In November, Charles Schwab & Co. disclosed instances of late trading and market timing in its Excelsior Funds, operated by its U.S. Trust unit.

Not only did the news mark Schwab's first public implication in the mutual fund mess, it also trained a spotlight on the internal tension between Schwab Institutional advisors and U.S. Trust, which Schwab bought for $2.7 billion in early 2000. Many Schwab advisors were wary of U.S. Trust from the beginning. The primary source of tension is the funneling of high-net-worth clients to U.S. Trust — a practice that seems to play the unit as a favorite.

The fact that the unit's indiscretion has now dragged the Schwab name into the mud pit highlights the problem with granting one unit a favored status, advisors say.

“I think they're playing a different game [at U.S. Trust],” one advisor says. “We have a pretty basic set-up here, and I'm not sure they're always necessarily on board with it. This whole thing has kind of proved it.”

Another advisor points out that U.S. Trust has been allowed to keep its own infrastructure rather than converting to Schwab platforms. “Considering that, it's little surprise that this happened,” he says.

Of course, Schwab acquired U.S. Trust specifically because of its deep experience in dealing with well-to-do clients. Force-converting such a firm to corporate practices and systems geared to mom-and-pop investors would seem counter intuitive.

Still, it's easy to understand why Schwab advisors would feel U.S. Trust is a double negative for them.

At Schwab's annual conference in November, during an open forum between senior management and Schwab Institutional advisors, several advisors lamented a trend of high-end clients passing up Schwab Institutional in favor of U.S. Trust.

“It stinks,” says one Schwab Institutional advisor. “They say they're not directing top clients straight to them, but I've personally seen three instances where it's happened. And I'm not alone.”

The disclosure of impropriety at U.S. Trust put Schwab management in an awkward position at its own conference. During the conference, before the news came out, Randy Merck, the firm's president of investment management, was asked for assurance that the firm would not end up in the headlines for mutual fund improprieties.

“You won't see that,” Merck said, flatly. “We don't anticipate any problems.”

Thirty-six hours later, he had to backtrack. “I was speaking specifically of the funds that Schwab manages,” Merck said afterwards. “It's an ongoing process, but we haven't found anything in those.”

The firm was quick to point out that the abuses were self-reported, and that it was cooperating with the SEC and the office of New York Attorney General Eliot Spitzer. Further, Schwab executives emphasized that the late trading and market timing were not prevalent.

“It has been a limited number of incidents, and we're still searching for problems” said Jeff Lyons, Schwab's executive vice president of mutual funds.

“We've done more than 33 million mutual fund transactions over the last two-and-a-half years. We're not through everything yet.”