OF LIPSTICK AND PIGS
If there was an award for clever advertising for financial firms, Charles Schwab would be the hands down winner this year. They were responsible for “putting some lipstick on the pig” and now they are touting how independent and better they are. Charles Schwab is getting out of the discount brokerage business. They want to be a full-service money manager and financial advisor. Stock in Charles Schwab has fallen off a cliff over the past couple years along with its earnings, trading volume and just about everything else. Charles Schwab should have taken on this role 20 years ago. Now that day traders and do it yourself investors are few and far between, they want to remodel themselves as an investor advocate. I don’t buy it and neither should you.
This past month a lawsuit was filed in Los Angeles Superior Court claiming that Schwab was guilty of running television ads that materially mislead investors. The suit takes issue with a television ad in which Schwab states “We don’t underwrite stocks; we only offer objective advice.” Schwab was indeed an underwriter for about 25 IPO deals when it was fashionable to do so. Schwab abandoned its underwriting activities two years ago, stating conflicts of interest. The suit states that Schwab should return all of its fees and commissions it received from its underwriting activities if it wants to run deceptive advertisements.
In a separate case, Michael Baker an ex-client of Schwab is suing over a $60 account termination fee. Schwab instituted this fee last year without warning customers. It is one of the more sleazy, devious moves I have seen in awhile. The purpose of the fee was to collect from customers who were dissatisfied with Schwab’s services and wished to move their account. Due to poor performance many clients were leaving the firm, Schwab needed to boost falling earnings and was doing everything to collect.
This past month Charles Schwab created a new position, chief investment strategist, handing the position to Elizabeth Sonders. (Liz Ann) Sonders is a 37-year-old senior investment strategist at U.S. Trust. In announcing the appointment Schwab co-CEO David Pottruck declared, “Schwab’s advice model has always been about helping investors, not hyping stocks.” If you are not familiar with Liz Ann she is most definitely very easy on the eyes. She looks like a Kappa Kappa Gamma sorority sister. She is going to be the face of Charles Schwab so I can understand the necessity of a pretty face. However, her job performance stinks. The growth fund Sonders currently comanages is down 35% through late November, nearly a full 10% worse than Morningstar growth peer group. Over the past four years the portfolio has returned an average –26% versus –16.5% for the peer group. As part of a three-person committee overseeing U.S. Trust’s growth portfolios, Sonders has shared investing responsibility with two other managers. Excelsior Growth shows it would earn a C rating from Schwab’s grading system. Liz Ann has been a regular on CNN’s Moneyline, Louis Rukeyser, and CNBC. Liz Ann’s claim to fame was in February 2000. She was featured in a New York Times story in which ten stock pickers were asked to identify one stock they would feel comfortable buying now and holding until January 1, 2010.” Sonders pick was JDS Uniphase Corp.; at that point in history the company was trading at $215 a share, now $2.
Schwab also has a conflict of interest when it comes to its trade executions. Schwab tells investors that it discounts their commissions. However they make up for the lost revenue in a shifty manner. Schwab sells a portion of the stock orders to electronic market makers which in turn execute the transactions without exposing the order to the market for price improvement. These firms then pay Schwab a few cents per share. Therefore, instead of seeking out the best available prices, Schwab moves the orders to an area of the market where customers are more than likely not receiving the best prices.
Another bit of information brought to our attention is Charles Schwab’s money market assets. They state that they have some $124 billion, most which is swept from brokerage accounts automatically. Most money market funds charge no more than 40 basis points, yet Schwab charges a staggering 75 basis points. Short-term rates yield about 100 basis points for investors. The rate they charge is the definition of excessive.
Last, but not least is the issue of margin loans. For a company that is purporting to be “looking out for the little guy,” the company sure does hand out many margin loans. We have railed against buying on margin on several occasions here in this newsletter and the radio show. The practice is one of the culprits in creating the stock market bubble. Margin loans allow small investors to take on leverage that is unnecessary and dangerous. Revenue from margin lending for Schwab will reach $400 million or 10% of total revenues this year. The average brokerage receives 5% of its revenue from margin loans. According to Putnam Lovell, in 2000, 31% of Schwab’s $5.8 billion in revenues came from such loans. Why would a firm that is “looking out for the little guy” be so willing to disperse and endorse a risky strategy?
Charles Schwab is trying to take advantage and capitalize from the many scandals that have affected Wall Street. That’s capitalism, and I have no problem with it. However, if you want to play the good guy, you must come clean that you have been, and are still a part of the problem. To quote Hal Holbrook from the movie Wall Street, “You can’t get a little bit pregnant.” I also take issue with how they are building this “full-service” firm. First, it takes more than a pretty face to head a firm. Secondly, have you ever been in a Schwab office? It would be nice to have some advisors that would be a little more seasoned. If I wanted N’Sync or the Backstreet Boys to manage my finances I would ask. The business model of Charles Schwab has failed. It will not be able to attract the top advisors and money managers that savvy better-informed advisors will demand. Investors that are attracted to Schwab’s colorful advertisements will be kicking themselves sooner than later.
