TD Ameritade settles with Cuomo, Schwab determined to fight

Charles Schwab & Co. (SCHW) decided to take a stand and fight New York Attorney General Andrew Cuomo over how it marketed auction-rate securities. Many others have already settled, as TD Ameritrade did today. Citigroup (C), UBS (UBS) and Goldman Sachs (GS) settled last year.

Auction rate securities were sold as liquid investments that were safe, cash-like investments. Few brokers who sold them understood the risks of the investments. Auction-rate securities (ARS) are short-term debt instruments whose prices are set at auctions. When the $330 billion market collapsed in February 2008, investors lost billions because they could no longer sell them.
The big Wall Street firms settled with regulators quickly and they were not forced to repurchase securities that downstream investors bought. That left firms like Schwab and TD Ameritrade (AMTD) holding the bag. Today TD Ameritrade agreed to buy back $456 million in auction-rates securities from investors.

Schwab, so far, has refused to settle and repay its investors, who lost $789 million according to a report in The Wall Street Journal. So today Cuomo warned that his office plans to sue Charles Schwab & Co. for civil fraud.

"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" these investments and then stopped supporting the market. Schwab added that "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 didn't see."

But the key question is did Schwab brokers truly understand the risks if they sold these investments as safe, cash-like investments? Others have already settled not wanting to test this theory. Cuomo says in his letter to Schwab that brokers admitted to their ignorance about the product.

Why is Schwab one of the last holdouts on this? If they believe the big Wall Street firms have a responsibility for the losses of Schwab clients wouldn't the company show more responsibility to its investors if they bought back the securities, as TD Ameritrade did today, and then file a suit with the Wall Street firms?

Schwab must admit that these ARS investments were not safe, cash-like investments and take responsibility for the marketing techniques used by the their brokers. If Cuomo does have proof their brokers were not well trained on this investment, all Schwab is doing is showing the weaknesses of its broker staff. Letting this go to court will cost Schwab more in reputation than repaying the investors harmed.

Lita Epstein has written more than 25 books including Trading for Dummies.

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