Charles Schwab 2010 Annual Report Download - page 86

THE CHARLES SCHWAB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted)
Schwab is required to provide collateral to certain brokerage clients. Schwab satisfies the collateral requirements by arranging LOCs,
in favor of these brokerage clients, which are issued by multiple banks. At December 31, 2010, the aggregate face amount of these
LOCs totaled $37 million. There were no funds drawn under any of these LOCs at December 31, 2010.
The Company also provides guarantees to securities clearing houses and exchanges under their standard membership agreement,
which requires members to guarantee the performance of other members. Under the agreement, if another member becomes unable to
satisfy its obligations to the clearing houses and exchanges, other members would be required to meet shortfalls. The Company’s
liability under these arrangements is not quantifiable and may exceed the cash and securities it has posted as collateral. However, the
potential requirement for the Company to make payments under these arrangements is remote. Accordingly, no liability has been
recognized for these guarantees.
L
egal contingencies: The Company is subject to claims and lawsuits in the ordinary course of business, including arbitrations, class
actions and other litigation, some of which include claims for substantial or unspecified damages. The Company is also the subject of
inquiries, investigations, and proceedings by regulatory and other governmental agencies. In addition, the Company is responding to
certain litigation claims brought against former subsidiaries pursuant to indemnities it has provided to purchasers of those entities.
Certain of these matters are described below.
The Company believes it has strong defenses in all significant matters currently pending and is contesting liability and the damages
claimed. Nevertheless, some of these matters may result in adverse judgments or awards, including penalties, injunctions, or other
relief, and the Company may also determine to settle a matter because of the uncertainty and risks of litigation. Based on current
information and consultation with counsel, management believes that the resolution of matters currently pending will not have a
material impact on the financial condition or cash flows of the Company, but could be material to the Company’s operating results for
a particular future period, depending on results for that period. However, predicting the outcome of a matter is inherently difficult,
particularly where claims are brought on behalf of various classes of claimants, claimants seek substantial or unspecified damages, or
when investigations or legal proceedings are at an early stage, and in many cases, including the Auction Rate Securities Regulatory
Inquiries and Total Bond Market Fund Litigation matters described below, it is not possible to determine whether a loss will be
incurred or to estimate the range of that loss until the matter is closer to resolution.
Auction Rate Securities Regulatory Inquiries: Schwab has been responding to industry wide inquiries from federal and state
regulators regarding sales of auction rate securities to clients who were unable to sell their holdings when the normal auction process
for those securities froze unexpectedly in February 2008. On August 17, 2009, a civil complaint was filed against Schwab in New
York state court by the Attorney General of the State of New York alleging material misrepresentations and omissions by Schwab
regarding the risks of auction rate securities, and seeking restitution, disgorgement, penalties and other relief, including repurchase of
securities held in client accounts. As reflected in a statement issued August 17, 2009, Schwab has responded that the allegations are
without merit and that Schwab intends to contest any charges. On March 15, 2010, Schwab filed a motion to dismiss the case and
various claims in the civil complaint, which remains pending.
Separately, the Company previously disclosed receipt of Wells notices from the Financial Industry Regulatory Authority (FINRA) in
November 2009 and February 2010 concerning its investigation into sales of auction rate securities through Schwab and providing an
opportunity to respond. On February 11, 2011, Schwab was notified by FINRA that its Enforcement staff will not recommend the
commencement of a disciplinary action against Schwab relating to this matter.
YieldPlus Fund Litigation and Regulatory Inquiries: The Company is the subject of consolidated class action litigation, regulatory
investigations and individual investor arbitration claims relating to the Schwab YieldPlus Fund , an ultra-short bond fund (“Bond
Fund”). The Bond Fund was designed to invest in a variety of fixed income instruments, including corporate bonds, asset-backed
securities, mortgage-backed securities and other fixed income investments. The credit crisis that began in mid-2007 led to a decline in
the value of a majority of fixed income investments market wide. As a result, certain Schwab clients who chose to invest in the Bond
Fund experienced a decline in their investments, leading to the litigation.
Nine class action lawsuits were filed between March and June 2008 on behalf of investors in the Bond Fund alleging violations of
California state law and federal securities law in connection with the fund’s investment policy, disclosures and
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