Schwab (SCHW) Is Sued For Fraud

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New York State Attorny General Andrew Cuomo is suing Charles Schwab (SCHW) for fraud. The legal action alleges that the brokerage sold auction rate securities to clients with little effort to educate customers about how the financial instruments worked and little warning to them when the market in ARS collapsed.

The action is unusual because dozens of Wall St. firms marketed ABS to their clients. The government forced most of them to make their clients whole because the companies had not been forthcoming about the dangers of the securities. That punishment would seem to have been adequate and it most cases it was. Schwab is now being singled out for more aggressive prosecution.

According to The Wall Street Journal, Cuomo “would be open to a settlement with Schwab, but it must agree to buy back the securities from investors still stuck with them.” Schwab claims that there was no fraud and that it acted in good faith as the entire ABS market collapsed leaving no one unscathed.

It is surprising that Schwab will not settle. The ABS that the company would buy from its clients are likely to recover much of their value over time, so Schwab will almost certainly not be stuck with a total loss. A victory by NYS could cause Schwab to not only pay back customers but also open it to civil penalties and additional suits from shareholders, which would cost the discount brokers millions of dollars.

Schwab is likely to regret not settling.

Douglas A. McIntyre