On Tuesday, the Securities and Exchange Commission (SEC) announced that it has instituted settled enforcement proceedings against San Francisco-based broker-dealer Charles Schwab & Co., Inc. The Commission charged that Schwab allowed investment adviser customers to change mutual fund orders after the 4:00 p.m. Eastern time market close, creating the risk that such customers could unfairly capitalize on late-breaking news at the expense of other mutual fund investors. Schwab consented to the entry of an order that it cease and desist from such violations and pay a $350,000 civil penalty.
Helane Morrison, District Administrator for the SEC's San Francisco Office, said, "The Commission requires diligent compliance with mutual fund pricing restrictions to maintain fairness to all mutual fund investors. Schwab's improper practices created an unacceptable risk that certain customers would be disadvantaged."
Added Marc Fagel, Assistant District Administrator for the SEC's San Francisco Office, "Schwab failed to ensure that their personnel knew and understood the mutual fund pricing rules. In order to maintain a fair playing field, broker-dealers must make certain that their personnel understand and enforce both the letter and spirit of the rules governing the pricing of mutual fund orders."
The Commission found that, since at least January 2001, Schwab engaged in a practice of allowing its investment adviser customers to change mutual fund orders after market close under certain circumstances and still receive that day's fund price. This occurred when a customer's original pre-4:00 p.m. mutual fund order was rejected by Schwab's computer system (such as when the customer had been banned from trading in a particular mutual fund or the mutual fund was closed to new investors). Schwab permitted the adviser to submit a substitute order in a different mutual fund. According to the Commission's Order, on hundreds of occasions since 2001, Schwab personnel contacted customers after the 4:00 p.m. market close and allowed the customer to submit a substitute order in a different fund while still receiving the current day's price. Schwab's practice of processing the substitute purchase order at the current day's price violated Rule 22c-1(a) under the Investment Company Act, which requires orders for mutual fund shares placed after 4:00 p.m. to receive the next day's fund price.
The Commission's Order does not find that Schwab personnel entered into any improper agreements with customers allowing the substitute orders, or that Schwab's customers engaged in any scheme to exploit Schwab's order entry process or circumvent its controls. However, Schwab's practice of allowing investment advisers to substitute mutual fund orders created a risk that investment advisers and their clients could capitalize on post-market close information by trading after hours based on stale fund prices. Schwab ceased the practice in October 2003, following an inquiry by the Commission staff and the initiation of an internal investigation by Schwab.
Without admitting or denying the Commission's findings, Schwab consented to issuance of the Order, which orders Schwab to cease and desist from committing or causing any violations and any future violations of Rule 22c-1(a) and pay a $350,000 penalty, and censures Schwab for its misconduct.
The Commission acknowledges the assistance of the New York Stock Exchange in this matter.