Auction-Rate Securities – Another Investor Rip-off

Trend: Auction-rate securities reimbursements will hit the financial firms with yet another wave of write-offs and bad publicity.

At WSJ.com, James B. Stewart, a columnist for SmartMoney magazine and SmartMoney.com, describes how big investment firms pushed auction-rate securities, mislead regulators, and undermined client loyalty and trust. Excerpts below.

Link: Auction-Rate Securities And the Ugly Truth - WSJ.com.

Auction-rate securities were sold by nearly all the big firms as a slightly higher-yielding, but safe, alternative to money-market funds. They proved anything but when the auction markets froze in February, stranding thousands of investors with more than $300 billion in illiquid holdings.

Thanks to a wave of subpoenas, lawsuits or threatened lawsuits, and the prospect of public disclosure, three of the biggest sellers of auction-rate securities agreed last week to reimburse clients. Citigroup led the pack by reaching an agreement with Mr. Cuomo and the Securities and Exchange Commission to stave off a lawsuit. Merrill Lynch, also under investigation, announced that it would reimburse clients. And UBS settled a pending lawsuit by agreeing to reimburse clients and pay a $150 million fine. Those firms said they will buy back a total of nearly $40 billion in the securities, a sum that, while large, can indeed be absorbed by their balance sheets.

What's really shocking are the allegations and evidence that some executives may have known that the auction-rate market was about to collapse even as they pressed their brokers to push the product on unsuspecting clients.

Mr. Cuomo's complaint against UBS is a withering portrayal of what he calls a "multibillion-dollar consumer and securities fraud." At UBS, top bank executives unloaded more than $21 million of their personal holdings of auction-rate securities as they realized the market was in trouble, the complaint alleges. In December, UBS's trading desk manager sent an email to the global head of municipal securities saying, "The auction product does not work." Other emails referred to the securities as a "huge albatross" for the firm and a "scary and delicate" situation.

Yet the firm kept peddling them to clients. According to the complaint, within "hours" of learning of trouble in the auctions, one UBS executive instructed his personal broker that "I want to get out of arcs [auction-rate certificates]" and sold off all $250,000 of his holdings. More than 50,000 UBS customers ended up owning more than $37 billion of the illiquid securities, according to the complaint. Mr. Cuomo characterized UBS's actions as a "flagrant breach of trust."