Schwab gets into hot water

Schwab (SCHW) has a squeaky clean image. Charles Schwab has run the firm he founded for decades, except for a brief period when the company was owned by another financial operation. But Schwab has always been the public face of his company, which has a current ad campaign called "Ask Chuck." This not one of those impersonal, "full service" brokerage firms where customers never know the name of the head man or woman. The Schwab approach gives customers and the public the sense that someone they can count on is in charge.

But the company is risking its reputation by not settling its dispute with New York State over the financial firm's sales and marketing of auction rate securities (ARS). Almost every other company on Wall Street has made provisions to get customers all or most of their investments in ARS back. The financial instruments are interest-bearing paper that many investors, both individual and corporate, where told were as liquid as cash, but carried a slightly better coupon. As it turns, out, the ARS market was controlled by a small number of very large Wall Street firms that essentially shut it down in the early stages of the credit crisis because of the risks involved in making a market in the instruments.

According to The Wall Street Journal, New York State Attorney General Andrew Cuomo will file fraud charges against Schwab for marketing the securities. The paper writes that "Schwab has denied allegations that anyone at the firm could have foreseen the auction-rate securities market's impending calamity." The firm's clients held $789 million in the paper.

Schwab may have trouble defending its decision in court, and it will almost certainly have trouble defending itself in the court of public opinion. The company is asking investors to believe that none of the senior officials at Schwab, all of them financial services executives and most of them employed on Wall Street for years, could not see the risk in ARS. Some of those risks were spelled out in the contracts between brokers like Schwab and the big operations that ran the ARS market.

Schwab is about to risk breaking the bond of trust it has with its customers and an image it took decades to create. That is a high price to pay when it could make the decision to get people who bought ARS through the company their money back.

Douglas A. McIntyre is an editor at 24/7 Wall St.


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