Charles Schwab’s recent article in the Wall Street Journal, entitled “Brokers Aren’t Responsible for Bad Bets,” is a cynical attempt to change the subject that compares very unfavorably with the intellectual honesty of Warren Buffet, according to Susan Antilla in her August 21 article in Bloomberg.com. Mr. Schwab’s article was in response to a lawsuit filed against Charles Schwab & Co., Inc. by the Attorney General of New York. The lawsuit alleges, in essence, that Schwab owed its customers a duty to properly understand and make accurate representations concerning the auction rate securities it sold, and that Schwab breached that duty by misrepresenting them as liquid, short-term investments without discussing the risks. 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. The Complaint can be found at http://www.oag.state.ny.us/media_center/2009/aug/aug17a_09.html.
After eight paragraphs, Mr. Schwab boiled his argument down to this: “The issue at stake here is whether independent investors should be allowed the freedom to choose what they are allowed to buy, sell or hold. Or should government try to enforce a guarantee against market risk through regulation or lawsuits like the attorney general has brought against us?”
Mr. Schwab completely misstates and ignores the true issue and the nature of the lawsuit. The securities laws do not require the abolition of risk or insurance against loss. That is a diversion, a red herring. But brokers who sell securities (including Schwab) do have legal duties to their customers understand those securities, not to misrepresent them (for example, as being safe and liquid when they are not), and to disclose all material risks associated with the securities. In short, the bedrock principal of the securities laws since the Great Depression is full and fair disclosure. We should not ask investors to bear undisclosed risks, much less fraudulent misrepresentations, which is the basis of the lawsuit in question. Moreover, the disclosures must be reasonably particular. Boilerplate disclosures (such all investments have risk and may decline in value) are legally insufficient when they merely paper-over significant, undisclosed risks.
As the article points out, “Cuomo’s 38-page complaint is awash with examples of [Schwab] brokers soliciting and misinforming investors about ARS. (Cuomo quoted from tape-recorded conversations). One broker called a customer who had a big cash balance in the money markets and suggested ARS. Customer: ‘I need the liquidity because, umm, I may buy a house soon.’ Broker: ‘So why don’t you go with something like we call, uhh, the PARS, periodic auction rate securities.’ They’re ‘very safe,’ the broker said. Similar examples abound.”
Mr. Schwab’s argument that his company was “surprised” by the auction rate securities market freezing up is simply belied by the facts Cuomo was able to gather. The complaint alleges that Schwab higher-ups knew about problems in the auction rate securities market but did not share what they knew with Schwab’s brokers or customers. Schwab brokers admitted, and audio-tapes confirmed, that they did not understand and repeatedly and persistently misrepresented, auction rate securities as being safe and liquid.
Mr. Schwab is angry at Cuomo, but does not have a problem with any of these tapes and broker admissions? For years now, Mr. Schwab has posted on Schwab’s website a Dear Investor, which begins: “I made a commitment. I’m on the side of the investor,” and ends with the importance of “a company you can trust.” There seems to be more than one Charles Schwab out there. Will the real Charles Schwab please stand up?
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