UBS to Pay $19 Billion as Auction Mess Hits Wall Street
A once-obscure corner of the bond market is triggering one of the messiest Wall Street scandals in years -- and potentially the largest mass bailout of American individual investors ever.
On Friday, facing allegations of wrongdoing over its sales of so-called auction-rate securities, UBS AG agreed to buy back from investors nearly $19 billion of the investments as part of a settlement with federal and a group of state regulators. It will start buying from individuals and charities in October and from institutional clients in mid-2010.
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UBS was the third major firm this week to vow to buy back the securities, which allegedly were improperly sold as higher-rate equivalents for super-safe money-market funds.
UBS, Merrill Lynch & Co. and Citigroup Inc. have committed to taking back a total of more than $36 billion of the instruments. Other financial firms are expected to follow suit.
Auction-rate securities are a kind of debt that soared in popularity in recent years. They let issuers such as municipalities and student-loan organizations borrow for the long term, but at lower, short-term interest rates. The rates reset at periodic auctions, hence the name. Wall Street sold more than $330 billion of these securities to more than 100,000 individuals and other investors.
State regulators from Massachusetts and New York have sued Merrill Lynch and UBS for civil fraud, with the UBS case now settled. Regulators from several states have also shown up on Wachovia Corp.'s doorstep demanding documents; the bank says it is cooperating. A New York state official has accused Citigroup of destroying documents, a charge Citi has denied. Federal prosecutors are preparing to file criminal charges against two former Credit Suisse Group brokers who allegedly lied to investors about auction-rate securities.
It's rare that Wall Street firms make good on client losses, and the size of the auction-rate payments is unprecedented. But a review of several recent regulatory cases reveals the legal pressure facing Wall Street, and shows that some authorities believe the auction-rate market, which was created in the mid-1980s, got out of control.
Regulators say that financial firms, at various times, secretly propped up failed auctions; misled investors on the safety of the securities; pressed brokers and research analysts to sell the very securities executives were trying to unload; and resisted client demands for relief.
'No Real Control'
"It was kind of like a Moroccan bazaar," William Galvin, secretary of the Commonwealth of Massachusetts, said in describing the way Wall Street sold auction-rate securities. "There was no real control, no warranty, no worry about backing up what you said."
Wall Street executives say the auction market functioned smoothly for more than 20 years, and only buckled this year under the stress of a credit crunch that limited their ability to provide support. As a Merrill official put it Friday, its brokers believed such securities were "good investments" for clients seeking higher short-term returns in exchange for some risk the assets couldn't quickly be resold.
The auction-rate scandal has hit tens of thousands of American investors, such as Ken Pugh, a 60-year old retiree in Fort Lauderdale, Fla., who formerly supervised the delivery-truck operations for the Sun Sentinel newspaper.
Mr. Pugh has $350,000, or his entire life's retirement savings, in auction-rate securities in an account at Bank of America, $300,000 of which are backed by student loans; his statement puts a zero in the column for the value of the $350,000. The zero, said a person familiar with the firm, is meant to be read as "not available." Bank of America footnotes statements to notify clients that the securities they hold are not worthless but are illiquid and not easily valued.
"I'm not a financial wizard, that's all I know,"
((more like dumb as a post))
says Mr. Pugh. "I took their word for it, and like a dope, this is where I am." Mr. Pugh says he was told the securities were "28-day CDs."
He has gone back to work at an environmental services company for extra cash to live on until he "gets some restitution," he says. "All the stuff my wife and I planned on doing, we can't."
Mr. Pugh has filed an arbitration claim against Bank of America. Bank of America says it "does not comment on client relationships."
Regulators and prosecutors have alleged several kinds of abuses in the auction-rate market, detailed in regulatory cases and investigations. One allegation is that brokers secretly propped up failed auctions.
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