Claiming to be holier than thou is not a prescription for winning friends among the thous. But it can be an effective marketing strategy in a business where public confidence is less than solid.
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Charles Schwab & Company, the brokerage firm, presents itself as an alternative to Wall Street.
On Wall Street, nobody has used that strategy better than Charles Schwab & Company. Eight years ago, when research analyst conflicts were in the news, Schwab ran a television commercial that memorably showed a manager at a rival brokerage firm promising “courtside playoff seats” to his brokers, but only if they “put some lipstick on this pig.”
On Schwab’s Web site now is a letter from Charles Schwab, the founder and chairman, proclaiming: “I made a commitment. I’m on the side of the investor.” For 30 years, he says, “we’ve kept our clients’ interest as our main focus, creating a true Wall Street alternative for all investors.”
It turns out that Schwab did not live up to those promises during the financial crisis, for which it agreed this week to pay $119 million to the Securities and Exchange Commission and other regulators, most of which will go to investors who bought into Schwab’s marketing hype for a fund full of risky investments that was promoted as a safe way to do better than a money market fund.
It may be debatable whether Schwab lied to investors about the fund. But it is clear that it misled them about a crucial aspect of the fund’s investments. As the financial crisis was growing, Schwab decided that a security’s maturity was not, as it previously said and as any normal person would think, the date a security was scheduled to mature. Instead, it decided that a security that would mature in 20 years, but whose interest rate was reset every month, had a one-month maturity.
To notice the change had been made, an investor would have had to be a very, very careful reader of financial statements. But even that reader would have had no way to figure out the impact of the change, which turns out to have been huge.
Companies that settle with the S.E.C. neither admit nor deny the commission’s allegations. But they seldom are as eager to point the finger of blame elsewhere as Schwab was. There was no hint of remorse that the fund had concentrated fund assets far more than it had told investors it would, or that it had made numerous misleading statements when the fund was crashing.
Instead, the firm says it never could have seen the disaster coming:
“The decline in the YieldPlus fund was the result of an unprecedented and unforeseeable credit crisis and market collapse. Until the credit crisis, the YieldPlus Fund was consistently one of the top performing funds in its category for eight years.”
And it wants us to know who the real villains are. Holier-than-thou is back:
“To provide future protection for individual investors from similar market crises, the company hopes that greater focus and attention will ultimately be given to the investment banks that created mortgage-backed securities and the ratings agencies that legitimized them with triple-A ratings, which have so far largely escaped scrutiny and accountability.”
Goldman Sachs, which paid $550 million to the S.E.C. after being accused of violating securities laws in putting together a particularly egregious mortgage-backed security, would no doubt be interested to know that it has “so far largely escaped scrutiny and accountability.”
In one way, Schwab has a point. Almost everyone connected with the credit bubble acted badly. But surely investment managers who promise to be different could show a little contrition about the fact that a fund they vigorously marketed as “a cash alternative for investors” lost nearly half its value.
A more reflective person than Mr. Schwab seems to be would long ago have figured out what went wrong at YieldPlus. It was the same things that let the fund seem to be a star performer for so many years. It took more risks than similar funds, and in good times such risks are rewarded.
Perhaps the biggest risk Schwab was taking was one that investors could not have known about. The S.E.C. states that in mid-2007, only 6 percent of the fund’s assets matured within six months. That was critical. It meant that when liquidity dried up in the credit crisis the fund had few securities that it could simply allow to mature. Instead, it had to sell assets for whatever it could get. In a lot of cases that was not very much.
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