Posted on 20 Jul 2009
In an official notice sent to Charles Schwab & Co. Friday, Attorney General Andrew Cuomo warned that his office plans to sue the largest online brokerage firm for civil fraud over its marketing and sales of auction-rate securities to clients. Emails and testimony cited in the letter show Schwab's brokers had little idea of what they were selling and later failed to tell clients that the market was collapsing.
Auction-rate securities -- short-term debt instruments whose prices reset in periodic auctions -- caused billions in losses for investors after the $330 billion market collapsed in early 2008.
Mr. Cuomo writes in the letter that his office would be open to a settlement with Schwab, but it must agree to buy back the securities from investors still stuck with them.
More than a dozen Wall Street firms and small brokerages agreed to pay more than $60 billion to buy back the securities from investors after investigators found they didn't properly inform clients about the risks, or that the market was crumbling, increasing their losses. Schwab is among a handful that haven't settled.
"The Attorney General's allegations are without merit," Schwab said in a statement. "They unfairly lay blame on our company for an illiquid market and improper behavior by the large Wall Street firms that created" and then stopped supporting the market.
"Schwab brokers, while trained to levels beyond industry standards, could not be expected to foresee and disclose market risks that even regulators and market experts did not foresee," Schwab said.
The attorney general's investigation of Schwab found that brokers were unaware of and misleading about the risks of the securities -- promoting them to customers as cash-like investments, according to the letter. It also found that some traders and executives knew the market was cracking as early as the autumn of 2007 and took steps to protect the company, but didn't disclose those problems to customers.
At Charles Schwab, which uses the advertising slogan "Talk to Chuck," brokers admitted their ignorance about the product, according to Mr. Cuomo's letter.
A broker testified to Mr. Cuomo's investigators: "I don't know what measuring scale you would want to use to assess my knowledge about auction-rate securities...but on whatever measuring scale my knowledge was pretty low," according to the letter.
Charles Schwab executives received daily reports showing in the fall of 2007 that demand for the instruments was declining rapidly, but it didn't make that information available to clients, said the letter.
In February of 2008, nearly 900 Charles Schwab customers got stuck with $789 million of securities, according to a person familiar with the matter. Schwab owes a small fraction of that amount now, said people familiar with the matter.
The letter cites an email exchange between Schwab executives where one writes there is "brand risk of course" if Schwab customers "can't get...access to their funds."
The letter reveals another exchange in which an executive wrote in an email after learning of failed auctions, "This will definitely hit the Bond Buyer (maybe not until Friday) and it will likely hit the Journal as well. B[ank] of A[merica] has told us that they are not telling anyone today [that] there has been a failed auction -- but it will likely come out tomorrow when the actual settlement occurs."
Bank of America settled last October with regulators and agreed to buy back $4.5 billion in securities from its clients.