April 13, 2010
District Court Denies Schwab Summary Judgment in Fund Class Action Involving Mortgage-Backed Securities
In re Charles Schwab Corp. Securities Litigation (No. C 08-01510 WHA, Apr. 8, 2010)Download Schwab.040810 provides an entertaining read and a rare victory for plaintiffs in defeating defendants' motion for summary judgment. Mutual fund holders alleged that the fund represented that the fund was diversified and never concentrated more than 25% in a single industry, but in fact it had concentrated more than 50% in residential housing and/or commercial real estate industry. Defendants' defense centered on a 3-sentence disclosure included in the SAI (which, you will recall, is not included in the prospectus but must be requested by investors):
The funds have determined that mortgage-backed securities
issued by private lenders do not have risk characteristics that are
correlated to any industry and, therefore, the funds have
determined that mortgage-backed securities issued by private
concentration policies. This means that a fund may invest more
than 25% of its total assets in privately-issued mortgage-backed
securities, which may cause the fund to be more sensitive to
adverse economic, business or political developments that affect
privately-issued mortgage-backed securities. Such developments
may include changes in interest rates, state or federal legislation
affecting residential mortgages and their issuers, and changes in
the overall economy.
The court placed these three sentences in the context of the 35-pages of "Investments, Risks and Limitations" contained in the SAI and found that, apart from the three sentences, the disclosure left the distinct impression that fund was diversified and that its plan was never to concentrate more than 25% in a single industry. Viewing the record most favorably to the plaintiffs, a jury could reasonably find that the three sentences had a low profile compared to the much higher profile of the attractive features of the fund. "In short, if defendants are going to define away the problem, a jury could reasonably find that they did not do so plainly enough."
The court also denied defendants' motion for summary judgment on loss causation. "If a mutual fund holds itself out as investing no more than 25% in a single industry but then, as actually planned, invests 50% in a single industry, there is no escape by blaming the industry rather than the promoter."
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