| 10 June 2010

E*TRADE Financial Corporation (ETFCD) lost an arbitration ruling in the case of a New Jersey couple seeking $1.3 million. The couple purchased auction-rate securities through E*TRADE in 2008 when they were allegedly sold as a safe alternative to cash. They were awarded $1.25 million plus $70,000 in legal fees.

We first started writing about the ARS debacle back in July of last year. The auction rate securities market collapsed in February 2008 and left many investors wondering what just happened. They had good reason to scratch their heads. Individual investors, charities, and small business were sold the opportunity to play in a market usually reserved for larger players. But rarely were they made aware of the real risks and in fact often they were told their investments were just as safe as cash.

While TD Ameritrade (AMTD) quickly settled for $304 million, Schwab (SCHW) and Raymond James held out, claiming the debacle was the fault of the underwriters and had nothing to do with their sales practices.

At issue for Schwab was roughly $780 million in securities purchased by about 900 individuals. As more and more banks and brokerages settled with the SEC and more details were revealed, we surmised that Schwab was going to be fighting an uphill battle. And in fact, Schwab had a little spat with the SEC in February related to he YieldPlus fund and ultimately has settled out of court in that case.

We think the surrounding circumstances in this case are similar to those of the Yield plus case for Schwab. In other words, as more firms settle or start to get tagged in FINRA rulings the pressure will build for Schwab and they're likely to look for a settlement.

When it comes to E*TRADE, however, it's unclear to us how much risk is at play. We know TD Ameritrade settled for $304 and Schwab is currently on the hook for about $800 million. The problem with E*TRADE is it doesn't have the cash to spare. In fact, they recently raised $147 million through a secondary offering in order to improve their balance sheet -- not because they wanted to but because the Office of Thrift Supervision demanded it.