Charles Schwab: Marketing Products That Are Too Good to Be True?

Charles Schwab (SCHW), the San Francisco-based brokerage pioneer, has done a lot for individual investors. Chuck, as he apparently prefers to be called, revolutionized Wall Street nearly 40 years ago when he introduced discount brokerage trading and dramatically undercut the exploitive trading costs charged by the major brokerage houses. Discount brokerage was a major breakthrough for individual investors, and Schwab’s innovation decidedly ranks as one of the watershed moments in Wall Street history.

Schwab now wants to make U.S. bankers quake in their pinstripes. His eponymous firm is offering customers a no-fee credit card that rebates two percent of all purchases, which seems like a pretty sweetheart of a deal. Even better, the firm claims it will reimburse its customers the obscene service charges banks now levy for making withdrawals at someone else’s ATM. If these products prove successful, the banking industry might have to dramatically reduce its high fees to remain competitive, just as the big Wall Street firms did.

But Schwab clients would be wise to be wary, as the firm is fast establishing a reputation for marketing products that are truly too good to be true. The first is the firm’s shameful Schwab YieldPlus account, which the firm aggressively marketed to customers as equivalent to a money market account. In fact, Schwab YieldPlus was laden with toxic sub-prime mortgages and when that market blew up, Schwab’s customers lost as much as 30 percent of their money. Schwab has refused to accept responsibility for its misleading sales practices and YieldPlus customers, including clients of Zamansky & Associates, have been forced to file lawsuits and arbitration claims in order to recover their money

Schwab also is refusing to accept responsibility for peddling auction rate securities to unsuspecting customers. In an op-ed in yesterday’s Wall Street Journal, Schwab passionately argues that New York Attorney General Andrew Cuomo shouldn’t be holding the firm culpable for marketing these products to customers because:

...roughly 90% of the clients who invested in these securities came to Schwab asking us to locate and make available these investments for them.

As regular readers of this blog know, auction rate securities were one of the most dubious Wall Street products in recent memory. The interest rates on these securities reset at weekly or monthly auctions, and were typically slightly higher than investors could receive from a money-market fund. The little-understood risk was that the auctions were essentially fixed by the big Wall Street firms and when the economy tanked, they were no longer willing to artificially prop up the market. As a result, investors, overnight, got stuck holding low-interest bonds with long-term maturity dates.

Schwab’s claim that some 90 percent of his customers who bought auction rate securities did so at their own behest is suspect. The major Wall Street firms had to use aggressive sales tactics to unload their inventory - “Gotta Move these microwave ovens!!” — and it is rather incredulous that the vast majority of Schwab’s customers actively sought out these products on their own. In any case, Cuomo has produced evidence that Schwab’s management definitely knew about the inherent risks of auction rate securities, but was focused “on public relations risks, not the implications to the market for auction rate securities.”

Moreover, Cuomo has made public considerable evidence that Schwab’s brokers actively positioned auction rate securities to customers as being equivalent in safety to traditional money market funds. The AG also has impressively substantiated that Schwab’s brokers didn’t have even a remote understanding of the auction rate securities market and that ignorance caused great harm to Schwab’s clients.

Most of the major Wall Street firms involved in the auction rate securities debacle have agreed to make their clients whole, but as was the case with its YieldPlus accounts, Schwab refuses to do right by his customers. Such hardened stances should make investors skeptical of products offered by Schwab’s brokers.

Caveat emptor: Talk is cheap, and when you “Talk to Chuck,” you do so at your own peril.

Comments

[Alan Young:]

Schwab already offers ATM-fee reimbursement to its checking customers, and has routinely made good on this policy for as long as I've been banking there.

Strangely, I haven't yet received an offer for the credit card you describe. I can't wait to start using it, though.

Aug 21 03:58 PM

[Bull 999:]

There are nop gaurantees against risk----get a clue Zamy

Aug 21 05:12 PM

[Tomos:]

Good article Jake.

Aug 21 05:36 PM

[Bull 999:]

Get a clue Zamy---no risk no return---no gaurantee
U tho would most likely have the government take care of us so we could never be taken advantage of nor could we excell!!

Aug 21 05:41 PM

[Bull 999:]

Get a clue Zamy Bamy---No risk No return---No gaurantee---U tho would have the government take care of us so we could not be hurt nor could we excell

Aug 21 05:44 PM

[traderraider:]

You can't present something as a "cash alternative" - that turns out to be nothing of the sort - and not suffer the repercussions. Yes, caveat emptor - but if the broker brings the product up - gotta explain pros AND cons. Not just the pros and expect a novice (by Schwab's own records) investor to understand the nuances.

Aug 22 10:37 AM

[Barefoot:]

I'm glad you called these jerks out on their malicious practices. I lost a lot of money in Schwab YieldPlus, and the one thing that may be worse than actually losing all that money is Chuck's outrageous refusal to accept any responsibility for their deceitful behavior.

Aug 24 01:50 PM

[Al the pal:]

Hey dummy, ARS were around for over 20 years without ANY problems, were rated AAA by the rating agencies and they continue to pay interest. The fact that the liquidity dried up was the underwriters problem and it was their fault for not disclosing it, not Schwabs. With re: to Yieldplus, duh-like the others said, no risk-no return, in order to get a better yield more risk needed to be taken. Again, how is Schwab responsible for a credit crises that no one saw coming with risks that were clearly outlined in their prospectus?

Aug 24 08:52 PM

[johnwhite:]

"Most of the major Wall Street firms involved in the auction rate securities debacle have agreed to make their clients whole, but as was the case with its YieldPlus accounts, Schwab refuses to do right by his customers." The Investors are truly running away from the guy. The article is great and can be used as a source for a Product Essay

Thank you.

Sep 02 05:41 PM

[johnwhite:]

"Such hardened stances should make investors skeptical of products offered by Schwab’s brokers." Oops, missed this quote. just as I said in my last comment.

John White
bookwormlab.com/colleg...

Sep 02 05:43 PM