By Thomas D. Mauriello, Esq.,
California co-counsel on the Shine Vernon legal team
Individual investors who lost money in the Charles Schwab YieldPlus Fund — and unfortunately their ranks are many — will soon have to make a major decision about how to pursue a recovery for their losses. They will have to decide whether to seek recovery by grouping their claims with those of other investors in a pending class-action lawsuit, or by pursuing their claims individually through arbitration.
A class-action lawsuit against Charles Schwab & Co., Inc. is pending in United States District Court in San Francisco. In the class action, Notices of Pendency of Class Action recently were sent to Schwab YieldPlus investors notifying them that they must affirmatively “opt out” of the class action if they wish to pursue on an individual basis recovery of their YieldPlus losses outside of the class action.
This “opt-out” date is Dec. 28, 2009, and the “opt-out” requests must be received by that date. One of the alternatives to seeking recovery of losses through the pending class action is to pursue recovery through binding arbitration sponsored by the Financial Industry Regulatory Authority (FINRA).
This article discusses the different approaches for seeking recovery for YieldPlus Fund losses, describes some of the features of class action securities litigation and FINRA arbitration, respectively, and provides other information that may assist individual investors in determining the best approach for them in seeking recovery of YieldPlus Fund losses.
What Is A Class Action?
A class-action lawsuit is a “representative” action. This means that certain individuals or entities – referred to as “class plaintiffs” or “class representatives” – represent the interests of absent class members in pursuing a recovery on behalf of the class. Class action lawsuits may cover a wide variety of types of injuries or losses, including not only investment disputes as in the case of the YieldPlus Fund but also deceptive or unfair consumer services or products, employment misconduct, harmful products, and many other issues.
Class actions are designed to take advantage of economies of scale by providing a means of recovery for persons who have valid legal claims but whose losses or damages, individually, are not large enough to justify the legal fees and costs associated with pursuing an individual lawsuit. By grouping together the claims of hundreds, thousands, or even hundreds of thousands of plaintiffs with similar, modest-sized losses, relatively small individual claims can be economically litigated.
Merely filing a lawsuit as a class action does not make it a class action. In order to proceed as a class action, the action must be “certified” or approved by the trial judge as a class action. This is done through a legal process called “class certification” in which the trial judge decides whether certain criteria are met.
These criteria include: whether the defendant engaged in a common course of conduct toward all class members, whether the claims of the class representatives are typical of the class, whether the class members are sufficiently numerous to make a class action preferable, and whether the class representatives and their counsel are adequate to diligently represent the interests of the absent class members.
Throughout this process, class counsel and the class representatives manage the litigation for the plaintiffs’ side; the absent class members essentially have no role except to opt-out of the class action (more on that below) or to object to a settlement with which they disagree.
If the class action litigation results in a settlement or a judgment following trial, a claims administration process is set up which requires all class members to submit “proofs of claim,” demonstrating the amount of their losses, with class members recovering a pro rata portion of the net recovery. For more information about securities fraud class actions, one commonly used resource for information may be found at: http://securities.stanford.edu/.
What Is FINRA Arbitration?
An individual who wishes to pursue recovery for investment losses from their brokerage firm on an individual basis — assuming that no class action has been filed regarding a particular wrongful financial conduct or product, or the investor has chosen not to participate in a filed class action –must pursue his or her claims in binding arbitration sponsored by FINRA. FINRA arbitration is a private forum in which a panel of three arbitrators decides the investor’s case.
The investor is represented by his or her own attorney and is able to determine the type of claims to assert and the amount sought in recovery. The investor does not represent any other investors and is directly responsible only for his or her own claims. FINRA arbitrations typically last several days. The investor is allowed to put on witnesses, offer documents into evidence and cross-examine the brokerage firm’s witnesses.
The arbitration typically takes place in a hotel conference room in a city nearest to the investors’ residence. A good resource for further information about FINRA arbitrations may be found at: www.finra.org.
The Zen of Class Actions: By Not Opting Out, You Are Opting In
On August 21, 2009, the Court in the Schwab YieldPlus Fund class action “certified” three classes of investors in that case, meaning that the Court found that the classes met the appropriate criteria for a representative or class action and, accordingly, could proceed and be litigated as a class action (The three specific classes are described below in this article.)
On Oct. 12, 2009, Notices of Pendency of Class Action were sent to Schwab YieldPlus investors, notifying them of the existence of the class action. The Notice of Pendency notified investors that they must “opt-out” of the class action if they desire to pursue recovery of their YieldPlus losses individually. The “opt-out” deadline date is Dec. 28, 2009. The “opt out” requests must be received by that date. See The Notice of Pendency. Those who wish to pursue individual arbitration or who are considering arbitration should heed this deadline carefully!
The Schwab YieldPlus Ultra Short Term Bond Fund: A Primer
We will address the options for Schwab YieldPlus investors below. As investors consider their options in pursuing Schwab YieldPlus recoveries, it is important to be aware of the events surrounding the fund, the reasons why a class action lawsuit exists, and why many investors have filed individual arbitration claims involving the fund.
Charles Schwab & Co. marketed the Schwab YieldPlus Fund as a safe alternative to money market funds, comparing it to 1- and 2-year certificates of deposit and describing it as “portfolio cash” on its website. However, the fund managers loaded the fund with high concentrations of riskier and less liquid mortgage- and asset-backed securities that exposed fund investors to the danger of substantial losses of their principal.
Consistent with the fund’s stated investment objectives and risk profile, many Schwab YieldPlus investors were retirees, baby boomers, and others who were seeking a safe alternative to cash. Instead, they were unwittingly exposed to undisclosed risk and lost substantial amounts of money.
Here are some key facts about this fund that investors should know:
- Schwab sold almost 3 million Schwab YieldPlus Fund shares from other Schwab proprietary mutual funds during the period Jan. 31, 2008 to April 1, 2008. At the same time, Schwab discouraged shareholder redemptions of Schwab YieldPlus, indicating in marketing materials, newsletters, talking points, and other investor communications that Schwab retail clients should hold their shares.
- In SEC filings and direct communications with shareholders and prospective investors, Schwab represented 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 an intermediate term bond fund. During the second half of 2007 and in 2008, when the fund was declining in value, these misrepresentations created the 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 recover most of their unrealized losses.
- 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 to investors this major change.
- 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 by comparing them to certificates of deposits.
- Schwab’s management failed to adequately disclose that investors had withdrawn $2.8 billion from the YieldPlus Fund in August 2007. Full disclosure did not come until Nov. 30, 2007, by which time the Fund’s net assets had dropped to $8 billion, down from $13.5 billion as of July 31, 2007.
- Unlike its peer funds 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 only 6.5 percent of its portfolio in 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 was forced to sell illiquid securities held in the portfolio at distressed prices.
- The Schwab YieldPlus Fund saw a catastrophic freefall when net assets plunged from a high of $13.5 billion in July 2007 to just $679 million on May 31, 2008. Schwab reports that as of May 31, 2009, the YieldPlus Fund’s assets were $161.72 million.
- Charles Schwab acknowledged in October 2009 that it has received a “Wells Notice” from the United States Securities and Exchange Commission, advising the company that the SEC’s enforcement staff intends to recommend that the Commission institute legal action against Schwab related to the YieldPlus Fund.
YieldPlus: Class Action Litigation versus Individual FINRA Arbitration
How does an investor interested in recovering their Schwab YieldPlus Fund losses decide whether to pursue FINRA arbitration or to participate in the class action litigation? Here are a few general comments regarding arbitration and class actions that may be useful to those who are pondering this decision:
In arbitration, the investor takes an active role in pursuing recovery of his or her losses. The investor must identify and hire his or her own attorney, assist the attorney with the preparation of the arbitration claim, gather documents that will be produced in discovery, participate in settlement negotiations or mediation and testify at arbitration hearing. The individual arbitration claimant has direct control over the arbitration litigation process as compared to the passive role that investors play in a class action.
Many experienced securities arbitration attorneys will handle strong securities arbitration cases on a contingency basis for legal fees. Attorneys will often advance some or a substantial portion of the costs of arbitration. Examples of costs associated with FINRA arbitration include FINRA filing fees, FINRA arbitrator compensation fees, copy costs, and expert witness fees.
From this author’s personal experience and review of certain statistics, as well as anecdotal evidence, a reasonable estimate is that approximately one-half of securities arbitrations may settle. In those cases that do settle, the individual arbitration claimant has substantial input into the terms and conditions of settlement. For cases that do not settle, many claimants find value in having their “day in court” through the process of being able to tell their story truthfully under oath before an arbitration panel, as well having the conduct of the brokerage firm scrutinized and called to account.
Results in arbitration vary substantially. Much depends on the background of each member of the three-person arbitration panel as well as other case-specific variables. However, in this author’s opinion, an investor generally has a better chance of maximizing his or her recovery — that is, obtaining a higher recovery — in arbitration versus a securities class action.
Unlike court, arbitration is a private proceeding. The pleadings filed by the parties in arbitration are not available to the public and the arbitration hearings are not open to the public. One possible advantage to this system is that it maintains the privacy of a claimant’s personal financial matters. One possible drawback is that arbitrators’ decisions are not subject to public scrutiny and, therefore, are open to charges that the process lacks transparency and is not fair.
In a class action, the investor takes a passive role and is not required to take any action at all to obtain a recovery. The investor’s interests are represented by the named class representatives and class counsel. Given that the litigation can impact the interests of the absent class members, the court is required to oversee the qualifications of the class representatives and class counsel, the suitability of the case as a class action, and approval of any settlement to ensure that it is fair and reasonable. Attorneys for the class are paid out of the recovery, usually receiving a fee consisting of 25 to 33 percent of the recovery, plus their costs.
The vast majority of securities fraud class actions — well over 90 percent — settle, and very few actually proceed to trial. The amount recovered by each investor in a class action settlement is based on a pro-rata share of the net settlement amount, according to the investor’s losses. That dollar amount of an investor’s recovery may vary widely based on a number of factors, including, but not limited to, the settlement amount, the amount of legal fees and costs, and the number of claims made.
Are You A Class Member?
There is one final but important point to note regarding the YieldPlus class action specifically, and that is that not all YieldPlus Fund investors fall into one of three separate classes certified by the court.
The first class is based on Section 11 of the Securities Act of 1933 and consists of investors who purchased shares of the YieldPlus Fund during the period Nov. 15, 2006, through March 17, 2008 that are traceable to a false and misleading registration statement for the fund.
The second class is based on Section 12 of the Securities Act of 1933 and consists of investors who purchased the YieldPlus Fund during the period May 31, 2006, through March 17, 2008, that are traceable to a false and misleading prospectus for the fund.
The third class is based on Section 17200 of California’s Business and Professions Code and consists of those California resident investors who held shares in the YieldPlus fund on Sept. 1, 2006.
Investors who purchased YieldPlus Fund shares prior to May 31, 2006, may not be in any of the three classes. Investors are urged to speak with counsel to better understand their rights and whether they fall within any of these classes.
Where To Go From Here?
There is no “one size fits all” solution for everyone. Whether a Schwab YieldPlus investor participates in the class action or chooses to pursue recovery through FINRA arbitration will depend on a number of issues, including, but not limited to, the size of the investor’s losses, the dates of the purchases and sales of the fund’s shares, the person’s desire to play an active role in the case and analysis of likely recoveries.
The first thing that a Schwab Yield Plus investor should do is to make an informed decision about whether to actively pursue an individual claim in arbitration or to be a passive class member in the class action litigation. Most of us have busy lives with family and work, and it is easy to avoid thinking about the past loss of money in the YieldPlus Fund. However, if an investor fails to make a conscious and informed decision, the decision will be made for the investor automatically. If an “opt-out” election is not made before Dec. 28, 2009, the investor will be automatically included in the class.
To learn more about the Schwab YieldPlus class action, investors may contact plaintiffs’ class action counsel through their website at http://www.hagens-berman.com/schw or by phone (206) 623-7292 and (206) 623-7292 or the claims notice administrator, Gilardi & Company, through its website at http://www.gilardi.com or by phone at (800) 654-5763 and (800) 654-5763.
To learn more about pursuing a YieldPlus claim through FINRA arbitration, you should contact an experienced attorney who specializes in securities arbitrations.
The Shine Vernon legal team is presently handling on a contingency fee basis numerous individual arbitrations on behalf of investors involving the Schwab YieldPlus Fund and Schwab California Tax Free YieldPlus Fund. The team, which includes experienced investors rights attorneys and former SEC enforcement attorneys, is jointly investigating, researching, and prosecuting Schwab YieldPlus claims in various states, including California, Texas, New York, Illinois and Florida.
For more information, please contact attorney Chris Vernon by email at firstname.lastname@example.org or by phone at (239) 319-4434.