The Securities and Exchange Commission is starting the year with a bang, announcing a $119 million settlement with the Charles Schwab Corp. for misleading investors and failing to prevent the misuse of nonpublic information.
The SEC also charged two Schwab senior executives with fraud and other securities law violations in a complaint filed in San Francisco federal court.
The charges signal the SEC’s continued focus on how major industry players communicate with investors.
Last year, Goldman Sachs agreed to pay $550 million for misleading investors of a collateralized debt obligation by misstating and omitting key facts, and State Street Corp. shelled out $313 million to investors who were not informed about their exposure to subprime mortgages. Also, Citigroup paid $75 million to settle charges that it had misled investors about its exposure to subprime securities - though the SEC was criticized for settling that case on the cheap.
The SEC, as well as the Financial Industry Regulatory Authority and the state of Illinois, alleged that Schwab marketed its YieldPlus mutual fund - which at its peak in 2007 had $13.5 billion in assets and more than 200,000 accounts - as a cash alternative that was only slightly more risky than a money market fund. In fact, according to the SEC, at one point, half of the fund's assets were invested in private-issuer, mortgage-backed and other securities.
The SEC also charged the company with deviating from the YieldPlus fund's concentration policy without obtaining the required shareholder approval.
During the credit crisis of 2007–2008, the fund’s assets fell from $13.5 billion to $1.8 billion.
"All financial firms and professionals — including large mutual fund providers — must be vigilant in accurately describing the risks of the products they sell to the public, especially the widely-held mutual funds that are the bread-and-butter investments of retail investors,” said Enforcement Division head Robert Khuzami in a written statement.
Schwab, represented by Quinn Emanuel Urquhart & Sullivan partner Faith Gay, said in a formal statement that that fund’s decline was “the result of an unprecedented and unforeseeable credit crisis and market collapse.”
The company also implied that the SEC’s attention more rightly belongs elsewhere. “To provide future protection for individual investors from similar market crises, the company hopes greater focus and attention will ultimately be given to the investment banks that created mortgage-backed securities and the ratings agencies that legitimized them with triple-A ratings, which have so far largely escaped scrutiny and accountability,” the statement read.
Reached by phone, Gay declined further comment.
In April, Schwab settled a class action related to the fund for $200 million.
The SEC brought individual charges against Charles Schwab Investment Management former chief investment officer for fixed income Kimon Daifotis and Charles Schwab & Co. Inc. executive vice president Randall Merk, who was a trustee of the YieldPlus and other Schwab funds.
Merk is represented by Susan Brune and MaryAnn Sung of Brune & Richard.
In a statement, Brune said, “Mr. Merk will fight the SEC’s civil lawsuit. The SEC’s claims are infected by hindsight bias and are not supported by the actual evidence. We look forward to presenting all of the facts in court.”
SEC lawyers working on the case include David Gottesman, Frederick Block, Antonia Chion, Robert Cohen, Melissa Hodgman and David Mendel.