Charles Schwab - Securities Fraud - Schwab YieldPlus Fund

Florida Investment and Stock Fraud FINRA Arbitration and Litigation Attorney, Russell L. Forkey, Esq.

As more information become available, we will bring it to you either here or in our blog. If you invested in the Schwab YieldPlus Fund and believe that you suffered damages as a result thereof, please call us and schedule an appointment for your initial free consultation.

November, 2011:

Recent Update Regarding Yield Plus.

Original Article:

On January 11, 2011, the Securities and Exchange Commission instituted two enforcement actions relating to activities associated with the Charles Schwab YieldPlus Fund, which is an ultra short bond fund. The releases associated with each action are set forth below:

SEC v. CHARLES SCHWAB INVESTMENT MANAGEMENT, CHARLES SCHWAB & CO., INC., and SCHWAB INVESTMENTS, Civil Action No. CV-11-0136 EMC (N.D. Cal. Jan. 11, 2011)

SEC CHARGES SCHWAB ENTITIES WITH MAKING MISLEADING STATEMENTS REGARDING THE SCHWAB YIELDPLUS FUND

The Securities and Exchange Commission on January 11, 2011 charged Charles Schwab Investment Management (CSIM) and Charles Schwab & Co., Inc. (CS&Co.) with making misleading statements regarding the Schwab YieldPlus Fund and failing to establish, maintain and enforce policies and procedures to prevent the misuse of material, nonpublic information. The SEC also charged CSIM and Schwab Investments with deviating from the YieldPlus fund's concentration policy without obtaining the required shareholder approval.

CSIM and CS&Co. agreed to pay more than $118 million to settle the SEC's charges.

The YieldPlus Fund is an ultra-short bond fund that, at its peak in 2007, had $13.5 billion in assets and over 200,000 accounts, making it the largest ultra-short bond fund in the category. The fund suffered a significant decline during the credit crisis of 2007-2008 and saw its assets fall from $13.5 billion to $1.8 billion during an eight-month period due to redemptions and declining asset values.

According to the complaint filed in federal court in San Francisco and a related order issued by the Commission, CSIM and CS&Co. failed to inform investors adequately about the risks of investing in the YieldPlus Fund. For example, they described the fund as a cash alternative that had only slightly higher risk than a money market fund. The statements were misleading because the fund was more than slightly riskier than money market funds, and the Schwab entities did not adequately inform investors about the differences between YieldPlus and money market funds. In particular, the maturity and credit quality of the YieldPlus Fund's securities were significantly different than those of a money market fund.

The SEC also found that the YieldPlus Fund deviated from its concentration policy when it invested more than 25 percent of fund assets in private-issuer mortgage-backed securities (MBS). Mutual funds and other registered investment companies are required to state certain investment policies in their SEC filings, including a policy regarding concentration of investments. Once established, a fund may not deviate from its concentration policy without shareholder approval. Schwab's bond funds, including the YieldPlus Fund and the Total Bond Market Fund, had a policy of not concentrating more than 25% of assets in any one industry, including private-issuer MBS. The funds violated this policy, and the Investment Company Act, by investing approximately 50% of the assets of the YieldPlus Fund and more than 25% of the Total Bond Fund's assets in private-issuer MBS without obtaining shareholder approval.

According to the complaint and the related order, the YieldPlus Fund's NAV began to decline and many investors redeemed their holdings as the credit crisis unfolded in mid-2007. Unlike a money market fund, few of the fund's assets were scheduled to mature within the next several months. As a result, the fund had to sell assets in a depressed market to raise cash. While the YieldPlus Fund's NAV declined, CSIM and CS&Co. held conference calls, issued written materials, and had other communications with investors that contained a number of material misstatements and omissions concerning the fund.

The Commission also found that CSIM and CS&Co. did not have policies and procedures reasonably designed, given the nature of their businesses, to prevent the misuse of material, nonpublic information about the fund. For example, they did not have specific policies and procedures governing redemptions by portfolio managers who advised Schwab funds of funds, and did not have appropriate information barriers concerning nonpublic and potentially material information about the fund. As a result, several Schwab-related funds and individuals were free to redeem their own investments in YieldPlus during the fund's decline.

Without admitting or denying the allegations in the Commission's complaints, CSIM and CS&Co. agreed to pay a total of $118,944,996, including $52,327,149 in disgorgement of fees by CSIM, a $52,327,149 penalty against CSIM, a $5,000,000 penalty against CS&Co., and pre-judgment interest of $9,290,698. CSIM's disgorgement may be deemed satisfied, up to a maximum of $26,944,996, for payments made within the next 60 days to settle related investigations by FINRA or state securities regulators. The Commission seeks to have payments placed in a Fair Fund for distribution to harmed investors, and the related recoveries by other regulators, such as FINRA, may be contributed to the Fair Fund. The payments and any Fair Fund are subject to approval by the United States District Court for the Northern District of California.

The Commission today also instituted related cease-and-desist proceedings against CSIM, CS&Co. and Schwab Investments for the same conduct. In connection with these proceedings, CSIM, CS&Co. and Schwab Investments consented to a Commission order requiring them to cease and desist from committing or causing future violations of the federal securities laws. The Commission order also requires them to comply with certain undertakings, including correction of all disclosures regarding the funds' concentration policy. In addition, the Commission censured CSIM and CS&Co., and required them to retain an independent consultant to review and make recommendations about their policies and procedures to prevent the misuse of material, nonpublic information.

In its complaint, the Commission alleges and, in its related order, found that:

  • CSIM and CS&Co. willfully violated anti-fraud provisions of the Securities Act of 1933, Sections 17(a)(2) and (3).
  • CSIM willfully violated anti-fraud provisions of the Investment Advisers Act of 1940, Section 206(4) and Rule 206(4)-8.
  • Schwab Investments willfully violated Section 13(a) of the Investment Company Act of 1940 by deviating from its concentration policy, and CSIM willfully aided and abetted and caused the violation.
  • CSIM and CS&Co. willfully aided and abetted and caused violations of the false filings provision of the Investment Company Act, Section 34(b).
  • CS&Co. violated Section 15(g) (formerly Section 15(f)) of the Securities Exchange Act of 1934, and CSIM violated Section 204A of the Advisers Act, both of which require policies and procedures that are reasonably designed, taking into consideration the nature of the entities' businesses, to prevent the misuse of material, nonpublic information.

The second action related to the Schwab YieldPlus issues was also filed on January 11, 2010.

SEC v. KIMON P. DAIFOTIS AND RANDALL MERK, Civil Action No. CV-11-0137 MEJ (N.D. Cal. Jan. 11, 2011)

SEC CHARGES KIMON DAIFOTIS AND RANDALL MERK FOR DEFRAUDING INVESTORS IN THE SCHWAB YIELDPLUS FUND

The Securities and Exchange Commission on January 11, 2011 charged Kimon Daifotis and Randall Merk with fraud and other securities law violations in a complaint filed in the U.S. District Court for the Northern District of California. Daifotis is the former lead portfolio manager for the Schwab YieldPlus Fund and was the Chief Investment Officer for Fixed Income for Charles Schwab Investment Management (CSIM). Randall Merk is an Executive Vice President at Charles Schwab & Co., Inc. (CS&Co.), and formerly was President of CSIM and a trustee of the YieldPlus and other Schwab funds.

In its complaint, the Commission alleges that Daifotis and Merk committed fraud and other securities law violations in connection with the offer, sale, and management of the YieldPlus Fund. YieldPlus is an ultra-short bond fund that, at its peak in 2007, had $13.5 billion in assets and over 200,000 accounts, making it the largest ultra-short bond fund in the category. The fund suffered a significant decline during the credit crisis of 2007-2008 and saw its assets fall from $13.5 billion to $1.8 billion during an eight-month period due to redemptions and declining asset values.

According to the complaint, Merk and Daifotis misled investors about the risks of investing in the YieldPlus Fund. For example, they described the fund as a cash equivalent or alternative that had only slightly higher risk than a money market fund in marketing and other communications. The statements were misleading because the fund was riskier than money market funds, and Merk and Daifotis failed to inform investors adequately about the differences between YieldPlus and money market funds. For example, the maturity and credit quality of the YieldPlus Fund's securities were significantly different than those of a money market fund.

The complaint further alleges that, in mid-2007, the YieldPlus Fund's NAV began to decline and many investors redeemed their holdings. Unlike a money market fund, few of the fund's assets were scheduled to mature within the next several months. As a result, the fund had to sell assets in a depressed market to raise cash. While the YieldPlus Fund's NAV declined, Merk, and Daifotis held conference calls, issued written materials, and had other communications with investors that contained a number of material misstatements and omissions concerning the fund. For example, in two conference calls, Daifotis made false and misleading statements that the fund's was experiencing "very, very, very slight" and "minimal" investor redemptions. In fact, Daifotis knew or was reckless in not knowing that YieldPlus had experienced more than $1.2 billion in redemptions during the two weeks prior to the calls, which caused YieldPlus to sell over $2.1 billion of its securities. Similarly, Merk authored, reviewed and approved misleading statements about the fund, such as a false claim that the fund had a "short maturity structure" that "mitigated much of the price erosion" experienced by its peers.

The complaint also charges Daifotis with aiding and abetting the YieldPlus Fund's deviation from its concentration policy by directing the Fund's investment of more than 25% of fund assets in private-issuer mortgage-backed securities (MBS). Mutual funds and other registered investment companies are required to state certain investment policies in their SEC filings, including a policy regarding concentration of investments. Once established, a fund may not deviate from its concentration policy without shareholder approval. Schwab's bond funds, including the YieldPlus Fund and the Total Bond Market Fund, had a policy of not concentrating more than 25% of assets in any one industry, including private-issuer MBS. The complaint alleges that the funds violated this policy, and the Investment Company Act, when Daifotis directed the investment of approximately 50% of the assets of the YieldPlus Fund and more than 25% of the Total Bond Fund's assets in private-issuer MBS without obtaining shareholder approval.

The complaint also charges Merk with aiding and abetting violations of anti-fraud provisions of the Investment Advisers Act. The complaint alleges that Merk approved other Schwab funds' redemptions of their investments in YieldPlus at a time when Merk knew or was reckless in not knowing that a portfolio manager for those funds had received material, nonpublic information about the YieldPlus Fund without the authorization of the YieldPlus Fund's board of trustees.

In its complaint, the SEC alleges that:

  • Daifotis and Merk violated anti-fraud provisions of the federal securities laws, specifically Section 10(b) and Rule 10b-5 of the Exchange Act and Section 17(a) of the Securities Act, and aided and abetted violations of Section 10(b) and Rule 10b-5 of the Exchange Act and Section 206(4) and Rule 206(4)-8 of the Investment Advisers Act;
  • Merk aided and abetted violations of additional anti-fraud provisions of the Investment Advisers Act, Sections 206(1) and (2);
  • Daifotis and Merk violated and aided and abetted violations of the false filings provisions of the Investment Company Act, Section 34(b);
  • Daifotis aided and abetted violations of the shareholder voting rights provision of the Investment Company Action, Section 13(a).

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