Schwab defies New York AG on buying back auction rate securities

The Charles Schwab Corp. today said it will not meet New York Attorney General Andrew Cuomo’s demand that it repurchase auction rate securities from clients that purchased them from the discount-brokerage firm, even though its exposure to a buyback is relatively limited.

“We don’t approach it lightly,” Walt Bettinger, president and chief executive of the San Francisco-based firm, said in a webcast today. But “our decision to not settle with the attorney general [is based on] principle and precedent.”

He argued that Schwab has no responsibility to purchase the securities that most brokerage firms sold as highly liquid alternatives to money market funds, because it never actively marketed them to investors, paid financial advisers to sell them or sponsored the auctions at which the securities were bought and sold.

Schwab disclosed that retail investors are holding about $100 million of the now-illiquid securities purchased from the company, but said about 90% of them were bought by self-directed investors who asked for the securities.

The firm did not disclose the amount of auction rate securities held in custody at the firm for clients of registered investment advisers.

“To be asked to stand behind losses or illiquidity that a client suffered based on circumstances that we had no knowledge or control of … we thinks sets a very, very dangerous precedent,” Mr. Bettinger said.

Last week, TD Ameritrade Holdings Corp. of Omaha, Neb., said it will not include RIA clients in its regulatory-mandated plan to repurchase $400 million to $500 million of the securities from its retail-brokerage clients.

TD Ameritrade said the buyback could cost between 5 cents and 10 cents a share, though it believes that the amount will ultimately be recovered.

Banks and brokerage firms sold auction rate securities for more than 20 years as higher-yielding alternatives to money market funds, saying they could be redeemed at auctions held weekly or monthly.

The market worked well until February 2008, when large firms such as UBS AG and The Goldman Sachs Group Inc. stopped supporting the auctions as a result of the worldwide credit crisis.

Many big banks have agreed with regulators to repurchase billions of dollars of the securities, but smaller brokers that did not organize the auctions were not subject to those earlier settlements.

Mr. Cuomo last week threatened to sue Schwab if it does not agree to repurchase the securities from eligible investors.

Separately, Mr. Bettinger said Schwab’s custody business for independent advisers remains “extremely healthy” despite a slowdown in the rate of new assets coming onto its platform for much of the past year.

Schwab has about twice the market share of RIA assets under custody as Boston-based Fidelity Investments, its nearest competitor, according to industry surveys.

“From mid-2008 until a couple of months ago, we saw a decline in the rate of growth of net new assets,” Mr. Bettinger said, noting that RIAs were busy trying to work with existing clients instead of prospecting for new ones.

“In the last few months, we’ve seen that net-new-asset figure start to move again, which we are very encouraged by.”

Schwab recently started a promotion that waives commissions on online trades from new clients brought to its platform by RIAs, reimburses clients for exit fees on assets transferred from their former brokerage firms and waives next year’s annual fee to advisers for a core technology offering.

In both the first and second quarters, net new assets from RIAs fell from the year-earlier periods.

Mr. Bettinger repeated earlier statements that Schwab hasn’t experienced a flood of new independent advisers joining its platform from big brokerage firms.

“We have always felt that it would be more of a long-term trend rather than a bubble,” he said, noting that big brokerage firms are offering strong retention packages to keep top brokers from leaving.

Mr. Bettinger said scores from advisers assessing Schwab’s performance as a custodian are higher than it receives from clients in its retail-brokerage business.

Joe Martinetto, Schwab’s chief financial officer, expects revenue from money market fees, net-interest margin and other interest rate products to remain sluggish for the rest of the year because short-term rates are so low.

If rates remain the same, the company expects to give up about $200 million of waived money market fees for the year — including more than $150 million over the third and fourth quarters.

Schwab, TD Ameritrade and other fund providers have waived fees so that investors in funds with close-to-zero yields don’t lose money.

The firms also are suffering from lower investment returns on cash sitting in their bank and brokerage accounts.

Related Topics: Charles Schwab Institutional