Charles Schwab’s $119 million settlement on Tuesday of fraud charges with the Securities and Exchange Commission in connection with the Schwab YieldPlus Fund provides additional ammunition for jilted fund investors and may begin to close an ugly chapter for Schwab.
Investors rights attorneys Christopher Vernon, of Vernon Healy, and former SEC lawyer Thomas Shine, in conducting their sweeping investigation of fraud and misconduct involving the Schwab YieldPlus Fund on behalf of investors nationwide, uncovered and long ago publicly exposed much of the most egregious conduct that formed the basis of SEC charges.
Without admitting or denying wrongdoing, Schwab agreed to pay $119 million to settle SEC charges that Schwab:
-- fraudulently misrepresented the safety of the YieldPlus bond mutual fund to investors;
-- failed to prevent abuse of inside information;
-- and violated securities laws by changing the YieldPlus Fund’s investment concentration policy without a required vote of shareholders.
The settlement announced Tuesday comes in addition to $235 million that Schwab agreed to pay to settle a federal class action lawsuit as well as separate payments and settlements connected to legal claims brought by individual investors in arbitration.
Many of the SEC charges filed Tuesday track closely the allegations filed in investor claims made public by Vernon and Shine in 2008 and 2009. Some of these investigative findings were made public on the Vernon Healy blog, ProtectingInvestors.com.
The Shine Vernon legal team long ago publicly exposed key investigative findings including that:
-- Schwab’s senior management changed the Schwab YieldPlus Fund’s investment policy in September 2006 to allow for a higher concentration in riskier mortgage-backed securities and asset-backed securities, without obtaining shareholder approval or clearly disclosing this major shift to investors;
-- Schwab embarked on a self-dealing “damage control” marketing campaign to avert redemptions of Schwab YieldPlus by Charles Schwab retail clients, while behind the scenes Schwab executives were quietly selling 2.9 million Schwab YieldPlus Fund shares from other Schwab proprietary mutual funds during the period January 31, 2008 to April 1, 2008. Marketing materials, newsletters, talking points, and other investor communications by Schwab managers urged unwitting Schwab retail clients to hold their shares.
-- Schwab ignored the warnings of securities and banking regulators about the risky
nature of mortgage-backed securities and collateralized mortgage obligations, including warnings to refrain from deceptive advertising of such securities and comparisons to certificates of deposits;
-- In SEC filings and direct communications with shareholders and prospective investors, Schwab misrepresented the Schwab YieldPlus Fund as an ultra short-term bond fund. In reality, the fund was heavily weighted with floating and variable rate bonds with long-term maturities, which gave the fund a weighted average maturity equivalent to a much longer term bond fund. During the second half of 2007 and in 2008, when the fund was declining in value, these misrepresentations created the false illusion that if investors held on to their positions for the next six months to a year, the bonds held in the fund’s portfolio would mature at face or par value and the fund and its shareholders would recoup their unrealized losses.
-- Unlike its peers in the Morningstar ultra short bond fund category, the Schwab YieldPlus Fund failed to maintain adequate cash on hand to meet investor redemptions. Schwab YieldPlus Fund had little cash, while its peers in the ultra short-term bond fund category averaged 27 percent of their positions in cash. As more and more investors sought to sell their shares, Schwab’s lack of cash forced it to sell illiquid securities held in the portfolio at distressed prices.
The funds’ high concentrations in risky and mostly illiquid securities exposed investors to the risk of substantial losses of principal.
Gina Edwards & Associates LLC private investigative agency contributed to Vernon and Shine’s investigation, uncovering that Schwab changed the YieldPlus Fund concentration policy without shareholder approval in violation of the Investment Act of 1940, among the key charges leveled by the SEC Tuesday and first disclosed publicly by Shine and Vernon.
Shine and Vernon were also the first attorneys to file an investor claim naming Schwab YieldPlus Fund manager Kimon Daifotis as a respondent. One day after Vernon and Shine filed the claim against Daifotis in June 2008, Schwab announced that it had replaced Daifotis as the fund manager of YieldPlus.
Chris Vernon is a founding partner of the Naples, Fla. based law firm Vernon Healy, which represents investors throughout the United States. Shine, a former enforcement attorney with the Securities and Exchange Commission in Washington, D.C., is in private practice in the Melbourne, Fla. area.