On January 11, 2011, the SEC charged Charles Schwab Investment Management (“CSIM”) and Charles Schwab & Co., Inc. (“CSC”) with making misleading statements regarding the Schwab YieldPlus Fund and failing to establish, maintain and enforce policies and procedures to prevent the misuse of material, nonpublic information. The SEC also charged CSIM and Schwab Investments with deviating from the fund's concentration policy without obtaining the required shareholder approval. On the same day, FINRA settled with CSC regarding improper marketing of the fund. In addition, the SEC filed a complaint in federal court against CSIM's former fixed income chief investment officer, Kimon Daifotis, as well as Randall Merk, an executive vice president at CSC and formerly president of CSIM and a trustee of the fund, alleging that Mr. Daifotis and Mr. Merk committed fraud and other securities law violations in connection with the offer, sale and management of the fund.
According to the SEC, investors were not adequately informed about the risks of investing in the fund. For example, the fund was described in marketing materials as having only slightly higher risk than a money market fund. The SEC found that the statements were misleading because the fund was more than slightly riskier than money market funds, and CSIM, CSC and the executives did not adequately inform investors about the differences between the fund and money market funds. The SEC also found that the fund deviated from its concentration policy when it invested more than 25% of its assets in private-issuer mortgage-backed securities, contrary to its policy of not concentrating more than 25% of its assets in any one industry.
Furthermore, the SEC found that material misstatements and omissions concerning the fund were made. The fund suffered a significant decline during the credit crisis of 2007 and 2008 and its assets fell from $13.5 billion to $1.8 billion during an eight-month period due to redemptions and declining asset values. The fund's portfolio consisted of investments that were scheduled to mature within the next several months. However, when investors began pulling money out of the fund, the fund had to sell assets in a depressed market to raise cash. In response to market events and fund redemptions, CSIM, CSC, and the executives held conference calls, issued written materials, and had other communications with investors that contained a number of material misstatements and omissions concerning the fund, including misstatements by Mr. Daifotis regarding minimal investor redemptions and by Mr. Merk regarding the liquidity of the fund and its ability to avoid selling assets at depressed prices.
In addition, the SEC found that CSIM and CSC did not have policies and procedures reasonably designed to prevent the misuse of material, nonpublic information about the fund, including specific policies and procedures governing redemptions by fund portfolio managers, and did not have appropriate information barriers concerning nonpublic and potentially material information about the fund.
CSIM and CSC agreed to pay the SEC a total of nearly $119 million, including $52 million in disgorgement of fees by CSIM, a $52 million penalty against CSIM, a $5 million penalty against CSC, and pre-judgment interest of $9 million. CSC agreed to pay FINRA $18 million, including a fine of $500,000 and $12.5 million to a fair fund to be established by the SEC to repay fund shareholders for fees paid to CSC. The SEC's case continues against the executives.