The Schwab YieldPlus Fund was promoted as "a smart alternative for your cash," among other things - before its value plunged - prompting the SEC to investigate whether Schwab's customers were misled on this investment.  The investigation may evolve into an SEC "message case." 

And just in case Schwab thinks it's being singled out, a person with direct knowledge of the SEC investigation said that federal investigators also are looking into similar funds managed by Bank of America and Citigroup. So reports NYTimes reporter Eric Dash.

And just in case anyone thinks this case is very similar to, say, the CDO's (collateralized debt obligations) sold by Goldman Sachs, it should be remembered that Schwab’s YieldPlus Fund was aimed not at institutional investors but at individual investors. 

And just in case Goldman thinks it's being singled out, it may be reassuring to know the SEC is also examining certain CDO sales practices at Deutsche Bank, JPMorgan Chase and Morgan Stanley - again, investments involving large, sophisticated institutions.

    The Investigation into Schwab YieldPlus.   Taken together, these cases put Wall Street on collective notice that investors must better understand the financial products they are being sold.  But as far as Schwab, 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 having received a Wells notice from the SEC, alerting the brokerage firm that the commission might file civil charges against the company and a senior executive.   The regulators decline to comment on the investigations, but a recent class-action lawsuit filed against Schwab may provide a glimpse at the ways Schwab promoted its fund.

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, according to the lawsuit.

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.

    SEC Investigations into Citigroup, Bank of America Funds.   SEC investigators are looking into several Citigroup fixed-income hedge funds to see if sales materials 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 SEC, 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.  Stay Tuned!    [NYTimes, 11/17]