Auction-rate securities probe widens

Regulators question smaller brokerages

August 23, 2008|By Walter Hamilton | Walter Hamilton,Los Angeles Times

NEW YORK - Regulators looking into the auction-rate securities debacle have turned their attention to nearly 40 brokerages that might have sold the paper to clients but didn't underwrite it.

Investigators from the Financial Industry Regulatory Authority plan to conduct examinations at the brokerages, with the first inspections beginning Monday, to determine whether the companies were aware of the problems in the auction-rate market and adequately warned customers about the risks.

The regulatory sweep represents a major widening of auction-rate probes that until now have centered on the big investment banks that underwrote the debt and managed auctions of the securities.

On Thursday, three more Wall Street companies agreed to make amends with customers who bought auction-rate securities. The addition of Merrill Lynch & Co., Goldman Sachs Group Inc. and Deutsche Bank AG brought to eight the companies that have reached legal settlements regarding the securities.

The eight companies - including Citigroup Inc. and UBS AG - agreed to repurchase about $50 billion of roughly $60 billion in auction-rate debt estimated to be held by individual investors.

The inspections of smaller brokerages are coming as New York Attorney General Andrew M. Cuomo is trying to force those companies as well to buy back auction-rate securities.

"We're starting with the largest banks, in terms of number of people involved ... and we're working our way down the list," Cuomo said Thursday. "We're now focusing on some of the midsize players in the market."

Cuomo's office has sent subpoenas to brokerages such as Fidelity Investments, Charles Schwab Corp., TD Ameritrade Holding Corp., E*Trade Financial Corp. and Oppenheimer & Co.

Auction-rate securities are long-term debt instruments designed to trade like short-term securities. They were issued by many municipalities and closed-end mutual funds and pitched by brokers to small investors as safe and easily redeemable.

As the credit crunch worsened, the $300 billion auction-rate market froze in February, leaving investors unable to sell their holdings.

A bond-industry trade group representing regional brokerages has contended that they have no obligation to repurchase auction-rate securities because they simply facilitated purchases at the request of clients and took no role in creating the securities.

However, a lawyer in Cuomo's office sent a letter to the trade group rebutting those claims.

Benjamin Lawsky, a special assistant, said Cuomo's probe "has already begun to uncover some disturbing facts that seem to belie the innocent picture of downstream brokerages."

It seems "highly unlikely that the firms had no understanding of what was happening in the [auction-rate] market," Lawsky added.

Walter Hamilton writes for the Los Angeles Times.

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