Wachovia and Auction Rate Securities

[Sapphire Capital]

July 17, 2008

In the latest sign of a regulatory crackdown of the auction rate securities market, a team of 10 state securities regulators showed up at the St. Louis headquarters of Wachovia Securities Thursday to demand documents and conduct interviews about the firm's sales and marketing practices, according to Missouri authorities.

The group includes investigators from Missouri, Illinois, Massachusetts, New Jersey, Pennsylvania and other states, all of which are part of a task force of states regulators investigating auction rate securities and led by the Massachusetts securities regulator. They are all members of the North American Securities Administrators Association.

The Missouri Secretary of State Robin Carnahan's office has also subpoenaed more than a dozen Wachovia Securities agents and executives seeking more information and records on its auction rate securities business, according to a statement issued by the office.

The Missouri Securities Division launched an investigation in April into Wachovia Securities and others requesting records and information. Wachovia has not fully complied with requests, "prompting today's onsite inspection," according to the regulator's statement. The Securities and Exchange Commission also requested information from Wachovia earlier this year.

The state's Securities Division is also conducting investigations into auction rate securities sales at Commerce Bank N.A. and Stifel, Nicolaus & Co. Inc.

"Most security firms, including Wachovia, are responding to inquiries from regulators about the auction rate securities industry," says Christy Phillips-Brown, spokeswoman for Wachovia. "The discussions that are occurring to day are a part of this ongoing process." No charges against Wachovia have at this point grown out of the investigations.

"Hundreds of Missouri investors have called my office because of inability to access their money," said Ms. Carnahan in the statement. She added that she aims to take actions to "make these investors whole."

The action comes after over 70 formal complaints were filed with the Missouri Securities Division over the last four months -- all from investors that feel they were misled in their purchase of auction rate securities, according to the statement.

The $330 billion market for auction rate securities allowed issuers such as municipalities, student loan companies, closed end mutual funds and financial institutions to borrow money for the long term, but at short term, or lower, interest rates.

The borrower's rates were set weekly or monthly in auctions that were conducted by Wall Street firms. When the brokerages stopped supporting the auctions as buyers-of-last-resort this past February, the market seized and investors were left unable to easily sell their securities and access their money.

Wachovia is the subject of arbitration clams and a class action lawsuit that was filed in New York in March. The basis of the claim is that investors were told they were buying securities "equivalent to cash or money market funds," according to the complaint. It also alleges that Wachovia "knew, but failed to disclose to investors, material facts about auction rate securities."

Wachovia was a mid-sized player in the auction rate securities business, and is the parent to the St. Louis-based brokerage firm formerly known as A.G. Edwards & Sons, Inc.

Several Wall Street firms have been the subject of civil litigation in the form of class action lawsuits and over 100 arbitration claims filed by investors, in addition to federal and state regulatory investigations.

Massachusetts' securities regulator filed a civil fraud lawsuit last month against UBS AG, which was one of the largest players in the auction rate securities market. The regulators allege the firm knowingly misled investors to buy auction-rate securities knowing the market was disintegrating. Massachusetts regulators also accused UBS of books and records violations for stalling in making its business records available to regulators.

UBS has said it will defend itself against the charges.

In the only known criminal matter to come out of the melt down of the auction rate securities market, the Justice Department's U.S. attorney's office for New York's Eastern District is conducting an investigation into whether two former Credit Suisse Group brokers lied to investors about how they placed their money into auction rate securities.

Credit Suisse, which is not a target of the investigation, according to people familiar with the matter, has said the firm immediately suspended the two brokers when problems arose about a year ago. The employees resigned from Credit Suisse in September of 2007.

The U.S. attorney's office and Paul Weinstein a lawyer for one of the brokers previously declined to comment on the investigation for a Wall Street Journal article last week. Kenneth Breen, a lawyer representing the other broker said previously his client shouldn't be blamed for an unforeseeable market failure and that the investors knew the risks.

Wachovia Corp.'s stock has fallen 80% in the past year along with many banks and financial institutions, as the company takes large losses on its loans. Recently, the stock has been under pressure amid turnover in the chief executive's office and news the company will report a $2.6 to $2.8 billion loss in the second quarter.

Firms are under pressure to buy back the securities they sold to investors, but the cost would be burdensome for many banks and brokerage firms already under pressure from the credit crunch.

Wednesday UBS announced a plan to purchase up to $3.5 billion of tax-exempt auction rate securities from its clients, then package it up and sell it to money market fund managers. If the plan works, this would represent less than 15% of its clients total auction rate securities' holdings.

Source: Liz Rappaport at [e-mail]

[Sapphire Capital]

uly 24 (Bloomberg) -- New York Attorney General Andrew Cuomo filed a lawsuit against UBS AG alleging the Zurich-based bank's promotion of auction-rate securities as safe, money market-like investments was fraudulent.

Cuomo is seeking to force UBS to offer to buy back at face value $25 billion in auction-rate securities held by the bank's customers in New York and nationwide. Massachusetts and Texas have filed similar complaints against UBS since the $330 billion market collapsed in February in an effort to force the firm to repurchase securities it marketed in their respective states.

``We believe we have nationwide jurisdiction and we're looking for recoveries nationwide,'' Cuomo said today at a press conference in New York announcing the suit. He said his investigation into UBS and other banks that sold auction-rate securities is continuing.

State and federal regulators have been probing Wall Street's sale of auction-rate securities since the banks abandoned the market in February, permitting thousands of auctions to fail and leaving investors unable to sell the debt. Municipalities, closed-end funds and student loan organizations sold the long- term bonds, and the investment banks ran the auctions where the interest rates were reset every week or month.

Cuomo alleges in the lawsuit filed today that UBS began an ``aggressive marketing'' campaign to sell the securities to investors as demand began to wane last year, forcing the bank to step in as a buyer at the auctions to prevent them from failing. UBS continued selling the securities even as the market unraveled, with at least seven bank executives involved in the marketing campaign unloading $21 million in personal auction-rate holdings, the attorney general said.

`Poor Judgment'

UBS spokeswoman Karina Byrne in an e-mailed statement said the bank will ``vigorously defend'' itself against the allegations in the suit, and ``categorically rejects any claim that the firm engaged in a widespread campaign'' to shift auction-rate debt off its books and into client accounts.

``While UBS does not believe that there was illegal conduct by any employee, we have found cases of poor judgment by certain individuals and are evaluating appropriate disciplinary measures for these individuals,'' Byrne said.

The bank, which had $19.1 billion in writedowns from the subprime crisis last year, on July 16 said it plans to offer to buy back as much as $3.5 billion in auction-rate preferred shares it sold for closed-end funds. Cuomo said today that the offer is insufficient and that it needs to buy back all the securities it sold.

Big Underwriter

UBS was the second-biggest underwriter of municipal auction- rate securities behind Citigroup Inc., according to data from Thomson Reuters. It held more than $11 billion of the debt on its books when the market collapsed, the bank has said.

Thousands of investors have been left stuck with securities that they thought were akin to money-market funds, facing losses if they attempt to sell their holdings in secondary markets, according to Barry Silbert, chief executive of Restricted Stock Partners in New York, which operates an exchange.

States and local governments have refunded or plan to replace at least $91.8 billion in auction-rate securities since the market's collapse in February sent borrowing costs as high as 20 percent, according to data compiled by Bloomberg News. Closed- end funds replaced $19.7 billion and student loan organizations less than $3 billion.

Massachusetts Suit

Cuomo's complaint echoes the findings in a lawsuit filed on June 26 by Massachusetts Secretary of State William Galvin that attempted to show through e-mails obtained from UBS that executives increased pressure on financial advisers at the company to sell the securities as demand from corporate cash managers waned. The suit alleges the company failed to warn investors that the securities might become illiquid, and instead continued to market them as cash equivalents.

Galvin is also investigating Bank of America Corp. and Merrill Lynch & Co. More than five states participated in a search of the securities division headquarters of Wachovia Corp. in St. Louis on July 17 as part of a coordinated auction-rate probe.

At least 12 state securities regulators are probing the collapse of the market, excluding New York, according to the North American Securities Administrators Association. The Texas State Securities Board this week filed a notice of hearing to suspend UBS's state license, claiming the bank engaged in fraud by marketing the long-term bonds as ``liquid investments.''

The Securities and Exchange Commission and Financial Industry Regulatory Authority are also probing the banks. Investors have filed about 110 arbitration claims against their financial advisers related to auction-rate securities, according to Nancy Condon, a spokeswoman for Financial Industry Regulatory Authority.

UBS said in a recent securities filing that it has also been named in three class-action lawsuits.