Chuck Schwab, whose brokerage is being sued by the Attorney General of New York for misrepresentations its salespeople made to clients about the liquidity and risks of auction-rate securities, is on familiar ground.
Once again Schwab clients are upset and the business is in trouble because of the completely predictable excesses of salespeople.
Schwab knows that it's in the nature of salespeople to misrepresent. Schwab knows that salespeople tend to steer clients to whatever product pays the best commissions rather than what is best for the investor. That's why the principle of "no selling" was a founding principle of the company. For many years, this principle was enforced and Schwab avoided scandal after scandal. On the occasions when the "no selling" rule was violated, Schwab generally came to regret it.
The situation in New York appears to be another example of this same dynamic.
The question is, how will Chuck Schwab respond? He has two basic choices. Plan A is to fight the suit in the courts and on the op-ed pages. Plan B is to admit violations of Schwab's own policies, accept responsibility, apologize, and make restitution. It appears that Chuck prefers Plan A. It's a mistake he will come to regret.
A little background. Schwab brokers are accused of repeatedly misrepresenting auction rate securities as liquid, short-term investments without disclosing the risks to clients whose profiles made then inappropriate candidates for such investments. The Attorney General claims that it has recordings of Schwab brokers comparing the securities with money-market funds or certificates of deposit. The claims are totally believable.
The problem was revealed when the market for auction rate securities seized up in February 2008. Since there were no buyers, there was no way for the clients to sell their investments. Even though Schwab's clients didn't lose money, they were angry that they couldn't get their money, in spite of Schwab's representations that it was as easy to get out of the investments as it was to get in.
Other brokerages such as TD Ameritrade have agreed to settle the matter by buying the securities it sold to its clients. Schwab has indicated that it will fight the suit. In fact, it asserts principled grounds for doing so. Schwab published an op-ed in the Wall Street Journal laying out the reasons why it's right to oppose settling.
"Whine-Fest"
Initial reactions were not generous. Schwab had the bad luck to come out with an op-ed piece on the same news cycle as Warren Buffett. Schwab's efforts did not compare well. A Bloomberg headline "Buffett Informs, Schwab Whines on Op-Ed Pages" tells it all.
Two money titans hit the op-ed trail this week. One of them, Berkshire Hathaway Inc. Chief Executive Officer Warren Buffett, offered constructive talk in the New York Times about why Congress must pay attention to the budget deficit once the U.S. economy gets back on its feet. The other, Charles R. Schwab, emoted in a whine-fest in the Wall Street Journal about regulators who are picking on the brokerage firm he founded.
"With his latest oeuvre, Schwab uses his business-guy celebrity to duck responsibility for customer losses and fudge the facts," writes Bloomberg News Correspondent Susan Antilla. "Under the headline 'Brokers Aren't Responsible for Bad Bets' -- he could just as easily have deleted the last three words -- Schwab offered up his version of the reason that Schwab customers are stuck with auction-rate securities that they can't cash in."
The Power of Taking Responsibility
Chuck would be a lot better off going with Plan B. If Schwab's investigations reveal that its brokers did indeed misrepresent the securities, he should say so, accept responsibility for not training and supervising them properly, apologize to the clients it served poorly, provide restitution by buying back the securities, and paying the fine. Then Chuck should write an op-ed piece on what lessons the company learned from this experience, what steps it is taking to present it from happening again, and reasserting the principles that have served Schwab well for so many years.
Chuck has the stature to hold his own with Warren Buffett. All it takes is a willingness to do the right thing, admit mistakes and apologize.
Bloomberg ended its article by quoting me on the power of apology.
John Kador, who wrote a book about Schwab, says the firm has veered from its original mission of serving self-directed investors, yet clings to the do-it-yourself image even as it sells products and gives advice. Schwab would be better served to apologize, admit its mistakes and move on, says Kador, whose most recent book "Effective Apology" might not be a bad addition for the Schwab chairman's end-of-summer reading list.
The ball is now in Schwab's court. There is still time for him to seize the high road, do right by his clients, and reassert the ethical standards that have typified the company. In the past he has acted on the principles of accountability, trnasparency, and humility. He can have all three by apologizing.
Apologizing won't be cost-free. It never is. It's just less costly than the alternatives.
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