BROKERS AREN´T RESPONSIBLE FOR BAD DEBTS / THE WALL STREET JOURNAL OP EDITORIAL

OPINION

AUGUST 19, 2009

Brokers Aren't Responsible for Bad Bets

By CHARLES R. SCHWAB

A blizzard of new proposed regulation and overzealous litigation is poised to jeopardize the low-cost investing model that tens of millions of investors have enjoyed for decades. In the last 30 years, individual investors have benefitted from huge innovations, including low commissions, online investing, mutual fund supermarkets, and the advent of exchange traded funds. Individuals now have broad access to domestic and global markets at costs lower than institutions enjoyed only a few years ago. This has provided needed capital to our economy and enabled the creation of personal wealth for average Americans.

But today's extraordinary regulatory and political environment is putting all of this at risk.

My company, Charles Schwab, was founded 35 years ago as a reaction to the high cost and inherent exclusivity of traditional Wall Street investing. Today we serve almost 10 million accounts. The majority are what we refer to as self–directed: They make their own decisions about what to buy, sell or hold. We provide them with an efficient platform, tools, assistance, education and, of course, low costs.

We are not alone. Our direct competitors serve millions of other American investors who are looking for essentially the same thing: the freedom to inexpensively invest on their own.

We have never guaranteed individual success. Our investors understand that along with investing comes risk, as well as potential reward. Unfortunately, we are now seeing a conscious effort to limit—if not eliminate—all risks for the individual investor, whether through consumer "protection," fiduciary liability for brokers, or the threat of litigation that attempts to make our firm, and others like us, more like an insurance company than a broker.

As an example, Schwab is currently being sued by New York Attorney General Andrew Cuomo, who alleges that we should have known beforehand that the Auction Rate Securities market would freeze. Auction Rate Securities are generally high-quality, long-term bonds that can be bought and sold on a weekly or monthly basis through an auction process. The interest rate paid on the bonds was reset at each auction according to investor demand. The auction process has largely been frozen since February 2008, leaving investors holding quality long-term, but illiquid bonds.

Though this market operated smoothly and reliably for over 20 years, it is a market that we had no direct involvement in establishing or maintaining. It's a market where roughly 90% of the clients who invested in these securities came to Schwab asking us to locate and make available these investments for them. We did not create the products, actively market them, and had no involvement in the events that led to the collapse of the Auction Rate Securities market.

The implication of this lawsuit is that firms like ours should have known that the market would fail. Should we also have known that Lehman Brothers or Bear Stearns were going to go under and compensate clients who bought their equity or debt? Should we have been able to predict which financial institutions would be the beneficiaries of government bailouts and which would not? I think it's fair to say we have all been surprised by many events this past year.

The issue at stake here is whether independent investors should be allowed the freedom to choose what they are allowed to buy, sell or hold. Or should the government try to enforce a guarantee against market risk through regulation or lawsuits like the attorney general has brought against us?

If Schwab is going to be held responsible for guaranteeing every decision an investor makes, we'd need to severely limit what they purchase. Would we tell them they couldn't buy Google or IBM stock because regulators or politicians don't think they are smart enough to assess the risks and could hold us accountable for any losses? The logical outcome would be that individual investors would be constrained to a small set of plain vanilla investments—Treasurys for all—or would be forced to pay us a fee to manage their account.

To be sure, we are happy to manage money for our clients. But millions of investors have decided that their needs are best served when they direct their own finances. Forcing them to pay an advisory fee would be a significant new cost to them and the fees would likely shut many small investors out of the capital markets altogether.

I've always believed in the power of the market to drive innovation and drive down cost. I also believe in the individual and his or her ability to make reasoned decisions. I don't think our clients, or our competitors' clients, are looking for regulators or politicians to protect them from risk by constraining their choices.

Today Schwab clients can open an account with as little as $1,000. If they invest their $1,000 in an S&P 500 Index fund, they would pay no commission and their total cost of management would be 90 cents per annum. For 90 cents a year they can access everything Schwab has to offer including education, tools, our Web site, 24/7 live phone service, as well as support from one of our approximately 300 branches across the country. This is an incredibly powerful model that I'm proud of, and a model that I think is good for this country and the market.

Don't let litigators and politicians jeopardize it. If they succeed, the individual investor will pay a heavy price.

—Mr. Schwab is founder and chairman of the Charles Schwab Corporation.


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