As the Securities and Exchange Commission and state regulators Monday announced another settlement in their ongoing auction-rate securities probes, broker Charles Schwab fought back against related allegations brought by New York Attorney General Andrew Cuomo.
Schwab denied any wrongdoing in response to a letter sent by Cuomo's office last week notifying the brokerage that it faced fraud charges if it did not reach a settlement that provided retail investors of ARS with liquidity.
"The attorney general's allegations are without merit," Schwab said in a statement. "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." The firm went on to say that to blame it for the industry’s larger problems is “preposterous.”
In February 2008, the auction-rate securities market collapsed as banks that had been propping up auctions allowed them to fail, leaving investors holding billions of dollars worth of illiquid securities and issuers paying penalty interest rates as high as 20%.
In nearly a dozen previous settlements in which underwriters and broker/dealers agreed to buy back billions of dollars of illiquid ARS, Cuomo stated that underwriters and broker/dealers knew of growing risks to the ARS market as early as August 2007 but continued to market them to investors even as they took steps to protect their firms.
In letter sent to Schwab on Friday, Cuomo's office alleged that Schwab brokers "repeatedly misled investors about the risks of investing in auction-rate securities." The letter cited recordings in which Schwab brokers told investors that the securities were safe short-term investments. The brokerage failed to adequately train its brokers to ensure they had a basic understanding of the securities before selling hundreds of millions of dollars of them to investors and it knew about auction failures in the fall of 2007, the attorney general alleges.
Schwab defended its practices. "Schwab 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," the firm said.
Schwab said regulators had let the Wall Street firms that created the securities "off the hook" by not requiring them to repurchase ARS that downstream investors bought.
Cuomo's office did not respond to requests for comment.
Meanwhile, the SEC, state securities regulators and Cuomo announced they have reached ARS settlements of securities fraud charges with TD Ameritrade.
The SEC and state regulators claim TD Ameritrade—which did not underwrite ARS—misrepresented the securities as safe and liquid to customers when acting as their agent for purchases and sales.
Under the states' "settlement in principle," which stems from an investigation led by the Pennsylvania Securities Commission, the firm will return about $456 million to clients whose funds were frozen in the ARS market, according to the North American Securities Administrators Association. SEC officials said they are reluctant to cite specific dollar figures in connection with their settlement because the figures are in flux.
Both settlements require TD Ameritrade to buy back at par value by certain dates in March all ARS purchased through the firm by individuals, charities, nonprofit organizations, small businesses and institutions with assets at the firm of $10 million or less for individuals, before Feb. 13 in the SEC settlement or Feb. 14 in the states' settlement.
They also require the firm to reimburse eligible individual investors who sold ARS at a discount after the market collapsed and to consent to a special, public arbitration procedure to resolve claims of additional damages individual investors suffered as a result of not having access to their funds.
TD Ameritrade officials said yesterday it will be able to carry out the settlements because of its strong financial position.