The collapse of the auction rate securities markets continues to be a focus of government enforcement actions. Many sellers of ARS have settled with the SEC, the New York Attorney General and, in some instances, other state AGs. Typically, those settlements have required the repurchase of auction rate securities from retail customers and the best efforts of the seller to bring liquidity to the market so that larger institutional and corporate investors may liquidate their positions.

Not all cases have settled, however. Last month the SEC filed an action against Morgan Keegan related to the collapse of the auction rate securities markets. The case is in litigation as discussed here. Yesterday, New York Attorney General Andrew Cuomo filed a similar case against Charles Schwab & Co., The People of the State of New York v. Charles Schwab & Co., (S. Ct. NY. Filed Aug. 17, 2009). The complaint in this case is similar to those in the settled ARS cases, alleging that investors were sold the securities based on representations that they were safe and liquid, when in fact they were not.

The Charles Schwab case amplifies these claims. According to the complaint, the Attorney General secured tapes of brokers selling the securities and making these representations to customers. One broker “guaranteed” that the customer could readily trade out of the positions. Another told the potential investor that the most difficult thing about the ARS market was getting into it, not getting out of it. These claims, and other similar ones, the complaint states, were false.

The Attorney General’s suit goes on to claim that Schwab failed to ensure its brokers and sales force were property equipped to tell investors about the liquidity risks of auction rate securities that were known to the firm. The firm also knew, or was reckless in not knowing, about difficulties in the markets beginning as early as August 2007. Because of Schwab’s misleading sales practices many of its customers purchased ARS based on false assurances of liquidity and without having been provided with basic information about the securities. These actions violated the New York Martin Act. The complaint seeks, among other things, the repurchase of the securities along with penalties and costs. This case is in litigation.

One of the few criminal cases related to the collapse of the ARS market is U.S. v. Tzolov, Case No. 1:08-cr-00370 (E.D.N.Y. Filed Aug. 20, 2008) which named as defendants two former UBS brokers. Yesterday Eric Butler, one of the defendants in that case, was convicted of conspiracy and securities fraud following a three week trial. Mr. Butler, and co-defendant Julian Tzolov, were charged with defrauding investors in connection with the purchase of action rate securities. Specifically, the indictment claimed that the two former brokers solicited investors to purchase ARS backed by student loans on the basis that they were safe, conservative investments. Without telling the investors, the brokers switched the investors into much riskier higher-yield mortgage backed collateralized debt obligations which paid higher commissions. The scheme was discovered in August 2007 when the market for mortgage backed CDO’s collapsed. Investor losses were about $1 billion.

Shortly prior to trial Mr. Tzolov pleaded guilty. Previously, while on bail, he fled the country. He was returned by Spanish authorities and is currently waiting for sentencing.

The SEC brought a parallel action against the two former brokers, SEC v. Tzolov, Case No. 08 civ 7699 (S.D.N.Y. Filed Sept. 3, 2008), discussed here.

As the market crisis investigations of DOJ, the SEC and state regulators continue to unfold there will in probability be other similar cases filed.