Charles Schwab To Pay $119M For Misleading Investors

Charles Schwab Corp. has agreed to pay $119 million to settle a government criminal probe over misleading investors about their Schawab YieldPlus Funds. 

The U.S. Securities and Exchange Commission (SEC) filed fraud and securities law violation charges against Schwab on Tuesday, and the YieldPlus Fund settlement was announced the same day. The agreement comes more than a year after the SEC filed issued a “Wells notice” saying that the company was under investigation for fraud.

Schwab YieldPlus funds are ultra-short bond funds, which were heavily promoted as conservative investment alternatives to money market funds or cash. Despite being advertised to generate income with minimal changes in share price, the fund lost more than 30% of its value between June 2007 and June 2008 due to heavy investments in risky subprime mortgage securities, which some experts indicate violated the prospectus.

According to the SEC, regulators first became concerned about the YieldPlus Funds as early as 2004, and warned Charles Schwab that the disclosures it was making to investors were insufficient. The brokerage made changes to those disclosures, but the SEC says they did not go far enough.

The SEC charged the company with making misleading statements, failing to establish, maintain and enforce policies that prevent the misuse of material, nonpublic information, and also accused the company of deviating from the YieldPlus Fund’s concentration policy without getting shareholder approval.

In addition to charges against the company, the SEC also filed complaints against Randall Merk, the company’s executive vice president, and former president of Charles Schwab Investment Management (CSIM), as well as Kimon Daifotis, CSIM’s former chief investment officer. The SEC accused the two men of committing fraud and violating a number of securities laws.

Late last year Schwab reached a tentative $235 million settlement in a Schwab YieldPlus Fund class action lawsuit representing about 250,000 investors who say they lost about $800 million when the YieldPlus fund collapsed. The class action lawsuit alleges that Schwab misled investors and failed to properly disclose the nature of the risks associated with certain securities held by the bond funds.

 Schwab still faces nearly 200 individual stockbroker arbitration claims for up to $34 million. Those investors opted out of the Schwab class action lawsuit prior to the original deadline in December 2009.

Many financial fraud lawyers have suggested that some investors may be better served by pursuing an individual arbitration claim to recover their Schwab YieldPlus losses through the Financial Industry Regulatory Authority (FINRA), as opposed to participating as a class member. Panels of FINRA arbitrators have already heard a number of claims filed by investors, awarding losses of more than $20 million so far.