Cuomo may sue Schwab over auction-rate securities

Instead of the carrot-and-stick approach, New York Atty. Gen. Andrew Cuomo on Monday used two sticks in his bid to force Charles Schwab Corp. to pay off clients who bought auction-rate preferred securities from the discount brokerage.

Stick No. 1: Cuomo threatened Schwab with a lawsuit if the firm didn’t agree to buy back the notorious securities.

Stick No. 2: Applying peer pressure, Cuomo announced that TD Ameritrade Inc. settled a similar case and would repurchase $456 million of the securities. TD Ameritrade also settled with the Securities and Exchange Commission.

Schwab, refusing to budge, issued a long statement defending itself and chastising Cuomo for deciding to “try cases in the press.”

Auction-rate securities, popular before the credit markets collapsed in 2008, were essentially long-term debt masquerading as short-term instruments. They were pitched by brokers to small investors as safe and easily redeemable -- which they were, until demand for all such engineered securities dried up. Investors were stranded with about $330 billion of auction-rate issues, unable to sell them (although they kept earning interest).


Cuomo, the SEC and other regulators have since negotiated buyback settlements with 20 brokerages and other financial firms that sold auction-rate preferred securities. The regulators asserted that the brokerages misrepresented the securities’ safety.

In a letter to Schwab warning of a lawsuit, Cuomo excerpted from interviews his office did with Schwab brokers and from recordings of Schwab sales pitches. One broker allegedly told a client that unloading auction-rate securities was as “easy as just selling.”

Schwab said its brokers “could not be expected to foresee and disclose market risks that even regulators and market experts did not foresee.”

Schwab asserts that the big brokerages that created the securities should have been forced to buy them back from all investors who purchased them, including those who bought the issues from third parties such as Schwab.

A person familiar with Schwab’s exposure said its clients still owned about $100 million of auction-rate securities.