SEC Puts Schwab On Notice Over Mutual Funds

By Christine Caulfield

Law360, New York (October 15, 2009) -- Charles Schwab Corp. is facing a possible enforcement action by the U.S. Securities and Exchange Commission over two mutual funds that invested heavily in mortgage-backed securities.

The brokerage said in a regulatory filing Wednesday that it had received a Wells notice alerting it that SEC staff intended to recommend the filing of an enforcement action against three units of the company and the president of the funds for possible securities law violations.

The fixed income funds under investigation by the commission — the Schwab YieldPlus Fund and the Schwab Total Bond Market Fund — are already the target of putative class actions, the San Francisco-based brokerage said.

“The company intends to respond to the notice to explain why it believes enforcement charges are unwarranted,” it said.

Schwab spokesman Greg Gable declined to comment on the notice Thursday.

An investment advisory firm filed a putative class action in the U.S. District Court for the Northern District of California against Schwab in August 2008 alleging its Bond Market Fund deviated from its stated investment strategy by investing heavily in mortgage-backed securities.

Northstar Financial Advisors Inc. claimed that Schwab violated the law when it deviated from the fund’s stated investment objective to track the Lehman Brothers U.S. Aggregate Bond Index, by investing in risky non-U.S. agency collateralized mortgage obligations that were not part of the Lehman Index, and by investing more than 25 percent of its total assets in U.S. agency and nonagency mortgage-backed securities and CMOs.

Investors alleged in a separate suit in the same court that Schwab and other defendants misrepresented the risk profile of two YieldPlus funds and improperly changed their investment policies.

According to that suit, filed in March 2008, the company failed to give customers accurate information about the risks of the funds and deprived them of the opportunity to vote on changes to its investment policies.

At the time of the filing, the funds had decreased significantly in value.

The lawsuit includes charges of securities fraud against Schwab, subsidiaries Charles Schwab & Co. Inc. and Charles Schwab Investment Management Inc., and CEO Charles R. Schwab.

The plaintiffs allege the defendants issued false and misleading registration statements and prospectuses related to the funds and made material omissions in assessing the funds' levels of risk and diversification.

Auditor PricewaterhouseCoopers LLP was initially named as a co-defendant in that suit but was subsequently dropped.

The plaintiffs in that case are represented by Hagens Berman Sobol Shapiro LLP.

Northstar is represented by Berman DeValerio and Greenbaum Rowe Smith & Davis LLP and Wolf Popper LLP.

Schwab is represented by Morrison & Foerster LLP.

The Northstar case is Northstar Financial Advisors Inc. v. Schwab Investments et al., case number 3:08-cv-04119, in the U.S. District Court for the Northern District of California.

The YieldPlus case is In re: Charles Schwab Corp. Securities Litigation, case number 08-cv-01510, in the U.S. District Court for the Northern District of California.

--Additional reporting by Jacqueline Bell, Pete Brush and Anne Urda