Cuomo files ARS suit against unhappy Schwab

By John O'Brien | Aug 17, 2009


NEW YORK (Legal Newsline) - As promised, New York Attorney General Andrew Cuomo has filed a lawsuit against Charles Schwab & Co., and the company is not pleased about it.

Cuomo filed suit against Schwab Monday, alleging the company misrepresented the risks in investing in auction rates securities. The ARS market crashed in Feb. 2008, and Cuomo has been the central figure in litigating against involved companies.

Schwab says Cuomo is wrong for attacking Schwab, and that the Wall Street underwriters who hid the risks are the ones at fault.

"Clients who purchased these products and companies like Schwab that filled client orders, were misled by the major Wall Street underwriters who concealed the degree to which the ARS market was so dependent on their support," said Sarah Bulgatz, the director of corporate relations for Schwab.

"Up until the time the auction rate securities market collapsed, there was an uninterrupted 20-plus year period where there was no indication the market for these securities was at risk of collapse and that the underwriters would simply abandon them."

Auction rate securities are investments that have their interest rates periodically reset by auction.

So far, Cuomo has reached agreements with several companies that allow investors to buy back some of what they lost. He has secured more than $61 billion in investor buy-backs through deals with companies like TD Ameritrade, Merrill Lynch, JP Morgan Chase and Morgan Stanley.

Cuomo believes Schwab had an obligation to make "accurate representations" about the market to customers. He had warned the company of impending litigation in July.

"Schwab misrepresented auction rate securities to hundreds of its customers as safe, liquid investments that were suitable for their short-term, cash management purposes," says Cuomo's complaint, filed in New York County Supreme Court

"In fact, auction rate securities were complex financial instruments with significant, inherent and increasing liquidity risks. Schwab persistently failed to disclose or made misrepresentations that concealed the risk that customers would not be able to sell their auction rate securities and could thus lose liquidity should auctions fail."

Cuomo said he has audio recordings of Schwab brokers misleading investors about the risks of the ARS market. He said one Schwab broker described preferred auction-rate securities to a customer as a "short-term institutional holding instrument" that was particularly suitable for managing the customer's cash balances.

"If you need to have that access to them at any time, that's a good place for those to be," the broker said, according to Cuomo. "You know if you think you might need to get into that money, that's probably as good a place -- if not better than anywhere -- to leave them."

Cuomo also notes Schwab advertisements that noted the company's expertise.

"Schwab failed to adequately educate its brokers about auction rate securities or train them in the sale of auction rate securities," the complaint says. "Consequently, Schwab brokers typically either did not understand auction rate securities or did not have the knowledge necessary to provide accurate disclosures.

"One broker admitted that Schwab customers 'probably did not know that here is a product (auction rate securities) you might not be able to sell' because he and other Schwab representatives did not know enough about the securities to warn their customers.

"Another Schwab broker who sold auction rate securities to Schwab's customers acknowledged, '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.'"

Schwab previously criticized Cuomo for issuing a press release on the matter.

"We're confident that we will prevail when we have the chance to expose the workings of this market completely rather than just through selective sound bites in the press," Bulgatz said.

"We believe the NYAG ought to focus its efforts on the firms that underwrote these products, failed to disclose the key risks and then abandoned the products, rather than damaging the reputation and harming the shareholders of other companies that acted in good faith."

Cuomo's suit seeks to have Schwab disgorge all gains and pay all restitution and damages caused by its alleged actions, while also paying penalties and costs. The company should also buy back auction rate securities from defrauded customers, Cuomo says.

From Legal Newsline: Reach John O'Brien by e-mail at

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