The ARS market became illiquid nearly two years ago when large broker-dealers – firms that historically supported secondary-market ARS auctions – stopped doing so as the credit crisis got progressively worse. Because the auctions were the primary mechanism for investors to sell their securities, the entire ARS market, estimated at that time to be over $300 billion, became illiquid. Since then, the major broker-dealers, which in addition to their auction market-maker role, also underwrote ARS and sold them through their retail brokerage franchises, have bought back at par over $60 billion of ARS.
TD Ameritrade is making investors whole on their ARS purchases. From the WSJ:
TD Ameritrade Inc. agreed to buy back $456 million of auction-rate securities from about 4,000 clients as part of a settlement with New York Attorney General Andrew Cuomo, the Securities and Exchange Commission and Pennsylvania securities regulators.
The online brokerage firm intends to return the money to customers, including individuals, charities, nonprofit entities and businesses, by March 2010 but could need until June 30 to complete the buybacks. TD Ameritrade said it will buy back the debt from clients with accounts of under $250,000 within 75 days.
Schwab on the other hand decided that investors took the risk on their own and are responsible for the losses. It fired back at the New York Attorney General with the following (from Charles Schwab
The Attorney General’s allegations are without merit. They unfairly lay blame on our company for an illiquid market and improper behavior by the large Wall Street firms that created and then, despite their obligations, stopped
supporting Auction Rate Securities.
Schwab did not create the products and had no involvement in the events that led to the collapse of the ARS market, events brought about by the Wall Street underwriters who manufactured, marketed and then simply abandoned their responsibility as lead managers for the auctions.
The NYAG presumes that Schwab somehow knew of a risk that the entire ARS market could seize up at any time, and failed to disclose that risk to its clients, which is preposterous.
- Schwab did not know until it occurred that the market for ARS was in danger of freezing up or that the underwriters could, and would, walk away from their obligation to support the liquidity of these securities.
- In fact, just days before the collapse, Schwab was told by one of the major Wall Street underwriters that investors would have access to liquidity; days later they simply walked away from the market.
- Schwab did not know that other broker dealers were routinely propping up the market for ARS, creating an artificial impression of liquidity.
- Schwab was not involved in the withdrawal of supporting bids for ARS that precipitated the market’s freezing.
- Based on the facts available and over two decades of historical precedent with ARS performance, Schwab, like other third-parties and the market regulators themselves, could not anticipate there was a risk of system-wide paralysis.
- Schwab’s limited participation in the ARS market was driven by client demand, not a desire for investment banking fees; roughly 90% of purchases were unsolicited trades.
- Schwab did not underwrite ARS or serve as an auction agent for ARS.
- Schwab did not trade in ARS on a proprietary basis or have an inventory of ARS that we then sold to clients.
- Schwab did not place proprietary bids in or artificially prop up the market for ARS.
- Schwab did not develop marketing materials or provide research to promote auction rate products.
- Schwab did not offer sales incentives relating to ARS transactions; indeed, Schwab did not compensate its Financial Consultants at all for ARS transactions.
The rationale for such different approaches may have to do with Schwab having a stronger case. The outline above makes their posture fairly clear. Nevertheless Andrew Cuomo is gearing up for a fight with a pending legal action against Schwab.
Disclosure: no positions in SCHW, AMTD