Charles Schwab & Co. and its former high-profile fund manager engaged in deception and fraudulent conduct when they misrepresented the Schwab YieldPlus Fund as safe haven for investors while loading the fund with high concentrations of risky mortgage- and asset-backed securities that exposed fund investors to steep losses of their principal, according to claims filed today by the Shine Vernon legal team on behalf of investors with more than $400,000 in losses.
The Shine Vernon team, which is headed by former SEC enforcement attorney Thomas Shine and longtime investor rights’ attorney Chris Vernon and two other former SEC attorneys, has filed arbitration claims on behalf of individual investors with Schwab YieldPlus Fund (SWYPX, SWYSX, SCHW) losses totaling $1.7 million this month. The team has filed claims on behalf of Schwab YieldPlus investors with losses totaling almost $3 million since mid-July.
Many Schwab YieldPlus investors represented by the Shine Vernon team are retirees and baby boomers who’ve suffered significant losses of principal. In the last month, the Shine Vernon team has filed claims on behalf of investors including a park ranger, ocean engineer, insurance broker, retired banking industry professional, consultant, real estate developer, boat broker, journalist, judge, and two real estate professionals.
Charles Schwab acknowledged today that it has received a Wells Notice from the SEC, alerting the company that the SEC intends to seek legal action against Schwab related to the YieldPlus Fund and the Total Bond Market Fund.
Charles Schwab compared its Schwab YieldPlus Fund to the safety of 1 and 2-year certificates of deposit and described it as “portfolio cash” on its website, but actually, the bond mutual fund managers loaded the fund with high concentrations of risky mortgage- and asset-backed securities that exposed fund investors to the danger of substantial losses of their principal, the claims asserted.
“The breadth of misconduct we’ve uncovered as part of our investigation is profoundly disturbing,” Shine said.
According to arbitration claims filed today with the Financial Industry Regulatory Authority on behalf of individual investors:
— 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 this major shift to investors;
— Schwab embarked on a self-dealing “damage control” marketing campaign to avert redemptions of Schwab YieldPlus by Charles Schwab retail clients, quietly selling 2.9 million Schwab YieldPlus Fund shares from other Schwab proprietary mutual funds during the period January 31, 2008, to April 1, 2008, while indicating in marketing materials, newsletters, talking points, and other investor communications that unwitting Schwab retail clients should hold their shares.
— 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 including comparisons 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 and explicit disclosure didn’t come until November 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;
— In SEC filings and direct communications with shareholders and prospective investors, Schwab misrepresented 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 false 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 the face or par value and the fund and its shareholders would recover most of their unrealized losses.
— Unlike its peers 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 had to sell illiquid securities held in the portfolio at distressed prices;
The Schwab YieldPlus Fund saw a catastrophic freefall, as 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 at $161.72 million.
The Shine-Vernon legal team has interviewed more than 100 investors as part of its Schwab YieldPlus investigation and filed arbitration claims on behalf of investors in Florida, California, Texas, New York, Missouri, Minnesota, Illinois, Alabama, and Hawaii.
“The Schwab YieldPlus Fund is a sad example of how the greed on Wall Street and the mortgage-backed securities crisis combined to devastate average investors,” Vernon said.
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