NY Attorney General Cuomo To Sue Charles Schwab Over Auction-Rate Securities (ARS)
New York Attorney General Andrew Cuomo is not shy when it comes to Wall Street. Cuomo has led the charge to hold investment firms such as Citigroup, Merrill Lynch, UBS and others accountable for their misdeeds on everything from how they marketed and sold certain investments like auction-rate securities and credit default swaps to the way in which some companies misrepresented their financial health to retail and institutional investors. Now it’s Charles Schwab & Company’s turn to be in Cuomo’s legal hot set.
On July 17, the New York Attorney General’s office sent an official letter to Schwab, stating Cuomo’s plans to sue the San Francisco-based brokerage firm unless it agreed to buy back nearly $800 million worth of auction-rate securities from customers. According to Cuomo’s letter, Schwab’s brokers failed to understand the product they were selling to investors and Schwab’s management had prior knowledge about problems in the auction-rate market yet failed to inform clients.
The $330 billion market for auction-rate securities collapsed in February 2008, leaving thousands of individual and institutional investors holding illiquid investments. Faced with lawsuits by state and federal regulators, the investment firms that initially sold the instruments as cash equivalents agreed to buy back more than $50 billion of auction-rate securities from retail investors and small businesses.
Charles Schwab has more than just auction-rate securities to worry about. The company also is facing hundreds of arbitration claims by investors who say the brokerage misrepresented the risks and asset composition of two ultra-short bonds, the Schwab YieldPlus Fund (SWYPX) and the Schwab YieldPlus Select Fund (SWYSX).
Investors in the funds, collectively known as the Schwab YieldPlus Fund, contend Charles Schwab marketed the products as relatively conservative investments whose risk levels were similar to money-market funds. Instead, the Schwab YieldPlus Fund was over-concentrated in high-risk, illiquid mortgage-backed securities. After the collapse of the housing market, the overconcentration in speculative investments resulted in massive losses of more than $1.3 billion. In total, the Schwab YieldPlus Fund lost nearly 40% of its value in 2008. By comparison, the average ultra-short bond fund fell 1.9%.
The Financial Industry Regulatory Authority (FINRA) is continuing to review investor claims against Charles Schwab. Previous decisions by arbitration panels show that FINRA has awarded more than $500,000, or about 81%, of an investor’s claimed damages. Other FINRA claims are producing awards for 100% of the damages claimed.
Most recently, a San Diego arbitration panel ruled on July 17 that Charles Schwab was liable to the widow of San Diego resident Everett Ross for losses sustained by the Ross family trust in the Schwab YieldPlus Fund. The award included 100% of the claimant’s net out-of-pocket losses of $157,498 plus expert witness costs, as well as the entire cost of the arbitration proceeding against Charles Schwab.
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