New York State Attorney General Andrew Cuomo has sued Charles Schwab & Co., alleging the company failed to disclose the risks of auction-rate securities to its clients.
In a response filed by Schwab last week, when it was clear the attorney general was preparing a lawsuit, the company alleged it is being wrongly punished for "a market calamity that it neither caused nor could have foreseen."
That lawsuit, filed yesterday, is part of a broad effort by Cuomo to force brokers into buying back auction-rate debt, at face value, from investors who were led to believe they were safe investments.
The auction-rate market collapsed last year, when it totaled about $330 billion in assets. Other banks and brokerages have settled with Cuomo, with companies agreeing to a total of about $61 billion in buybacks thus far. Schwab has rejected a settlement, arguing the real culprits in the market collapse were the underwriters of the security.
Schwab argues it only made the securities available to clients through its brokerage platform, but did not actively market the securities or pay its brokers commissions for selling them. "Schwab did not underwrite any ARS, did not actively market ARS to its customers [and] did not buy ARS for its own account," the company wrote in a letter to Cuomo's office.
Thousands of customers of San Francisco-based Schwab held about $787.9 million of auction-rate securities as of February 13, 2008, Cuomo's office estimated, according to Reuters.
The attorney general's office argues that, even in its limited role, Schwab had an obligation to properly inform investors of the risks associated with auction-rate securities.
"Charles Schwab owed its customers a duty to properly understand and make accurate representations concerning auction rate securities," Cuomo said in a written statement announcing the lawsuit. "Today we commenced a lawsuit to remedy Schwab's repeated breach of that duty. This filing should send a signal that anyone in the industry who misrepresented the risks of investing in auction rate securities will be held accountable."
Basing much of its evidence on recorded conversations between Schwab representatives and customers, the attorney general's office cited as one example a Schwab broker who told a customer that the hardest part of investing in an auction rate security "is getting into it. That would be the tough part. I mean, getting out is something as easy as just selling it."
The company responded that the transcripts represented "isolated incidents" out of "tens of thousands of subpoened emails and numerous recorded telephone calls."