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Wednesday, January 12, 2011

Schwab to Pay $119 Million in Yieldlus Settlement With Regulators

Just to put this fine in perspective, Charles Schwab's Q3 2010 net income was $335 million.  This fine represents about 35% of that income.

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View this article on our website: Schwab to Pay $119 Million in YieldPlus Settlement With Regulators

Schwab to Pay $119 Million in YieldPlus Settlement With Regulators

Schwab has agreed to pay $119 million to settle with the SEC, Finra and Illinois regulators over misleading statements regarding its YieldPlus Fund.

The Securities and Exchange Commission also brought fraud charges on Tuesday against the firm’s former chief investment officer for fixed income and a current executive VP. That case continues.

The SEC claims the two executives failed to inform investors adequately about the risks of investing in the fund. While the fund was described as a cash alternative with only slightly higher risk than money market funds, it was actually much riskier than money funds, the SEC says in a press release.

Schwab expects to include an after tax charge of $97 million in its fourth quarter financial results related to the settlements, according to a statement from the firm.

Schwab neither admits nor denies the SEC’s findings.

“Schwab has acted in good faith by working with the SEC and FINRA to address their concerns as well as by resolving most client claims including entering into a substantial settlement of a federal class action lawsuit,” the firm states. “We are pleased that the bulk of associated payments will go directly to YieldPlus shareholders, further reducing the impact of the credit crisis on them.”

Indeed, private litigants nationwide that have sued Schwab over losses in YieldPlus will receive $200 million in a settlement with the firm; $35 million is allocated to California investors suing under state law.

The SEC also found that the fund deviated from its concentration policy without obtaining required shareholder approval. The fund invested about 50% of its assets in private-issuer mortgage-backed securities; its concentration limit was 25%, according to its policies, the SEC says.

Schwab had argued that it did not need shareholder approval to increase the fund’s investments in mortgage-backed securities.

The fund’s assets under management hit a peak of $13.5 billion in 2007, but declined to $1.8 billion during an eight-month period due to redemptions and declining asset values, according to the SEC.

While the fund’s net asset value fell, Kimon Daifotis, the firm’s former CIO for fixed income, and Randall Merk, executive VP and formerly president of Charles Schwab Investment Management, made misstatements and omissions regarding the fund during conference calls, in issued written materials, and through other communications with investors, the agency says.

“For example, in two conference calls, Daifotis made false and misleading statements that the fund was experiencing ‘very, very, very slight’ and ‘minimal’ investor redemptions,” the SEC release states. “In fact, Daifotis knew that YieldPlus had experienced more than $1.2 billion in redemptions during the two weeks prior to the calls, which caused YieldPlus to sell more than $2.1 billion of its securities.”

In addition, the agency also charged Schwab with failing to establish, maintain and enforce policies and procedures to prevent the misuse of material, nonpublic information.

"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,” the SEC says. “As a result, several Schwab-related funds and individuals were free to redeem their own investments in YieldPlus during the fund's decline."

As part of the settlement, Schwab must correct all concentration disclosures for YieldPlus and the Total Bond Market Fund. The firm must also retain an independent consultant to review and make recommendations about their policies and procedures to prevent the misuse of material, nonpublic information.

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