The Securities and Exchange Commission is examining whether Schwab misled its customers about YieldPlus , which, it turned out, was packed with subprime investments, according to a person with direct knowledge of the investigation. Federal investigators are also looking into similar funds managed by Bank of America and Citigroup , this person said.
If this all sounds a bit familiar, that is because it is. How much banks and others did — or did not — disclose about the risks associated with certain investments has been a big issue on postbailout Wall Street. Several other banks and investment companies have settled claims that they hoodwinked investors about certain securities or funds in the heady days before the collapse.
But unlike, say, collateralized debt obligations sold by the likes of Goldman Sachs , Schwab’s YieldPlus fund was aimed not at savvy institutional investors but at individual savers. The S.E.C. is also examining certain C.D.O. sales practices at Deutsche Bank , JPMorgan Chase and Morgan Stanley , but those inquiries largely involve big, sophisticated institutions.
Taken together, these cases are putting Wall Street on notice that investors must better understand the financial products they are being sold.
Federal regulators have been looking into the marketing practices of the Charles Schwab bond fund for well over a year. In October 2009, Charles Schwab acknowledged that it had received a Wells notice from the S.E.C., alerting the brokerage firm that the commission might file civil charges against the company and a senior executive.
Although S.E.C. officials declined to comment on the investigations, a recent class-action lawsuit filed against Schwab provides a glimpse at the ways Schwab promoted YieldPlus.
According to the lawsuit, filed in March 2008 in federal court in San Francisco, Charles Schwab marketed and sold the YieldPlus fund as a stable, short-term bond fund. In fact, the Charles Schwab fund invested more than 45 percent of its assets in mortgage-backed securities, the lawsuit claims. That made YieldPlus a much riskier investment than Schwab let on.
The lawsuit also claims that Schwab brokers were trained to sell the fund as a “safe alternative to cash” and were paid to steer their customers into it. For putting customers in YieldPlus, brokers stood to collect fees that were 10 times higher than they would have collected by steering their clients to traditional certificates of deposit.
Charles Schwab agreed to settle claims for $235 million last spring, although the firm backed out of the deal this month. In a statement announcing that it had backed out of the deal, Schwab dismissed the allegations and said it looked forward to a “fair and complete hearing” in court.
“The decline of the YieldPlus fund was caused by the credit crisis and unprecedented housing collapse of 2007-2008, not by any Schwab wrongdoing,” Schwab said. A hearing over the scuttled deal is scheduled for Thursday.
S.E.C. investigators are also examining whether sales materials for several Citigroup fixed-income hedge funds adequately disclosed the risks associated with those funds. One series, known as ASTA and MAT, invested in municipal bonds. Another, Falcon, invested in municipal bonds, bank loans and mortgage-backed securities.
But the funds relied on leverage to juice their returns, and when the markets turned against them in 2008, they were forced to shut down.
Citigroup pitched its funds to wealthy investors, including some of its own executives, including Sallie L. Krawcheck, Robert E. Rubin and Stephen Volk, according to people with knowledge of the situation. Such high-net-worth individuals are considered “sophisticated investors,” exempting Citigroup from certain registration requirements and making it trickier for regulators to bring a case.
Citigroup, which spent $250 million to cover a small portion of its clients’ losses in those funds, said that it had been cooperating with the inquiry since mid-2008 but denied that it had misled its customers. Danielle Romero-Apsilos, a bank spokeswoman, said customers were put on notice that the funds were more volatile than the stock market and they could lose their entire investment.
Bank of America faces similar scrutiny over the marketing of its Columbia Strategic Cash Management fund, which invested in mortgage bonds and other longer-term assets to offer institutional clients slightly higher returns than a traditional money fund. That fund also failed when the real estate market collapsed, forcing Bank of America to liquidate it.
Shirley Norton, a Bank of America spokeswoman, said that, as a matter of practice, the bank did not comment on regulatory investigations but always cooperated with them.
The S.E.C., meanwhile, has brought enforcement actions against mutual funds run by Evergreen Investments, Morgan Keegan and the State Street Corporation, as well as several of those firms’ employees. So far, more than $690 million has been recovered for investors through settlements and private litigation.