Schwab violated law in YieldPlus rejiggering: Judge

District court rules that the mutual fund's heavy bets on mortgage-backed securities required shareholder approval

Charles Schwab Corp. violated an investment adviser law when it failed to get shareholder approval before investing more than 25 percent of the assets in its YieldPlus mutual fund in mortgage-backed securities, a federal judge ruled.

U.S. District Judge William H. Alsup in San Francisco said yesterday that Schwab’s fund managers in 2006 “reversed field and repudiated” the fund’s policy of limiting investments in any one industry to 25 percent. Doing so required a shareholder vote under the Investment Company Act of 1940, Alsup wrote.

“It was an entire repudiation of a clear-cut definition that had become a fixture of the fund on which shareholders were entitled to depend for the safety of their savings,” the judge wrote. “A vote was required.”

Steve W. Berman, an attorney for Schwab investors suing the company, said the ruling affects California YieldPlus shareholders who bought into the fund before 2006. Their damages are estimated at as much as $157 million, he said. Alsup didn’t rule on claims by a nationwide group of investors with damages estimated at $802 million, Berman said in a telephone interview.

“While we strongly disagree with the judge’s ruling on this issue, he has only ruled on one of several claims, and there are many more issues to be decided,” a Schwab spokesman, David Weiskopf, said in an e-mail. “We look forward to putting all the facts, evidence and expert testimony to the jury and presenting a strong case at trial.”

The Securities and Exchange Commission, which has questioned Schwab over its handling of YieldPlus, also told the company that it needed investor approval, according to court filings.

Schwab has tried to dissuade the agency from bringing a variety of claims against it, filings said. Schwab may face an SEC lawsuit over the fund, the company said in October.

YieldPlus shareholders lost millions when the fund, which had invested half of its assets in mortgage-backed securities without federal insurance, fell amid the collapse of the housing market.

Alsup’s pretrial ruling means the claim that the lack of a shareholder vote violated the law doesn’t have to be decided by a jury. The judge hasn’t ruled on whether other claims should be decided at a trial scheduled for May 10.

Investors claim Schwab misled shareholders by describing the fund as only “marginally” riskier than cash. The company failed to disclose that mortgage-related securities eventually accounted for more than half of the fund’s value and might be hard to sell, investors said in complaints now consolidated before Alsup.

The case is In Re Charles Schwab Corp. Securities Litigation, 08-cv-01510, U.S. District Court, Northern District of California (San Francisco).