More On Legal & Compliancefrom The Advisor's Professional Library
- Privacy Policies and Rules Whether an RIA is SEC or state-registered, the firm must have policies and procedures in effect to protect clients privacy. Policies and procedures should explicitly require an RIA to send out its privacy notice each year.
- Whistleblowers A whistleblower is any individual providing the SEC with original information related to a possible violation of federal securities law. The Dodd-Frank Act established a whistleblower program that enables the SEC to reward individuals who voluntarily provide such information.
Schwab’s YieldPlus Bond Fund, an ultrashort-term bond fund, was marketed as an alternative to money market funds and similar investment vehicles that was relatively low risk and had minimal fluctuations in net asset value (NAV).
However, on Tuesday both the SEC and FINRA imposed penalties on both Charles Schwab & Co. and Charles Schwab Investment Management, as well as two Schwab executives, in connection with charges filed by the SEC. Allegations were that the fund was far from low risk after its portfolio’s configuration changed, but marketing materials continued to present it as a safe alternative to money markets.
Schwab was charged, according to the SEC, “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.” They were also charged with deviating from the fund’s concentration policy in the absence of required shareholder approvals.
The two executives, Kimon Daifotis, Schwab Investment Management's former chief investment officer for fixed income, and Randall Merk, an executive vice president at Schwab and former president of Schwab Investment Management and trustee of the YieldPlus and other Schwab funds, also faced an SEC complaint in federal court that alleges they “committed fraud and other securities law violations in connection with the offer, sale and management of the YieldPlus Fund.”
Schwab agreed to pay $118 million to settle the charges against them; the case against Daifotis and Merk is ongoing.
In a statement on the settlement, Schwab said it had "worked closely with these parties to bring this matter to a constructive conclusion, and believes that resolving it in this way is in the best interests of the company, its stockholders, and clients who experienced losses in the YieldPlus Fund as a result of the global financial crisis.”
The company statement went on to say that its founder and chairman, Charles R. Schwab, was himself a major investor in YieldPlus, that it “would never seek to profit at the expense of its clients” and that the decline in the YieldPlus fund “was the result of an unprecedented and unforeseeable credit crisis and market."
FINRA assessed its own penalties on Schwab, ordering it to pay $18 million into a Fair Fund to be established by the SEC to repay investors in YieldPlus. That amount was reached by assessing the $17.5 million in fees that Schwab collected for sales of the fund, in addition to a fine of $500,000. Both amounts will have been designated as restitution to customers.
According to Antonia Chion, associate director of the SEC's Division of Enforcement, even though Schwab had marketed the fund as low risk, “at one point, half of the fund's assets were invested in private-issuer, mortgage-backed and other securities with maturities and credit quality that were significantly different than investments made by money market funds.”
The SEC determined that the fund deviated from its concentration policy by putting approximately 50% of its assets into private-issuer mortgage-backed securities. Its concentration policy forbade more than 25% of its assets to be invested in this way. As the credit crisis took hold in 2007, asset values fell and withdrawals increased, causing the fund to fall, during an eight-month period, from its high of $13.5 billion in assets and more than 200,000 accounts to only $1.8 billion.
AdvisorOne had previously reported on a settlement attempt. In November, the company was thought to have agreed with plaintiffs’ attorneys on a settlement in a class action suit after on-again, off-again negotiations. The penalty assessed by the SEC and FINRA is cheap compared to what plaintiffs’ lawyers could have won for their clients, had they accepted a settlement originally negotiated back in the spring of 2010, when Schwab had said it agreed to pay $235 million to settle all claims.
Back-and-forth negotiations resulted in Schwab withdrawing on Nov. 8 from yet another agreement because plaintiffs’ lawyers said that the settlement was not all-encompassing and would allow them to retain the right to further sue Schwab on behalf of additional investors.
Of the spring settlement, Schwab had said it was fully prepared to contest the allegations at trial but “wanted to provide significant and speedy financial benefit to valued clients who purchased or held the fund during the period covered by the lawsuit and to put the matter behind us.”
As previously reported, the company had argued that until the credit crisis, the YieldPlus Fund was consistently one of the best performing funds in its category for eight years and held a Morningstar 5-star rating from December 2004 through September 2007. Even in the face of the credit crisis, the company notes YieldPlus shareholders lost, on average, only 7.5% of their investment when dividends are counted.