Schwab Entities Misled Investors, Violated Fund Concentration Policy – SEC

Jack Humphrey, Regulatory journalist
January 12, 2011 /

Charles Schwab Investment Management (CSIM) and Charles Schwab & Co., Inc. (CS&Co.) have hidden the risks in putting money to YieldPlus Fund from the investors who were made to believe it was a cash alternative and had only slightly higher risk than a money market fund.

This was among the allegations filed by the US Securities and Exchange Commission January 11, 2011 in a San Francisco federal court, seeking the Schwab entities to settle the SEC charges by paying at least $118 million in financial penalties, disgorgement and prejudgment interest.

The commission also tagged CSIM’s former chief investment officer for fixed income Kimon Daifotis and Schwab official Randall Merk, who serves as executive vice president at CS&Co., for violating federal securities law when they handled the sale and management of and helped in the misleading statements in the risk in YieldPlus Fund.

According to SEC’s complaints against Schwab entities, YieldPlus Fund, an ultra-short bond fund, was far more risky than money market fund, different from Schwab’s claims. In 2007, YieldPlus Fund became the largest ultra-short bond fund in its category when assets climbed to $13.5 billion and the total number of accounts registered went a record high of 200,000. However, its fortune reversed during the credit crisis in 2007 and 2008 when asset values declined, affecting its very own assets that fell 87 percent to $1.8 billion in eight months time as investors withheld their holdings.

While the assets of YieldPlus Fund continued to decline, Schwab entities, including Daifotis and Merk, made the investors to believe that the fund has been experiencing only a very minimal redemptions from investors, the SEC said, pointing to several conference calls and misstated written materials that Schwab used to hide the risks. As a matter of fact, the SEC continued, Daifotis was aware that YieldPlus Fund had sold at least $2.1 billion of its securities following redemptions worth at least $1.2 billion that happened two weeks before misleading communications were sent to investors.

The SEC further found that Schwab violated the Investment Company Act and the very policy of its bond fund concentration stating that YieldPlus Fund and the Total Bond Market Fund should concentrate not more than 25 percent of assets in any one industry. Schwab actually invested nearly 50 percent of the assets of the YieldPlus Fund and more than 25 percent of the Total Bond Fund’s assets in private-issuer MBS while not informing investors about this.

The financial penalties to be paid by Schwab will go to the Fair Fund to redress losses of investors. Schwab is also bound to sign an undertaking requiring it to correct all disclosures related to the funds’ concentration policy and retain an independent consultant to go over the policies and procedures.

 

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