Financial Regulatory Forum

Schwab faces ARS fraud charge, TD Ameritrade settles

By Reuters Staff
July 20, 2009

New York State Attorney General Andrew CuomoBy Jonathan Spicer
NEW YORK, July 20 (Reuters) – New York’s attorney general, probing illegal marketing and sales of auction rate securities, intends to charge Charles Schwab CorpĀ  with civil fraud and has reached a settlement with rival TD Ameritrade Holding Corp, his office said on Monday.
Schwab, the largest U.S. online brokerage, denied the allegations as “without merit.” TD Ameritrade, the second-largest, agreed to return $456 million to investors holding the auction rate securities, or ARS, a market that froze early last year.
The TD Ameritrade settlement brings to about a dozen the number of brokerages and other firms that have agreed to buy back more than $61 billion in ARS from investors, the office of New York Attorney General Andrew Cuomo said, calling it “the single largest consumer recovery in history.
“Today’s notice should send a signal that if Charles Schwab will not stand by its customers, this office will,” Cuomo said in a statement.
In a letter to Schwab, Cuomo’s office said the company “engaged in repeated and persistent fraudulent, deceptive and illegal business practices” connected with ARS, falsely marketed the securities, and failed to warn clients when it knew the ARS market could collapse.
The July 17 letter said Schwab brokers, interviewed as part of a continuing investigation of ARS, admitted misrepresenting the securities as liquid, short-term investments. Other Schwab brokers admitted to “knowing little about” ARS, it said.
One such broker testified: “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,” the letter from Cuomo’s office said.
Cuomo is open to a settlement with Schwab under which the San Francisco-based brokerage and asset manager would buy back the ARS from investors.
Schwab has until the end of this week to reply to Cuomo’s office.
“The attorney general’s allegations are without merit,” Schwab, which promotes its straight-taking brand, said in a statement on its website. “They unfairly lay blame on our company for an illiquid market and improper behavior by the large Wall Street firms that created and then, despite their obligations, stopped supporting auction rate securities.”

CREDIT CRISIS FREEZE
ARS are long-term debts whose rates are set at periodic auctions. The credit crisis of 2007 put increasing pressure on the ARS market, and by February 2008 the market became frozen after brokerages stopped supporting the auctions.
Schwab, part of a small group that has not settled, said it did not create the products and had no involvement in the events that led to the collapse of the ARS market.
Omaha, Nebraska-based TD Ameritrade said its role in the ARS market “was significantly different from that of other financial institutions that have previously announced similar programs,” adding the settlement was best for its clients.
TD Ameritrade will buy at par ARS that clients purchased through the firm on or before Feb. 13, 2008. The company did not admit or deny the allegations, according to the U.S. Securities and Exchange Commission.
Others that have settled ARS cases with authorities include Bank of America <BAC.N>, Citigroup <C.N> and UBS <UBSN.VX>.
Cuomo’s office said investors who were misled to think the securities were more liquid than they were. It said that Schwab management knew as early as August 2007 about problems in the ARS market.
Schwab said in the statement its “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, or that were intentionally veiled by the underwriters.”
Schwab’s current client ARS holdings are likely in the $500 million range, said Fox-Pitt Kelton analyst David Trone.
“We expect Schwab to ultimately repurchase these securities from clients to avoid negative press,” Trone said in a note, adding he does not expect the civil fraud suit to materially impact the company’s results. “The brand’s squeaky clean image is important to the model, and we don’t expect any damage.”
The analyst said TD Ameritrade’s one-time charge could hit earnings in the current quarter by up to 4 cents per share.
Schwab shares were up 0.4 percent in afternoon trading on the Nasdaq, while TD Ameritrade’s shares were down 0.2 percent. (Reporting by Grant McCool, Martha Graybow and Jonathan Spicer in New York, additional reporting by Ajay Kamalakaran in Bangalore; editing by Tim Dobbyn)

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