[Update 1: adds FINRA settlement]
The Securities and Exchange Commission
brought regulatory charges against entities and executives of financial services firm Charles Schwab
for misleading investors in a fund with half of its assets in private-label mortgage-backed securities.
The two entities, Charles Schwab Investment Management and Charles Schwab & Co., settled with the SEC for more than $188 million, but the case continues against the executives.
The Financial Industry Regulatory Authority
ordered Schwab to pay $18 million and a $500,000 fine into a fund for restitution to customers in connection with the SEC case. The SEC filed complaints in federal court, alleging that Randal Merk, an executive vice president for CSIM, and Kimon Daifotis, CSIM's former chief investment officer, committed fraud and other violations when selling and managing the firm's YieldPlus Fund.
"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 Robert Khuzami, director of the division of enforcement at the SEC.
Antonia Chion, associate director of the SEC's division of enforcement, alleged that Schwab marketed the fund as an alternative with only slightly more risk than a money market fund. However, at one point, half of the fund's assets were invested in private-label MBS and other securities that hold a very different credit quality than money market funds.
In a statement released Tuesday, Schwab said it worked closely with the SEC and regulators to resolve the issues, and said the company's founder Charles Schwab was one of the largest investors in the fund.
Leading up to the credit crisis, the YieldPlus Fund was one of the top-performing funds in its category. According to the SEC, at its peak in 2007, the fund had $13.5 billion in assets and more than 200,000 accounts. But the fund suffered significant damage in 2007 and 2008, with assets falling to roughly $1.8 billion in one eight-month period as values declined and redemptions were filed.
The SEC found that the YieldPlus Fund deviated from its concentration policy, investing more than 25% of its assets in private-label MBS leading up to the crisis. Institutions were required to cap the percentage of assets in one industry at 25%, which Schwab and its executives passed, eventually investing more than 50% of the assets in MBS, the SEC alleged.
In its statement, Schwab said it would scrutinize such investments more closely in the future, passing much of the blame onto credit rating agencies.
"To provide future protection for individual investors from similar market crises, the company hopes that 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 company said.
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