Schwab Rejects ARS Allegations

Charles Schwab Corp. (SCHW) denied allegations made by New York Attorney General Andrew Cuomo of civil fraud over its marketing and sale of Auction Rate Securities (ARS).

The official notice cites emails and testimony that allegedly indicate that Charles Schwab's brokers had an insufficient idea of the risks inherent in the debt instruments while selling to clients, and later protected the company's position but failed to caution clients when the ARS market was collapsing. Cuomo mentioned that there was a possibility for a settlement with Schwab based on the condition that it buys back the securities from investors who still have them.

(ARS are debt instruments with rates that are reset in periodic auctions. The credit crisis of 2007 put increasing pressure on the ARS market and, by February 2008, the $330 billion market collapsed after brokerages stopped supporting the auctions.)

Schwab has condemned the allegations, calling them unfair and baseless and arguing that it did not create the products and had no involvement in the events that led to the collapse of the ARS market.

A number of brokerage firms have already agreed to pay more than $60 billion to buy back the securities from investors after investigators found they didn't properly inform clients about the risks, or that the market was crumbling. In October 2008, Bank of America (BAC) settled with regulators and agreed to buy back $4.5 billion in securities from its clients.

In February 2008, almost 900 Charles Schwab customers had ARS worth $789 million, but only a small fraction of that amount is outstanding now.

After the second quarter results; we are maintaining our Hold recommendation on the shares.

Read the full analyst report on SCHW