Break points haul Schwab into court

Renowned class-action lawyers are using a consumer-friendly California statute to sue Charles Schwab & Co. Inc. for allegedly bundling mutual fund purchases made by customers and then not passing on the savings to them.

The class action is one of four separate but nearly identical lawsuits filed April 15 in California Superior Court in San Francisco County by Hulett Harper Stewart LLP and Emge & Associates, both of San Diego. It relies heavily on the “break point” study published last month by NASD, the New York Stock Exchange and the Securities and Exchange Commission.

The other three suits were filed against The Bear Stearns Cos. Inc., Merrill Lynch & Co. Inc. and Salomon Smith Barney Inc., all in New York.

The law firms say they have completed an initial study that shows that San Francisco-based Schwab and the three Wall Street firms misled the general public about the “existence or non-existence of break-point discounts.”

Mutual fund companies apply percentage discounts at each threshold, or break point – generally $50,000, $100,000, $250,000 and $500,000 – in the purchase of front-end-load funds.

Such funds are typically sold by stockbrokers because the load goes toward paying their commissions.

No excuses

Schwab doesn’t employ commission-earning stockbrokers.

But Kirk B. Hulett, a partner with Hulett Harper Stewart, insists that Schwab’s mutual fund supermarket approach doesn’t absolve it.

“[The earning of commissions] is by the entity in the case of Charles Schwab,” Mr. Hulett says.

Glen Mathison, a Schwab spokesman, suggests the California lawyers may be shooting from the hip.

“We don’t think the lawsuit reflects an understanding of our business or accurately characterizes the relationship we have with third-party mutual funds,” Mr. Mathison says. “We find the lawsuit is without merit, and we plan to vigorously defend ourselves.”

Less than 6% of the 4,722 mutual funds offered by Schwab carry front-end loads. And just 25% of the front-load funds on Schwab’s platform are sold to retail investors, he adds.

But the lawyers say Schwab may not have considered all the angles yet.

Left coast burden

“We’ll sit down and show some information with them that will satisfy their concerns at that time,” says Derek Emge, principal with Emge & Associates.

He adds that under the California statute 17200, Schwab is open to greater potential liability than its New York counterparts. As a California-based corporation, the broker is liable for any illegal actions it perpetrates nationally, whereas the New York firms’ exposure is limited to transactions completed with California consumers.

Smith Barney spokeswoman Mary Ellen Hillery says the firm declines to comment on the suit. Calls to Bear Stearns and Merrill Lynch were not returned.

A 17200 action is colloquially known as a “private-attorney-general” action because a law firm can bring suit on behalf of any concerned citizen – even if that person hasn’t sustained damages. It is the lawsuit equivalent of a citizen’s arrest.

Mr. Emge says using this statute is far less onerous for the prosecuting law firm than it would be to bring a class action.

In this case, the firms filed the suits on behalf of Dawn R. Steele, a resident of La Canada, Calif.

During the investigation of 44 broker-dealers by NASD, the SEC and the NYSE, it was determined that 42 of those firms had – intentionally or unintentionally – failed to apply break points properly to purchases made by customers. The study says that overcharges ranged from $2 to $10,000 for a given customer.

Hulett Harper Stewart and Emge & Associates chose the four firms following a private investigation, Mr. Emge says.

Still, attorney Christopher Keller, an associate with Goodkind Labaton Rudoff & Sucharow LLP in New York, thinks that the firms face an uphill battle in seeking a big payday out of this lawsuit. Goodkind Labaton has a large securities law practice.

“You haven’t seen a mountain of these things being filed,” Mr. Keller says.

One reason for that is that the NASD, NYSE and SEC study said that firms should and are taking self-corrective action, says Joel Bernstein, partner with Goodkind Labaton.

If these firms are working at self-policing themselves, “what does the lawsuit accomplish?” Mr. Bernstein asks.

Indeed, a March 11 press release by NASD says: “Following a December NASD/SEC directive to review their break-point policies and procedures, most firms report that they are undertaking significant reviews of their supervisory practices, and a number already have implemented changes.”

The NASD, NYSE and SEC study also indicates that most, if not all, of the communication lapses by broker-dealers were inadvertent.

For instance, firms didn’t have the technology to aggregate the fund purchases of a husband and wife who would have qualified for a discount. In other cases, the technology or procedures failed to aggregate purchases made for a Section 529 college savings plan and a 401(k).

But Mr. Hulett says that his discovery efforts may reveal that the behavior of these firms wasn’t as unintentional as the study showed.

“My history and suspicion tells me it’s not an accident in making these costly errors,” he says. “These errors are not to the detriment of Schwab and Merrill.”

Hulett Harper Stewart comprises lawyers who four years ago split from Milberg Weiss Bershad Hynes & Lerach LLP, the New York firm that brought a rash of lawsuits against publicly traded technology companies whose shares collapsed in 2000 and 2001.

The firm is likely well financed. Three months ago, Dennis Stewart – who recently helped win a court judgment of $800 million against Visa International and MasterCard Inc. related to overcharges for currency conversions on credit card purchases made abroad – joined the firm from Milberg Weiss as a partner.

In that instance, Mr. Stewart also relied on a 17200 action through the California legal system. Visa is based in Foster City, Calif., while MasterCard is in Purchase, N.Y.