Schwab faces adviser discontent

Financial advisers are looking to punish The Charles Schwab Corp. for leaving them in the lurch after its bond funds suffered when investments in mortgage-backed securities went sour.

Advisers are furious that the San Francisco-based company is, according to several industry sources, making settlement offers to the least sophisticated investors who lost money in its YieldPlus Fund, bypassing many of their clients.

What’s more, advisers are upset that Schwab seems unwilling even to discuss its other products that were felled by inappropriate investments in risky mortgage-backed bonds.

“We will not be commenting because of the litigation,” said David Weiskopf, a spokesman for Schwab, referring to a number of class actions against the company.

Industry experts said that if Schwab doesn’t address the concerns, it could have a major problem on its hands.

Using Fidelity Investments of Boston to take custody of new client money instead of Schwab is one tactic being considered by Sherman Doll, managing partner of Capital Performance Advisors LLP, a Walnut Creek, Calif.-based firm with more than $700 million in assets.

His clients weren’t hurt so much by dramatic losses in the YieldPlus Fund — it had fallen 29.23% year-to-date as of June 18 — as they were losses in Schwab Charitable’s ultrashort-bond pool.

“I think charitable clients lost more than 10% in 12 months in what they figured was a fairly safe fixed-income fund,” Mr. Doll said.

After calling Schwab to see what could be done for his clients, he said he was left with the feeling that Schwab wasn’t going to be doing anything.

“Although [the Schwab representative] was sympathetic about the loss, she said that the charitable donors should have understood that any fund other than a money market fund would have fluctuation,” Mr. Doll said. “I replied that a charitable donor shouldn’t expect that kind of a loss in a short-term-bond fund.”

Advisers will stay away from its proprietary mutual funds, a business Schwab has been trying to nurture for some time, said Tim Welsh, president of Larkspur, Calif.-based Nexus Strategy LLC and a former marketing director of Schwab Institutional.

“Once you have been burned by a fund or a fund family, the client remembers,” he said. “It could push back growing [Schwab’s] proprietary product in a big way.”

Beyond its proprietary funds, however, it’s hard to see Schwab suffering too much fallout, Mr. Welsh said.

“Schwab has weathered the storm of adviser discontent for decades,” he said.

But advisers have always remained loyal, Mr. Welsh said. That loyalty, however, will be put to the test.

Richard Schroeder, executive vice president of Schroeder Braxton & Vogt Inc., an Amherst, N.Y., financial advisory firm with $220 million in assets, agrees that Schwab is not properly handling the situation.

SCHWAB’S RESPONSE

Calls to Schwab did little to suggest that it was going to do anything to help his clients who had been in the YieldPlus Fund, he said.

“They haven’t been forthcoming,” Mr. Schroeder said about Schwab. “Once the controversy broke, the fund people were good at answering questions, but in our opinion seemed to minimize the problem.”

Mr. Schroeder is not considering moving custody of client assets away from Schwab. Instead, he said, he just won’t use Schwab’s funds.

“We’re just not comfortable with their fund management arm,” Mr. Schroeder said. “We don’t give second chances.”

Neither does Susan Brown, an adviser with Back Bay Financial Group Inc., a Boston-based firm with more than $400 million under management.

The firm’s clients weren’t in the YieldPlus Fund, but some were in the Schwab Total Bond Market Fund, she said.

That fund experienced losses (it had dropped 3.54% year-to-date as of June 18) as a result of investments in risky mortgage-backed securities, even though it was sometimes referred to as an index fund in marketing materials, Ms. Brown said.

If it truly was marketed as an index fund — something Ms. Brown said Schwab denies — it should not have held risky mortgage-backed bonds.

It’s easy to see why there is confusion surrounding the Total Bond Market Fund, some industry observers said.

Formerly the Schwab Long-Term Government Bond Fund, it was converted to the Schwab Total Bond Market Index Fund at the end of 1997. It was converted again — without much fanfare — in 2002 to the Total Bond Market Fund.

“We would have appreciated it if they could have put us in touch with the portfolio manager,” Ms. Brown said. “The fact is that they were unwilling to hold a conference call or allow us to talk to a portfolio manager. If I were looking at a Schwab fund now, it would influence my decision.”

ADVISERS UPSET

“Advisers are as upset or more as the clients who lost money,” said Andrew Stoltmann, a plaintiff’s attorney and partner in Stoltmann Law Offices PC in Chicago.

He said he has spoken to about 100 YieldPlus investors and has filed for Financial Industry Regulatory Authority Inc. arbitration for three of them, with average losses of about $30,000. Finra is based in New York and Washington.

Advisers may end up being “key witnesses” in those arbitration hearings, Mr. Stoltmann said.

Schwab is also accused in at least eight proposed class actions of misleading investors by describing the YieldPlus Fund in prospectuses as only “marginally” riskier than cash.

Schwab shouldn’t necessarily be cajoled into paying restitution to investors who lost money in its bond funds, said Matthew Wright, investment manager for Wade Financial Group Inc., which manages $160 million from Minneapolis.

“There’s always risk with investing,” said Mr. Wright, whose clients once owned Yield Plus Fund shares.

Having said that, he admitted that he would think very carefully about ever again using a Schwab fund.

“I would generally avoid them,” Mr. Wright said.

E-mail David Hoffman at [email protected].