Charles Schwab & Co., Inc. Responds to New York State Attorney General

SAN FRANCISCO--(Business Wire)--
Charles Schwab & Co., Inc. filed its written response on Friday, July 24, 2009,
to allegations by the Attorney General of New York (NYAG) concerning the
company`s sale of Auction Rate Securities (ARS) to retail clients. The letter is
available at www.aboutschwab.com.

The full text of the letter, submitted to the NYAG on behalf of Schwab by
outside counsel, follows below and is also attached to this news release as an
imaged copy.

Letter to the Office of the New York Attorney General from Schwab`s Outside
Counsel Quinn Emanuel Urquhart Oliver & Hedges, LLP

VIACERTIFIED MAIL AND EMAIL

David A. Markowitz, Esq.
Bureau Chief
Investor Protection Bureau
Office of the Attorney General
State of New York
120 Broadway
New York, NY 10271

Re: Auction Rate Securities

Dear Mr. Markowitz:

This responds to your July 17, 2009 letter to Carrie Dwyer at Charles Schwab &
Co., Inc. ("Schwab" or "the Company") sent via certified mail and overnight
delivery. The letter purports to be a 5-day notice letter under GBL 349(c), even
though, for the reasons stated below, that section does not apply to the subject
of your Office`s investigation and threatened suit.

We are disappointed that your Office has now publicly announced its intention to
file unwarranted charges against Schwab in connection with auction rate
securities ("ARS") that suddenly became illiquid when the lead ARS managers that
underwrote, launched, and supported those securities suddenly backed away from
that market and allowed their auctions to fail. The Attorney General`s decision
to sue Schwab for a market calamity that it neither caused nor could have
foreseen is the foregone conclusion of an investigation that was driven from the
outset by a self-imposed mandate to reach a predetermined result: nationwide
buybacks of illiquid ARS by every firm, regardless of fault and despite major
differences in the roles that each firm played in the ARS market.

The chain of events that brought us to the present impasse began last summer
when the Attorney General permitted the major Wall Street securities firms that
controlled the ARS market to buy back ARS only from investors who held the
securities at those firms rather than from all investors who owned ARS that
those firms underwrote. Having agreed to a settlement template for the
"upstream" firms that created, sustained, and finally abandoned the ARS market,
your Office then sought to impose the same outcome on "downstream" firms such as
Schwab that merely made ARS available to their clients. Such an indiscriminate,
outcome-driven approach necessarily ignores crucial distinctions among the
various actors, the drawing of which lies at the very heart of the proper
exercise of prosecutorial power and discretion. That your Office`s limited
settlements with the upstream firms left out an entire class of investors harmed
by their misconduct does not now justify going after innocent downstream firms
to rectify that omission.

As your Office learned during its investigation, unlike other firms, Schwab did
not underwrite any ARS, did not actively market ARS to its customers, did not
buy ARS for its own account, did not enter support bids in any auction, did not
pay its representatives any compensation for ARS transactions or otherwise
induce them to sell the product, and did not make and then break commitments to
support the ARS market. The Attorney General`s refusal to take these very
significant differences into consideration in this case is unjust. Schwab cannot
agree to a prepackaged resolution that unfairly punishes it and its shareholders
for events over which it had no control or ability to predict.

After taking one-sided testimony (during which Schwab`s counsel was not
permitted to ask questions or even request a transcript), selectively picking
through tens of thousands of subpoenaed emails and numerous recorded telephone
calls,1 and initiating contact with Schwab customers in an effort to solicit
complaints from customers who had not previously complained, your Office
evidently believes that it has come up with instances of minor failings on the
part of Schwab representatives to disclose some of the risks of ARS to this or
that customer. You seek to use those isolated instances as conclusive proof that
Schwab violated New York law and in service of your predetermined goal to force
every firm to buy back frozen ARS from customers across the country, regardless
of the facts.

There are several fundamental flaws with your approach, including the reliance
on faulty "fraud by hindsight" analysis; the failure to acknowledge that Schwab
and its customers were misled by the ARS underwriters; the misuse of
interactions with a handful of customers to draw conclusions about a much larger
universe of transactions; the fact that one of the statutes you rely on, New
York`s Consumer Protection law, does not even apply to securities transactions;
and your audacious assertion of nationwide jurisdiction over transactions that
have no substantive connection to New York State. We briefly address each of
these issues below.

Fraud by Hindsight

Your "fraud by hindsight" analysis takes the occurrence of an event that is
unfortunate but was entirely unforeseen by Schwab and improperly uses it to
assign liability to Schwab for failing to disclose the unknown risk of that
event. This is a widely discredited technique, depending as it does on using
after-the-fact knowledge to judge events that took place before those facts
became known. See, e.g., Denny v. Barber, 576 F.2d 465, 470 (2d Cir. 1978).

As you are well aware, prior to February 2008, there had been only a handful of
scattered auction failures in a retail ARS market that had seen hundreds of
thousands of successful auctions over more than two decades. At that time,
Schwab was not aware that the lead underwriters were routinely propping up the
auction market by submitting cover bids to prevent auctions from failing. Nearly
all ARS were receiving AAA ratings and these securities were very popular cash
management investments for investors of all types, from the largest and most
sophisticated corporate cash managers to ordinary retail investors. Securities
regulators such as the SEC, FINRA, and your own Office evidently shared this
view, as not one of them issued any warning about the risks of owning ARS prior
to the February 2008 market collapse. For these reasons, your criticism that
Schwab`s representatives considered and represented ARS to be safe, liquid
investments is unfair and misplaced. That is how everyone else viewed those
securities, and Schwab`s representatives were in a far less advantageous
position than were many others to draw any different conclusion.

Also wide of the mark is your suggestion that the August 2007 failures in
CDO-backed ARS constituted notice of "rising problems" in the retail ARS market.
Certain individuals at Schwab may have been aware of some of those failures, but
they involved an entirely different market, one involving private placement ARS
that were backed by structured products, had significant sub-prime mortgage
exposure, and could be sold only to Qualified Institutional Buyers (generally,
large corporations that own at least $100 million in securities). As with any
bond, liquidity problems due to credit concerns specific to that issue are
always a possibility, but there was no concern then that those private placement
ARS failures spelled trouble for the retail market and for high quality issues.

What does link the failures of those two entirely different ARS markets is a
common cause that the Attorney General seems not to have considered at all: the
global credit contagion and accompanying liquidity crisis that has held the
world in its grip for the past two years. The crisis started as a nasty
brushfire in the sub-prime mortgage field but soon blew up into a ferocious
firestorm that has swept the globe. The present crisis has resulted in a litany
of horribles that would have been, like the collapse of the entire ARS market,
unthinkable only a few short years ago. To name but a few: a major money market
fund "breaking the buck;" huge, unprecedented infusions of emergency capital by
nearly every central bank; the failure of more than 80 domestic banks, blank
check federal bailouts of several "too big to fail" enterprises; federal
guarantees of money market funds to quell investor fears and thereby avoid a
panic similar to that which occurred in the ARS market; and the bankruptcy of
venerable giants such as General Motors. Stock markets have cratered and
investment portfolios have been halved, or worse. (Ironically, retail ARS
holdings, while illiquid, generally have continued to pay interest and have thus
served as something of a forced safe harbor for the investors who own them,
another fact that seems to have escaped the Attorney General`s notice.) In
short, the failure of liquidity in the ARS market was but one of a series of
unfortunate consequences of a global liquidity panic that was not foreseeable to
Schwab, the regulators, or anyone else.

Schwab And Its Customers Were Deceived By The Underwriters/Lead Managers

Conspicuously missing from the Attorney General`s purported 5-day notice letter
is the major role that the lead underwriters played in deceiving Schwab,
withholding critical information regarding ARS from Schwab, and providing
misleading information knowing that Schwab would rely on that information and
pass it on to customers. As underwriters and "lead managers" of the auctions for
the ARS they underwrote and brokered, these firms had information regarding the
auction market, and their own manipulation of that market, that was not known to
or knowable by Schwab or Schwab's clients. In particular, Schwab did not know
that the lead underwriters were routinely submitting cover bids to prevent
auctions from failing and then using their sales forces to find buyers for ARS
they were forced to purchase in the auctions. Because this vital information was
concealed by the lead underwriters who had enormous incentives to maintain the
facade of a liquid market, Schwab had no reason to suspect that auctions were
clearing due to artificial support, rather than normal marketplace demand, and
no way of advising its clients regarding the true state of the market.

With no role in the underwriting of ARS, Schwab relied on the lead underwriters
for access to ARS and relied on information regarding ARS and the auction
markets provided by these firms. For example, during a November 2007 call, one
major underwriter assured Schwab that its auctions were not failing and were not
likely to fail. When this underwriter gave Schwab these false assurances, it
knew, but concealed, that its inventory of ARS was no longer sustainable and
would inevitably result in the firm`s withdrawal from the auction market in the
near-term. Indeed, your Office has found that, during this period, this firm was
aware of the increasing strains in the auction rate securities market and
increasingly questioned the viability of the auction rate securities market, but
did not disclose these increasing risks of owning or purchasing auction rate
securities to all of its customers. In fact, this underwriter continued to
deceive Schwab and conceal critical information right up to its complete
withdrawal from the auction market. Just days before it withdrew completely from
the auction market in February 2008, this firm gave Schwab more false
assurances, emphasizing that it had experienced only one previous auction
failure, back in 1990; but concealed the fact that it was planning, within days,
to withdraw its supporting bids from all its ARS auctions.

As your Office concluded in your enforcement actions against that firm and the
other underwriters through which Schwab accessed the ARS market, because
investors could not ascertain how much of an auction was filled through `cover`
bids and proprietary trades, those investors could not determine if auctions
were clearing because of normal marketplace demand, or because these firms were
making up for the lack of demand through `cover` bids and proprietary trades.

It is precisely this information that these same firms concealed from Schwab and
Schwab's customers. Nevertheless, the Attorney General chose voluntarily to
enter into Assurances of Discontinuance that released these underwriters from
public responsibility for their role in deceiving Schwab's clients into
purchasing the ARS products the underwriters created, propped up and then
suddenly abandoned. Schwab submits that, having released the real culprits from
responsibility for their acts, the Attorney General drop efforts to now shift
that responsibility to Schwab.

Unwarranted Assumptions Based on Incomplete Facts

In any event, your demand that Schwab buy back without exception all outstanding
ARS owned by its retail customers is based upon unwarranted assumptions drawn
from a small number of transactions and an incomplete factual record. Indeed,
contrary to your sweeping allegations, your own investigation elicited testimony
from some Schwab representatives who did recall discussing with clients the
remote risk of an auction failure for an individual issue and the consequences
if that were to occur. Your theory fails to take these inconvenient facts into
account.

Similarly, your theory completely ignores crucial factual variances, such as
widely different levels of ARS experience on the part of Schwab`s customer base
and whether ARS purchases were solicited or unsolicited. As you know from the
records Schwab produced, the vast majority of Schwab`s ARS transactions were
"unsolicited." Your demand for a universal buy back simply disregards these
highly relevant factual differences between clients and transactions.

The Consumer Protection Statute Does Not Apply to Securities Transactions

We are mystified by your stated intention to bring charges against Schwab under
New York`s Consumer Protection law. Most courts that have considered the issue
have ruled that the statute does not apply to securities transactions. See,
e.g., In re Eaton Vance Mutual Funds Fee Litigation, 380 F.Supp.2d 222, 240
(S.D.N.Y. 2005) (holding Section 349 "does not apply to securities transactions,
even when those actions are brought as claims by 'holders' of shares"); In re
Evergreen Mut. Funds Fee Litigation, 423 F.Supp. 2d 249, 264 (S.D.N.Y. 2006);
Gray v. Seaboard Securities, Inc., 14 A.D.3d 852, 788 N.Y.S.2d 471, 473 (3d
Dept. 2005); Fesseha v. TD Waterhouse Investor Services, Inc., 761 N.Y.S.2d 22,
23-24 (1st Dept 2003).

Some New York plaintiffs have attempted to circumvent these precedents by
arguing that their deceptive business practice claim relates to the service of
providing investment advice and not to the purchase of securities themselves.
Those efforts have not fared well. For example, the Gray court held that the
promised advice and recommendations were clearly "ancillary to the purchase of
securities." 788 N.Y.S.2d at 473 (quoting Berger v. E*Trade Group, 2000 WL
360092 (Sup. Ct., NY County, Mar. 28, 2000). The clear weight of authority holds
that claims arising out of securities transactions are not covered by the
Consumer Protection statute.

The New York Attorney General Does Not Have Nationwide Jurisdiction

We are equally mystified by your Office`s assertion that it can assert
jurisdiction over all of Schwab`s ARS transactions, regardless of whether they
involve New York customers or New York representatives. When Schwab raised this
issue, you said you planned to rely on the fact that the third-party agents who
conducted the auctions for ARS are located in New York. That is a tenuous -- and
untenable -- basis for asserting jurisdiction over transactions by an
out-of-state corporation that did not involve either New York residents or New
York sales representatives. Your Office has attempted, without success, to
employ a nearly identical tactic before. State v. Samaritan Asset Mgmt. Servs.,
Inc., 874 N.Y.S.2d 698, 702-04 (N.Y. Sup. 2008).

Executive Law § 63(12) Was Not Intended to Be Used in Cases Such as This

While there is not a clear statement from the legislature regarding the intended
use of Executive Law § 63(12), a fair reading of the legislative history
suggests that the purpose of permitting the Attorney General to commence a
special proceeding under that statute was to provide a mechanism for remedying
quickly any ongoing course of fraudulent conduct. We believe, and will argue in
court, that the expedited procedure set forth in § 63(12) should be reserved for
instances of repeated or imminent fraudulent conduct, not wielded as a tactical
weapon to cut off a defendant`s right to defend itself.

As suggested above, there are numerous material issues, both factual and legal,
upon which the parties fundamentally disagree. We do not believe that a court
will look with favor on the Attorney General conducting a year-long
investigation of a past market event and then rushing into court demanding
immediate adjudication without the defendant being afforded any discovery or a
meaningful opportunity to prepare and present a defense. There is no ongoing
course of fraudulent conduct here that warrants stripping Schwab of the basic
due process rights that any citizen deserves.

Conclusion

The Attorney General`s demand that Schwab act as an insurer against an
unprecedented market collapse that it did not cause and could not predict is
legally unsound. More than that, it is unjust and a dangerous precedent. The
filing of any charges against Schwab is totally unwarranted, and the Company
will vigorously defend itself in court.

Very truly yours,

Faith Gay

Quinn Emanuel Urquhart Oliver & Hedges, LLP

1 We cannot let pass without comment the suggestion that Schwab has been
anything less than completely cooperative with your Office. Schwab has responded
to even "informal" requests from your Staff that arrived by email or orally over
the telephone. We assume that your erroneous assertion that Schwab failed to
provide tapes of recorded telephone calls arises from a misunderstanding of the
agreement that your Staff and Schwab`s attorneys negotiated regarding the
production of tape recordings. As was explained then, not every conversation
between a Schwab registered representative and a customer is or was recorded.
Many other broker-dealers do not record any customer calls. Those calls that are
recorded by Schwab are indexed by name of representative, date, and time, rather
than by account number. Because of the periodic nature of the ARS market, unlike
an equity trade which usually occurs at the same time as the customer phone
call, significant time might pass between the time of the call and when an ARS
trade ticket is entered. These factors make it laborious, time consuming, and
sometimes not possible to find particular calls. When this was explained to your
Staff, they agreed to permit Schwab to produce, to the extent they could be
located, calls associated with the first two ARS purchases for any retail New
York customers holding ARS positions at Schwab as of April 13, 2009. Schwab
fully complied with that agreement and never heard a hint of dissatisfaction on
that score from your Office until your July 17th letter.

About Charles Schwab

The Charles Schwab Corporation (Nasdaq: SCHW) is a leading provider of financial
services, with more than 300 offices and 7.6 million client brokerage accounts,
1.5 million corporate retirement plan participants, 619,000 banking accounts,
and $1.3 trillion in client assets. Through its operating subsidiaries, the
company provides a full range of securities brokerage, banking, money management
and financial advisory services to individual investors and independent
investment advisors. Its broker-dealer subsidiary, Charles Schwab & Co., Inc.
(member SIPC, http://www.sipc.org), and affiliates offer a complete range of
investment services and products including an extensive selection of mutual
funds; financial planning and investment advice; retirement plan and equity
compensation plan services; referrals to independent fee-based investment
advisors; and custodial, operational and trading support for independent,
fee-based investment advisors through its Advisor Services division. The Charles
Schwab Bank (member FDIC) provides banking and mortgage services and products.
More information is available at www.schwab.com.

Photos/Multimedia Gallery Available:
http://www.businesswire.com/cgi-bin/mmg.cgi?eid=6015319&lang=en

Charles Schwab & Co., Inc.
Sarah Bulgatz, 415-667-0328 (Media)
Sarah.bulgatz@schwab.com
Michael Canady, 415-667-1834 (Investors/Analysts)
Michael.canady@schwab.com

Copyright Business Wire 2009

http://www.businesswire.com/news/home/20090816005036/en