U.S. Securities & Exchange Commission
SEC Seal
Home | Previous Page
U.S. Securities and Exchange Commission


LITIGATION RELEASE NO. 21805 / January 11, 2011

SEC v. KIMON P. DAIFOTIS AND RANDALL MERK, Civil Action No. CV-11-0137 MEJ (N.D. Cal. Jan. 11, 2011)


The Securities and Exchange Commission today charged Kimon Daifotis and Randall Merk with fraud and other securities law violations in a complaint filed in the U.S. District Court for the Northern District of California. Daifotis is the former lead portfolio manager for the Schwab YieldPlus Fund and was the Chief Investment Officer for Fixed Income for Charles Schwab Investment Management (CSIM). Randall Merk is an Executive Vice President at Charles Schwab & Co., Inc. (CS&Co.), and formerly was President of CSIM and a trustee of the YieldPlus and other Schwab funds.

In its complaint, the Commission alleges that Daifotis and Merk committed fraud and other securities law violations in connection with the offer, sale, and management of the YieldPlus Fund. YieldPlus is an ultra-short bond fund that, at its peak in 2007, had $13.5 billion in assets and over 200,000 accounts, making it the largest ultra-short bond fund in the category. The fund suffered a significant decline during the credit crisis of 2007-2008 and saw its assets fall from $13.5 billion to $1.8 billion during an eight-month period due to redemptions and declining asset values.

According to the complaint, Merk and Daifotis misled investors about the risks of investing in the YieldPlus Fund. For example, they described the fund as a cash equivalent or alternative that had only slightly higher risk than a money market fund in marketing and other communications. The statements were misleading because the fund was riskier than money market funds, and Merk and Daifotis failed to inform investors adequately about the differences between YieldPlus and money market funds. For example, the maturity and credit quality of the YieldPlus Fund’s securities were significantly different than those of a money market fund.

The complaint further alleges that, in mid-2007, the YieldPlus Fund’s NAV began to decline and many investors redeemed their holdings. Unlike a money market fund, few of the fund’s assets were scheduled to mature within the next several months. As a result, the fund had to sell assets in a depressed market to raise cash. While the YieldPlus Fund’s NAV declined, Merk, and Daifotis held conference calls, issued written materials, and had other communications with investors that contained a number of material misstatements and omissions concerning the fund. For example, in two conference calls, Daifotis made false and misleading statements that the fund’s was experiencing “very, very, very slight” and “minimal” investor redemptions. In fact, Daifotis knew or was reckless in not knowing that YieldPlus had experienced more than $1.2 billion in redemptions during the two weeks prior to the calls, which caused YieldPlus to sell over $2.1 billion of its securities. Similarly, Merk authored, reviewed and approved misleading statements about the fund, such as a false claim that the fund had a “short maturity structure” that “mitigated much of the price erosion” experienced by its peers.

The complaint also charges Daifotis with aiding and abetting the YieldPlus Fund’s deviation from its concentration policy by directing the Fund’s investment of more than 25% of fund assets in private-issuer mortgage-backed securities (MBS). Mutual funds and other registered investment companies are required to state certain investment policies in their SEC filings, including a policy regarding concentration of investments. Once established, a fund may not deviate from its concentration policy without shareholder approval. Schwab’s bond funds, including the YieldPlus Fund and the Total Bond Market Fund, had a policy of not concentrating more than 25% of assets in any one industry, including private-issuer MBS. The complaint alleges that the funds violated this policy, and the Investment Company Act, when Daifotis directed the investment of approximately 50% of the assets of the YieldPlus Fund and more than 25% of the Total Bond Fund’s assets in private-issuer MBS without obtaining shareholder approval.

The complaint also charges Merk with aiding and abetting violations of anti-fraud provisions of the Investment Advisers Act. The complaint alleges that Merk approved other Schwab funds’ redemptions of their investments in YieldPlus at a time when Merk knew or was reckless in not knowing that a portfolio manager for those funds had received material, nonpublic information about the YieldPlus Fund without the authorization of the YieldPlus Fund’s board of trustees.

In its complaint, the SEC alleges that:

  • Daifotis and Merk violated anti-fraud provisions of the federal securities laws, specifically Section 10(b) and Rule 10b-5 of the Exchange Act and Section 17(a) of the Securities Act, and aided and abetted violations of Section 10(b) and Rule 10b-5 of the Exchange Act and Section 206(4) and Rule 206(4)-8 of the Investment Advisers Act;
  • Merk aided and abetted violations of additional anti-fraud provisions of the Investment Advisers Act, Sections 206(1) and (2);
  • Daifotis and Merk violated and aided and abetted violations of the false filings provisions of the Investment Company Act, Section 34(b);
  • Daifotis aided and abetted violations of the shareholder voting rights provision of the Investment Company Action, Section 13(a).

In a related proceeding, the SEC issued a settled administrative order, and filed a settled district court complaint, against CSIM, CS&Co. and Schwab Investments.

See Also:




Modified: 01/11/2011