# FINRA Orders Schwab to Pay $18 Million to Investors for Improper Marketing of YieldPlus Bond Fund The Financial Industry Regulatory Authority (FINRA) issued a press release today announcing that it has ordered Charles Schwab & Company, Inc., to pay$18 million into a Fair Fund to be established by the Securities and Exchange Commission (SEC) to repay investors in YieldPlus, an ultra short-term bond fund managed by Schwab's affiliate, Charles Schwab Investment Management. The $18 million consists 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 have been designated as restitution to customers. The settlement is detailed in the FINRA AWC No. 2008012876902. Concurrently, the SEC charged Schwab entities and two executives for making misleading statements about YieldPlus. Schwab settled with the SEC and agreed to pay a fine of more than$118 million.

From June 2007 through June 2008, the total return on Schwab’s YieldPlus fund (SWYPX and SWYSX) was -31.7% when other ultra short bond funds had little or no losses.  These large losses occurred because Schwab’s YieldPlus fund was not an ultra short bond fund as claimed by Schwab.  It was instead an ultra long bond fund.

YieldPlus held large amounts of securities backed by illiquid, long-term, private label mortgages. It also held long maturity corporate bonds and trust preferred securities.  In doing so, Schwab’s fund violated concentration and illiquidity limits stated in its prospectus and had much more credit and liquidity risk than it disclosed in its SEC filings and marketing materials. YieldPlus’ long term securities including private label mortgage backed securities gave it a slight advantage over its peers prior to 2007.  Unfortunately, the extra yield was an order of magnitude smaller than the losses that followed when credit and liquidity spreads widened and the value of its long term holdings dropped significantly in 2007 and 2008.

YieldPlus’s heaviest reported losses occurred in early 2008, yet Schwab still appears to have understated these losses by significantly inflating the value of the fund’s holdings and therefore its net asset value (NAV).

## Friday, January 7, 2011

### SEC Press Release: Municipal Bond Fund

SEC Charges Former Portfolio Managers With Defrauding Utah Municipal Bond Fund

The U.S. Securities and Exchange Commission (SEC) issued a press release today announcing that it had
charged two former portfolio managers with defrauding a mutual fund that invests primarily in municipal bonds issued by the State of Utah and its county and local authorities.
Young and Albright – co-portfolio managers of the Tax Free Fund for Utah at the time – charged municipal bond issuers over $500,000 in “credit monitoring fees”, which were undisclosed and which they took for themselves. The press release also provides the SEC Orders against Young and Albright. Municipal bonds are bonds issued by government entities at the city, county and state levels. There are certain risks in investing in municipal bonds. Firstly, the municipal bonds issuers can default, leading to the loss of some if not all interest and principal to the investor. This is called default risk. Secondly, municipal bonds can be insured against default by a bond insurer, although the investor would be exposed to an ‘additional’ credit risk of the bond insurer itself. Thirdly, municipal bonds are subject to interest rate risks. Retail investors should also be aware of the extra costs of purchasing municipal bonds, such as fees and mark-ups and be sure that they are not excessive relative to the market. SLCG has written several papers relating to municipal bonds: Investors may find in our dedicated website many other interesting papers and notes. ## Thursday, January 6, 2011 ### SLCG Research: Futures-Based Commodity ETFs SLCG released today a new study about Futures-Based Commodity ETFs. In the past decade the price of commodities has increased substantially and many investors have wanted to diversify their portfolios by including commodities. The most common way to invest in commodities is by buying futures contracts, which requires a good understanding of the pricing of futures contract and specific features of the futures market. In the past few years we have seen many firms offer Commodity Exchange Traded Funds (ETFs) to facilitate in diversification through commodities. Some of these ETFs have grown exponentially, for example GLD, a gold ETF, has total assets of about$7 billion, and USO, an oil futures ETF, has total assets of more than \$1 billion.

In this paper we explore the rising group of Commodity ETFs that hold futures contracts and rebalance their portfolios periodically when the contracts expire. The returns of these ETFs have deviated significantly from the changes in the prices of their underlying commodities. We use crude oil ETFs (USO, USL, DBO) as case study examples to examine the sources of the deviation. We find that this deviation is correlated over time and that a significant portion of this deviation can be predicated by the term structure of the crude oil futures market.

We conclude that even though Commodity ETFs provide an alternative avenue to diversify through commodities, only investors sophisticated enough to understand and actively monitor commodity futures market conditions shall consider these ETFs.