New York Attorney General Andrew Cuomo has sent a letter to Charles Schwab & Co. giving notice of his intent to bring a civil fraud suit against the brokerage firm for its sales practices in connection with auction rate securities. Auction rate securities are variable rate instruments in which the rates are determined through periodic auctions, but since the auction markets collapsed in February 2008 the investors holding such securities have been unable to liquidate their investments. In an enforcement letter dated July 17, 2009, Cuomo’s office contends that Schwab misrepresented to its customers that auction rate securities were a safe, liquid cash equivalent without disclosing that the liquidity of the securities was completely dependent upon the success or failure of the auction process, which was subject to manipulation by the broker-dealers who sold the securities and ran the auctions.
According to Craig T. Jones, an Atlanta attorney who represents investors in several auction rate securities cases, “the allegations that New York has made against Schwab are consistent with what we have seen across the board in our auction rate cases.” Jones’ firm, Page Perry, represents investors in fraud and suitability claims all over the country. When the SEC issued an enforcement order fining 15 broker-dealers in 2006 for securities law violations relating to auction rate securities, Schwab was not covered by the order, but according to Jones, “everyone who was selling auction rate securities knew or should have known about the 2006 order.” Not only that, but problems with the securities were increasingly evident in the summer and fall of 2007 when auctions began to fail and rating agencies started downgrading the securities, but most broker-dealers failed to inform their customers of the increased risks and continued to misrepresent the product as a safe cash equivalent. Since the collapse of the market, many broker-dealers have entered into settlement agreements to redeem auction rate securities at par value, “but those who have refused to deal are now finding themselves in litigation,” says attorney Jones.
In a similar but unrelated development, federal authorities have filed criminal charges against Credit Suisse Group broker Julian Tzolov for fraud relating to auction rate securities. The Wall Street Journal reports that Mr. Tzolov is expected to plead guilty to charges that he sold higher-risk mortgage-backed auction rate securities to investors who thought they were getting lower-risk student loan-backed securities as part of a scheme to collect higher commissions in what is reportedly to the only criminal prosecution to date arising from the auction rate debacle.
It is estimated that investors were left holding a total of $330 billion in auction rate securities when the auctions froze in early 2008. While there is a limited secondary market in which some of these securities have been sold at a discount, many investors have turned to lawyers to explore their options. “In some cases there is a secondary market solution,” says Jones, “and in others the only viable strategy is to sue for rescission and/or damages. If you are one of the investors who got stuck with these securities, we would be happy to discuss your situation and see what approach makes the most sense for you.”