Charles Schwab & Co., the nation's largest discount stock brokerage firm, yesterday disclosed it lost more than $22 million in the stock market collapse, most of it because one corporate customer was unable to make good on losses speculating in stock options.
Schwab said the corporate customer, who has traded with Schwab since 1984, owed the firm a staggering $84 million after suffering losses on more than 500 stock option positions. Stock options give investors the right to buy or sell stock at a future date and at a specified price.
Under the terms of a court-approved settlement, the customer, whom the firm declined to identify, agreed to pay $67 million over a five-year period, leaving Schwab to absorb the rest.
Schwab said its $22 million in after-tax losses also reflects a reserve for problems related to another $13 million in customer borrowings.
United Press International said the customer who suffered the big losses was a foreign investor. Schwab declined to comment on that report, saying only that it was a corporate brokerage account.
The loss nearly wipes out Schwab earnings for the last six months. But the firm, which provides cut-rate brokerage services to nearly 1.9 million customers, emphasized at a press conference yesterday that it has hundreds of millions of dollars of capital and that no clients need worry that securities or stocks on deposit with Schwab are at risk.
"We are in incredible, unprecedented times," said Charles Schwab, chairman of the firm bearing his name. The stock market's recent performance is "something that happens once in a generation. It was perhaps the only time in our lifetime that we will witness something like it," Schwab said.
Sometimes investors buy or sell options in tandem with stock, so that their options trades represent a way to minimize possible stock trading losses. Someone who buys 100 shares of a stock for $100 a share can protect that investment, for example, by buying an option giving him the right to sell those shares within a specified time for at least as much. The option itself trades at a price that fluctuates to reflect changes in the price of the underlying stock.
But the customer who cost Schwab millions of dollars apparently traded options in a more speculative fashion, without completely offsetting positions in stocks or other securities. Speculation of this nature is known as trading "naked" options; Schwab called it trading "uncovered options."
The trading was done on margin, which means the customer put up only a small deposit to cover possible losses. When stock or options prices decline, brokerage firms require customers to put up more cash. But the corporate customer did not put up enough cash to cover his positions.
"This is a very substantial customer that had substantial equity with us and, in fact, this is a customer who has been with us since 1984 and has continuously met multimillion dollar margin requirements," said Schwab Vice President Barbara Rip.
The losses were triggered by the stock market's declines on Oct. 16 and 19, the latter known as Black Monday, when the Dow Jones industrial average declined 508 points.
Rip said the unprecedented losses prompted Schwab to increase its margin requirements, a move that will force investors to put up more cash for their options purchases.
"It was out of control because of the market volatility," Rip said. "What we want to do is revisit the margin requirements in highly volatile markets. We have been reassessing our credit exposure on each customer's account, we are increasing our margin requirements as needed ... and we are greatly restricting the writing of uncovered options."
In addition to the $22 million in after-tax losses attributable to customer trading losses, Schwab reported another $3 million in pretax losses related to executing orders for customers. Rip said the losses occurred during the recent chaos in stock markets, when Schwab customers asked to buy or sell securities at one price but the orders were executed, with unreasonable delays, at another price.
Schwab stock closed at $6.50 a share yesterday, down $1. The firm sold stock to the public on Sept. 22 at $16.50 a share.
Schwab is not the only firm reporting losses stemming from the collapse. But securities analyst Perrin Long predicted that Schwab, and some of the other firms reporting extraordinary losses related to the market turmoil, ultimately would recoup losses through brokerage commissions from the heavy trading volume.
Harold J. Bloom, chief financial officer of Minneapolis-based stock broker Piper, Jaffray & Hopwood, said that firm has problems similar to Schwab's, although not of the same magnitude. "It's like comparing a drink of water to the ocean," Bloom said, calling the firm's losses from customer borrowings "digestible."
Special correspondent Paul Farhi contributed to this report.