Charles Schwab Corp will pay $118.9 million to settle regulatory charges that it hid from investors the mortgage-related risks in a seemingly safe, multibillion-dollar bond mutual fund.
The U.S. Securities and Exchange Commission announced the settlement and filed a civil lawsuit charging two Schwab executives, Kimon Daifotis and Randall Merk, with violating securities fraud laws over how the Schwab YieldPlus fund was marketed.
Schwab, a discount brokerage and fund company, expects a $97 million fourth-quarter after-tax charge for its settlement, which it said resolves related proceedings by the Financial Industry Regulatory Authority and Illinois regulators.
The $118.9 million payment includes fines totaling $57.3 million and will be used for restitution to investors.
YieldPlus had about $13.5 billion of assets in more than 200,000 accounts in 2007, making it the largest ultra-short bond mutual fund at the time.
But it suffered a total return of negative 42 percent in 2008 and 2009 as the credit crisis caused riskier investments it held to lose value or become illiquid.
Redemptions fueled the decline, as assets fell to $1.8 billion from $13.5 billion in just eight months, the SEC said.
Tuesday's settlement follows approval last November 24 by U.S. District Judge William Alsup of a $235 million agreement by San Francisco-based Schwab to settle a lawsuit by investors who said they lost $970 million by investing in the fund.
The SEC settlement requires court approval. Its civil case against Daifotis and Merk seeks fines and other remedies.
STATEMENTS ALLEGEDLY MISLEADING
Many fund companies marketed ultra-short funds as a safe alternative to money market funds and other cash equivalents.
The SEC said Schwab marketed YieldPlus in this manner, but nonetheless put about half the fund's assets into private-issuer mortgage-backed securities, twice the maximum allowed, without getting required shareholder approval.
It accused Daifotis, a former chief investment officer for fixed income, in conference calls falsely said the fund was suffering very, very, very slight or minimal redemptions.
The SEC also said Merk, an executive vice president, approved statements suggesting the fund was structured to avoid large principal losses.
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, SEC enforcement chief Robert Khuzami said in a statement.
Schwab did not admit wrongdoing, and in a statement said it would never seek to profit at clients' expense.
Daifotis will defend against the SEC lawsuit, his lawyer David Bayless said in an interview.
He didn't do anything wrong, had no incentive to commit the fraud the SEC suggests, and invested a significant amount of his own money in the fund, Bayless said. He has been a shareholder from day one and never sold a single share.
Merk will also fight the lawsuit, which is not supported by the actual evidence, his lawyer Susan Brune said in a statement.
Schwab had in October 2009 received a Wells notice from the SEC indicating possible civil charges in the case.
In afternoon trading, Schwab shares were down 3 cents at $17.92 on the New York Stock Exchange.
The case is SEC v. Daifotis et al, U.S. District Court, Northern District of California.
(Reporting by Jonathan Stempel in New York, editing by Matthew Lewis, Gary Hill)