SAN FRANCISCO, CA, November 16, 2003 -- Charles Schwab Corporation (NYSE: SCH) CEO David S. Pottruck today issued the following statement via e-mail to employees of the Corporation:
All of you know that when Chuck Schwab founded our firm about 30 years ago, his vision was to create the most useful and ethical financial services firm in the world. For that reason, disclosures like those we made last Friday in our 10-Q are undoubtedly troubling and disappointing to all of us. In order to respond to your questions and the questions of our clients, we've prepared this email to give you more facts and share with you our perspective. This is somewhat complicated, so this email is going to be long.
First, some background. As a result of the early mutual fund scandals, subpoenas and requests for information were sent to over 100 of the largest mutual fund companies and broker dealers.
We take requests like this very seriously. We hope you can appreciate the magnitude of research that is required and the level of resources we have devoted to this. Remember, since the beginning of 2001, we have processed in excess of 33 million mutual fund trades.
Our research fell into three buckets: the SchwabFunds Family; the U.S. Trust-Advised Excelsior Funds; and trades we process on behalf of the over 4000 funds that are a part of the Schwab Mutual Fund Marketplace. Let's discuss these one at a time. And please remember, our research is still ongoing so some of these facts may change as we continue to dig.
First, the SchwabFunds Family. We have examined two years of activity in these funds. Thus far, there is no evidence of the kinds of things we've been reading about over the past few months like special arrangements to permit market timing or late trading, inappropriate portfolio manager trading in the funds, or questionable arrangements with hedge funds.
As to the Excelsior Funds, thus far, we have found no late trading arrangements. These funds have thousands of clients and there were market-timing arrangements, we believe, with five institutional clients. Market timing is a practice that puts an expense burden on other fund shareholders and frankly is not good business. New management, which came into this group last summer, began to identify and terminate these arrangements before any mutual fund scandal at other firms became public, and all five arrangements are now terminated. Unfortunately, two junior employees violated our ethics policy and deleted related email files during the investigation for reasons we do not fully understand. We have found those files in backup data sources and we are cooperating with the New York Attorney General's investigation. The employees have been terminated.
That brings us to the third bucket, the funds in the Schwab Mutual Fund Marketplace. It is here that our research is most complex. As you know, we average about 50,000 purchase and redemption transactions a day for over 4,000 funds. Over a million Schwab clients use the Marketplace, including individual investors, investment advisors, and a number of hedge funds.
For years, we have applied policies, procedures, systems, and oversight to help funds enforce their market timing policies. Market timing is effectively clients "betting" on short-term swings in the market. Even with our short-term redemption fees, some clients, especially professional investors, believe this to be a successful investing strategy. Of course, most funds typically try to discourage this type of trading, and we are active in supporting these efforts.
The other issue we have been researching is late trading and we have found a limited number of trades that may have been entered or processed after the 4:00 pm deadline. Most of these trades were received on time but for one reason or another had an adjustment or substitution after the deadline in a manner that may have been contrary to company policy. We believe that our culture - with so much emphasis on client service - could have influenced our employees in doing these substitutions since none of our employees earn commission payments on these trades. But let's be absolutely clear, client service cannot be an excuse for not following industry regulations.
Our research is still a work in progress. In the millions of trades we have processed over 99.99% appear to be fine. Right now there are 18 problematic trades but that number will change as our research continues.
Some might consider 18, 180, or even 1800 problem trades out of 33 million as a tolerable failure rate in a process combining people and technology. But in a firm where our ethics and our values are a huge reason why you work here, no failure rate, even .0001%, can be tolerated. We must strive to do better. We must strive for perfection.
Clearly, these industry-wide investigations have uncovered behaviors that are deeply disturbing. It might be easy to think that the entire mutual fund industry is corrupt or broken. We just don't believe that. We do know that millions of Americans have successfully provided for their retirements and their financial dreams through their participation in mutual funds. We sincerely hope that this continues and we will participate fully as an advocate for investors as changes to the industry are carefully considered.
Before we finish, I'd like to share with you the conclusions Chuck, the Executive Committee and I have reached.
As a firm, our moral compass is strong and continues to guide us. But even among 16,000 employees, all of us must know and follow the rules. Client service is not an acceptable excuse for failing to follow industry regulations that are clear. Our oversight systems cannot be content with 99.99%. We need perfection.
This has been a daunting task... we are a firm with over $350 billion of mutual fund assets, thousands of employees and millions of transactions to examine. We are grateful for the enormous effort extended by the research team. We are also grateful that every one of our employees is driven by our vision to be the most useful and ethical financial services firm in the world. This certainly includes a never-ending commitment to be within the letter, and especially the spirit, of the industry laws and regulations. That's the foundation as we strive each day to be worthy of our clients' trust.
The Charles Schwab Corporation (NYSE: SCH), through Charles Schwab & Co., Inc. (member SIPC/NYSE), U.S. Trust Corporation, CyberTrader, Inc. and its other operating subsidiaries, is one of the nation's largest financial services firms serving 7.6 million active accounts with $913 billion in client assets as of October 31 of this year. The Charles Schwab, U.S. Trust and CyberTrader Web sites can be reached at www.schwab.com, www.ustrust.com and www.cybertrader.com, respectively.
