FINRA Awards Damages to Couple Invested in Schwab Fund
July 5, 2011
Following an announcement from The Financial Industry Regulatory Authority (FINRA) in January that it ordered Charles Schwab & Company, Inc., to pay $18 million to repay investors in its YieldPlus Fund after investment losses, a FINRA Arbitrator awarded damages, attorney’s fees and other costs to a couple invested in the fund.
The $18 million Schwab was ordered to pay in January consisted of the $17.5 million in fees that Schwab collected for sales of the fund, plus a fine of $500,000, both of which will be distributed as restitution to customers, FINRA reported in a press release in January.
The couple’s lawyer, Mark A. Tepper, P.A., filed the claim against Schwab in which he alleged the firm, "trained its registered representatives to sell YieldPlus, to Claimants and others, as 'a smart alternative for your cash. However, unlike cash and money market funds, YieldPlus' portfolio held large positions in long term securities which exposed the portfolio to substantial market risk.”
The claim alleged that Schwab told its clients to hold onto their YieldPlus shares even with the discount brokerage firm itself was liquidating its own YiedlPlus shares from other mutual funds, as well as its funds operated for the benefit of Schwab senior management.
YieldPlus, an ultra short-term bond fund managed by Schwab's affiliate, Charles Schwab Investment Management, posted substantial losses in 2007-2008 because more than half its portfolio holdings were mortgage backed and asset backed securities, the claim said.
FINRA's investigation found that despite severe losses in Schwab’s YieldPlus' portfolio, the firm failed to change its marketing of the fund. “In written materials and in conversations with customers, some Schwab representatives omitted or provided incomplete or inaccurate material information relating to the fund's characteristics, risk and diversification, and continued to represent YieldPlus as a relatively low-risk alternative to money market funds and other cash alternative investments that had minimal fluctuations in net asset value (NAV),” FINRA noted.
Between Sept. 1, 2006 and Feb. 29, 2008 Schwab sold over $13.75 billion in shares of YieldPlus to customers, which accounted for approximately 98 percent of the amount Schwab customers invested in ultra short-term bond funds, FINRA added. During this time, Schwab's solicited sales of YieldPlus totaled approximately $3.36 billion, approximately 40 percent of which were to customers 65 years of age or older. Schwab collected approximately $17.5 million in fees from sales of the fund.
“Firms must ensure that their marketing materials are accurate and that their brokers are provided with current information about the products they are selling so they can provide investors with the information necessary to make informed decisions,” said Brad Bennett, FINRA Executive Vice President and Chief of Enforcement, in the press release from January. “Despite the drastic change in YieldPlus' holdings that increased the fund's risk and price volatility, Schwab failed to adequately provide this information to customers and its representatives, and instead continued to market the fund to customers as a cash alternative with minimal risk and price fluctuation.”
In its advertisements and sales literature, Schwab described YieldPlus as a “cash alternative investment.” In advertising campaigns, Schwab did not disclose that the higher returns in the fund resulted from the greater risk in the portfolio. Other advertisements emphasized the "minimal risk" and "high degree of price stability" in YieldPlus, FINRA reported.