Charles Schwab Must Face Auction-Rate Suit, Court Says

Charles Schwab Corp. must face a lawsuit in which New York state accused it of falsely describing auction-rate securities as liquid investments without disclosing the risks, an appeals court ruled.

The San Francisco-based brokerage was sued by Andrew Cuomo in August 2009 when he was attorney general. A trial judge in Manhattan, Justice O. Peter Sherwood of state Supreme Court, granted Schwab’s motion to dismiss the case in 2011.

A four-judge appeals court panel today reinstated two of the four claims in the case, securities fraud allegations based on the state’s Martin Act law, saying the attorney general’s office presented enough evidence for a trial.

“We find the Martin Act causes of action to be sufficiently pleaded given the fact that the statute is remedial and should be broadly construed in order to attain its beneficial purpose,” Justice Richard Andrias wrote. “Under the statute, the word ‘fraud’ is broadly defined so as to embrace even acts which ‘tend to deceive the purchasing public.’ Based on this standard, the complaint sets forth actionable Martin Act claims notwithstanding the absence of a specific allegation that Schwab represented ARS to be liquid at times when they were illiquid.”

Auction-rate securities are municipal bonds, corporate bonds and preferred stocks whose rates of return are periodically reset through auctions. The attorney general’s office sued on behalf of investors who bought the securities through Schwab.

State’s Accusation

The company was accused of engaging in “fraudulent and deceptive conduct” and failing to disclose the risks involved in the investments.

Schwab argued that the complaint didn’t allege statements that were false when made or identify who made the misstatements, when and where they were made or how they were misleading, according to Sherwood’s order.

Sherwood said the complaint is “devoid of any allegation of misrepresentations made that were untrue when made,” noting that the attorney general’s office spent more than a year investigating before filing the suit.

The appeals court said Sherwood based its conclusion on a finding that there had been no failures in the auctions in the 20 years preceding August 2007 and erroneously evaluated the merits of the claims.

Company Response

The company said it intends to fully defend its position and is confident the court will rule in its favor. About 98 percent of the auction-rate securities held by Schwab clients have been redeemed at par value, the company said in a statement.

“Unlike some other downstream brokerage firms, Schwab did not market or promote ARS, market or sell them to clients online or compensate its registered representatives for ARS transactions,” the company said. “Schwab’s role in these transactions was simply to accommodate clients when they asked for these types of products.”

The case is People of the State of New York v. Charles Schwab & Co. Inc., 453388/2009, New York State Supreme Court (Manhattan).

To contact the reporter on this story: Chris Dolmetsch in New York State Supreme Court at

To contact the editor responsible for this story: Michael Hytha at

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