“Another story we’re closely following today and that is involving Charles Schwab. New York Attorney General Andrew Cuomo expect today sue Schwab the company for civil fraud according to the Wall Street Journal. Auction rate securities, we talk about them, fixed income vehicles, value reset at auction, allegedly sold like cash, and many have settled over this. They said they’re like cash, easy to sell, but when the markets, froze up behind the credit crunch in February and they did stop supporting the auctions and several brokerages agreeing to buy back from clients. Charles Schwab has not and we’ll see what comes from this. We’ll keep an eye on that.” Fox Business Network 8/17/2009
New York AG Andrew Cuomo’s crusade against brokers and investment banks who peddled Auction Rate Securities has hit a road block with Charles Schwab (SCHW). While most banks who have been targeted by the investigation have been anxious to settle and make this problem go away, Schwab is holding their ground. The trouble started last year when the credit crisis struck, and the market for auction rate securities became extremely illiquid. The market was controlled by a small number of Wall Street banks who stopped making a market for the securities, in light of the risks associated with them as the credit market was in crisis last summer. Institutions and wealthy individuals who had been sold the securities had believed that they were relatively safe and highly liquid instruments, but were left holding the bag in the summer and fall of 2008. The lawsuit alleges fraud in the way that the ARS were marketed to clients.
Schwab is the first firm to really stand up against the accusations of wrong going in any meaningful way, as Citi (C), JP Morgan (JPM), Bank of America/ Merrill Lynch (BAC), UBS (UBS), and Morgan Stanley (MS) have all settled. In most cases, the settlement included the banks buying back the ARS’s from clients at par value. Charles Schwab contends that it did nothing wrong and could not have predicted the financial crisis that brought the credit market and ARS market to its knees. Furthermore, form Schwab’s point of view, it simply distributed the securities and any fraud that occurred was with the underwriters. Clearly, the firms listed above who have settled have played a different role in the crisis than Schwab as underwriters, and perhaps should be punished differently.
The total amount of ARS held by Schwab clients totaled $789 million, but now with the impending law suit Schwab will need to set aside a pretty penny in legal fees as well. According to the Wall Street Journal, “The lawsuit, filed in New York State Supreme Court in Manhattan, alleges Schwab knew or was reckless or negligent in not knowing about rising problems in the auction-rate securities market beginning in August 2007.” It will be extremely interesting to see how the courts will handle this case, because Schwab’s defense seems to be bordering on negligence saying that they were unaware that of the risks of ARS. That being said, we are not attorneys and would not suppose to understand the intricacies of this case.
Schwab stock is down a little more than 4% today, and we have reaffirmed our Fairly Valued rating on this stock. Schwab has certainly stuck its neck out on this one, and taking on Mr. Cuomo is risky as so many others have been anxious to sweep this under the rug.
