TD Ameritrade Holding Corp.'s agreement with regulators last week to buy back $456 million of auction rate securities from individual investors, charities and small- business clients leaves registered investment advisers out in the cold.
The pact with the Securities and Exchange Commission and state regulators in New York and Pennsylvania doesn't extend to clients who bought the securities through independent RIAs or who transferred auction rate securities to TD Ameritrade for custody after buying them from another firm.
That is be-cause regulators focused on sales practice violations committed directly by TD Ameritrade brokers, who marketed the securities as liquid alternatives to money markets funds, with slightly higher yields, according to regulators.
“At the end of the day, our view— and all the federal and state regulators agreed with us — was that it applies to the retail clients only, be-cause there was no intermediary between us and them,” said Fred Tomczyk, president and chief executive of the Omaha, Neb.-based firm. “The regulators realize that the independent RIAs were themselves acting as fiduciaries, and we were acting as custodians.”
TD Ameritrade's settlement is being closely monitored because it could be a precedent for future settlements as regulators press auction rate cases against other brokers, including some RIA custodians, whose clients are stuck with the flawed securities. When Boston-based
Fidelity Investments last year agreed to repurchase some ARS, it similarly excluded clients of RIAs from the offer.
Mr. Tomczyk conceded that the distinction might irritate RIAs who keep their customers' assets with TD Ameritrade and who conduct much of their trading through the firm. The advisers may be especially irked because the firm has been pushing hard in recent years to develop its institutional arm for RIAs as part of its plan to diversify from a largely commission-based revenue model.
Advisers who purchased ARS for clients are in some ways in the same boat as TD Ameritrade and other “downstream” brokers who initially argued that they were so far removed from the underwriting of the securities and the operations of the auctions that they weren't responsible for failing to anticipate the market's collapse.
That collapse left investors stuck with more than $300 billion of the long-term debt, which was sold with promises that it could be redeemed at weekly or, approximately, monthly intervals.
“We totally understand those points, and in our hearts we agree with them,” Mr. Tomczyk said of aggrieved advisers. “But as an organization you have to stand back and do what's right for the organization.”
MOTION TO DISMISS
TD Ameritrade, which was not assessed fines or penalties by regulators, likely expects that its settlement will make private class actions over its auction rate sales moot, several lawyers said. The firm in April moved for dismissal of a class complaint, but the court has not yet ruled, a company spokeswoman said. A federal court dismissed a similar suit against Zurich, Switzerland-based UBS AG, one of several big banks that underwrote and structured ARS, after UBS repurchased ARS as part of a regulatory settlement.
As of May 1, clients of TD Ameritrade held about $690 million of ARS, including $190 million placed by independent RIAs, the company said in a regulatory filing. In a conference call with investors last week, TD Ameritrade chief financial officer William Gerber estimated that the firm will repurchase between $400 million and $500 million of the securities, since some have already been redeemed by their issuers. He declined in an interview to discuss how much is still held by RIAs and their clients.
The buyback, which TD Ameritrade expects to initiate next month for investors with $250,000 or less of the securities and by next June for larger holders, applies to “self-directed investors” as well as those who worked with the firm's brokers, the company said in a Q&A about the settlement on its website. But, according to the message, clients of independent RIAs “relied on those advisers to manage their assets and used TD Ameritrade only to custody their assets.”
The firm said it will continue a program of extending loans to clients of RIAs with ARS who are in need of cash, though it didn't specify rates for the loans. Mr. Tomczyk said few clients of RIAs, or of the firm directly, have made use of the loan offer since it was made available last year.
The settlement requires TD Ameritrade to reimburse borrowing costs that exceeded the amount clients earned in interest or dividends on the securities frozen in their accounts, and to cover losses eligible clients may have incurred by selling the securities on or before Feb. 13, 2008.
Many advisers who use TD Ameritrade as their custodian said they understand the firm's position. Unless a fixed-income desk at their custodian actually recommended the security, they said, advisers must bear the responsibility for their clients' investments.
“If TD had to bail out every bad investment, they'd be out of business,” agreed Ray Mignone, founder of an eponymous RIA in Little Neck, N.Y., which keeps about $170 million of client assets in custody with TD Ameritrade.
Paul Baumbach, managing partner of Mallard Advisors LLC, keeps his Newark, Del.-based firm's approximately $110 million of client assets with TD but absolves the firm of all responsibility in the auction rate crisis. Mr. Baumbach has been trying to help a client sell his auction rate securities back to a large bank-owned brokerage that made the original sale. “The sin was committed there,” he said.
In short, says Michael Hecht, an analyst of discount brokerage stocks at JMP Securities in New York, independent advisers are stuck.
“The RIA is on the hook to do due diligence,” he said. “In this model, you can't turn around and say "make me whole.'”
The same day that TD Ameritrade's settlement was unveiled, New York Attorney General Andrew Cuomo accused San Francisco-based Charles Schwab & Co. of misleading investors about the safety of ARS and gave the firm five days to resolve his investigation or face prosecution.
The SEC and the Alabama Securities Commission last week sued Morgan Keegan & Co. of Memphis, Tenn., over the same issue, prompting the firm to say it was “surprised and disappointed” at the action.
In a statement, Schwab denied responsibility.
“Schwab brokers, while trained to levels beyond industry standards, could not be expected to foresee and disclose market risks that even regulators and market experts did not foresee, or that were intentionally veiled by the underwriters,” the firm said.
E-mail Jed Horowitz at [email protected].
