The 41-page Cuomo lawsuit, filed in New York state court, demands that Schwab be forced to buy back any remaining auction-rate securities from clients and pay costs, penalties, and other relief. A Cuomo news release said other auction-rate securities vendors have already agreed to $61 billion in investor buybacks.
According to the Cuomo statement, a key legal issue is whether Schwab sales people properly portrayed risk level inherent in the auction-rate securities. Authorities charged that undertrained Schwab personnel “repeatedly and persistently” assured investors the securities were akin to money-market instruments or certificates of deposit and that they would be able to get at their money when they needed it.
“Charles Schwab owed its customers a duty to properly understand and make accurate representations concerning auction rate securities,” said Cuomo, in the statement. “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.”
Cuomo continued: “These representations gave investors a false sense of security that their investments would always be liquid when auction rate securities, in fact, faced significant, inherent liquidity risks.”
Recorded Sales Conversations
The Cuomo news release quoted from audio recordings it said were made during the investigation including one conversation in which a Schwab broker “guaranteed” the customer could redeem the security on the auction date. Another Schwab broker described preferred auction rate securities as a “short-term institutional holding instrument” that was particularly suitable for managing the customer’s cash balances.
Cuomo charged that one broker told a client: “If you need to have that access to them at any time, that’s (ARS) a good place for (excess cash balances) to be. 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.”
The suit also alleged Schwab misrepresented the level of knowledge its personnel had about the auction-rate securities.
“…Schwab’s persistent fraud was possible because Schwab failed to train or otherwise ensure that its brokers had even a basic understanding of auction rate securities,” Cuomo alleged. “Brokers interviewed during the investigation all confirmed that they received no formal training from Schwab relating to auction rate securities. As a result, many Schwab brokers misunderstood or knew little about the auction rate securities they were selling to Schwab’s customers.”
According to Cuomo, Schwab pursued the ARS sales despite problems starting in August 2007 with rising inventories of the instruments in the final months of 2007.
The company was only concerned about its public relations exposure from problems with investors who were unable to redeem their securities and not how the investors were faring after making the purchases through Schwab, Cuomo alleged.
The complaint is available here .
Schwab's response to early publicity about Cuomo's investigation is here .
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