice for funds. For instance, the ADV states that when Schwab Private Client recommends that a client invest in retirement accounts assets in front-end load funds, “and you follow that advice, Schwab will receive compensation from the fund on the amount you invest. These amounts will be indirectly paid by you as part of the front-end sales load charged by the fund. The amounts paid to Schwab by front-end load funds will vary depending on the particular fund in which you invest.”

The amount of fees paid to Schwab by clients for Schwab affiliate funds will depend on the funds but can range from .06% to 1.27%. The amount of fees paid to Charles Schwab Investment Management for Schwab ETFs will vary depending on the particular fund and will range from 0.4 to 0.46% of assets.

Schwab also receives additional fees or compensation to offset processing costs by Schwab for the exchange of securities for equity options or other covered security sell transactions. See: Schwab makes play for ETF-distribution domination but not without risks.


Mentioned in this article:

Sound Compliance Services
Consulting Firm
Top Executive: Peter Mafteiu



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