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JPMorgan, Morgan Stanley Near Auction-Rate Settlement

By Karen Freifeld

Aug. 14 (Bloomberg) -- JPMorgan Chase & Co. and Morgan Stanley are on the verge of completing settlements with government regulators to buy back auction-rate securities from clients, people briefed on the negotiations said.

State regulators, JPMorgan, the third-largest U.S. bank by assets, and Morgan Stanley, the second-biggest U.S. securities firm by market value, aimed to announce the accords yesterday, the people said. Wachovia Corp., the fourth-largest U.S. bank, also is nearing a deal, said Laura Egerdal, a spokeswoman for Missouri Secretary of State Robin Carnahan, who is in the talks.

"We made great progress over the weekend,'' Egerdal said yesterday of discussions between Wachovia and a multistate task force. "There are a few more things to work out. They are still in discussions.''

Citigroup Inc., based in New York, and Zurich-based UBS AG settled state and federal claims last week that they improperly saddled investors with the bonds by marketing them as alternatives to money markets. The banks, accused of fraud, will buy a combined $26 billion of auction-rate bonds from clients and pay $250 million in fines.

Merrill Lynch & Co. said it would offer to purchase about $10 billion of the securities, and Morgan Stanley proposed buying $4.5 billion from individuals this week.

Regulators said the Merrill and Morgan Stanley deals fall short. Merrill is still negotiating a settlement, according to a spokesman for Massachusetts Secretary of State William Galvin.

"Massachusetts is in conversations with Merrill Lynch but there are no imminent agreements at this point,'' Galvin spokesman Brian McNiff said yesterday in a phone interview. Galvin sued Merrill last month.

'Game was Fixed'

The $330 billion market for auction-rate securities, typically bonds with interest rates set at weekly or monthly auctions, seized up in February after investment banks abandoned their role as buyers of last resort. For more than two decades, the market allowed municipalities, student-loan agencies and closed-end mutual funds to borrow for the long-term at rates similar to short-term debt.

"UBS pushed the sales of these instruments as 'cash alternatives' without telling their customers of their vulnerabilities,'' Galvin said in a June 26 release, announcing charges his office filed against the biggest Swiss bank. "The game was fixed; only the customers were in the dark,'' he said.

The market shrank to about $206 billion by the end of the second quarter as municipal borrowers refinanced about 60 percent of their auction-rate bonds and closed-end mutual funds redeemed 40 percent of their preferred shares, based on an estimate by Bank of America Corp. analyst Jeffrey Rosenberg last week. Banks might have to write down a total of $4 billion as they buy back auction-rate securities, he said in a report.

Largest Underwriters

Wall Street's costs to end federal and state auction-rate probes may wind up exceeding the sanctions from abuses of mutual funds and analyst research in the past decade.

The investigation of mutual-fund abuses from 2003 cost more than $5 billion in penalties and agreements to reduce fees, while New York Attorney General Andrew Cuomo's predecessor, Eliot Spitzer, and regulators including the U.S. Securities and Exchange Commission won $1.4 billion from 10 firms accused of using tainted research to win investment-banking deals.

UBS, Citigroup and Merrill were among the largest underwriters of auction-rate debt, according to Thomson Reuters. The other main banks in the market included New York-based Morgan Stanley, Goldman Sachs Group Inc., JPMorgan, Lehman Brothers Holdings Inc., Toronto-based Royal Bank of Canada, and Wachovia and Bank of America, both based in Charlotte, North Carolina.


Goldman has yet to reimburse clients, angering large investors in the securities, the Wall Street Journal reported today. Goldman spokeswoman Andrea Raphael told the newspaper the bank is working with clients to address their financing needs.

JPMorgan said its customers own about $5 billion worth of auction-rate securities, which includes $3 billion held by individuals, according to an Aug. 11 regulatory filing.

Cuomo, whose office sent letters on Aug. 11 to JPMorgan, Morgan Stanley and Wachovia asking for immediate settlement talks, wants the firms to start auction-rate buybacks for individuals, reimburse customers who sold bonds at "below-par'' prices, and institute a claims-resolution process.

Historic Costs

Cuomo also expects any resolution to address relief for institutional investors, refinancing fees for certain municipal issuers and penalties for banks.

Alex Detrick, a spokesman for Cuomo, declined to comment. JPMorgan spokeswoman Tasha Pelio also declined to comment, as did Erica Platt, a spokeswoman at Morgan Stanley, Wachovia spokeswoman Christy Phillips Brown, Merrill spokesman Mark Herr and SEC spokesman John Nester.

UBS will buy $8.3 billion of the securities from its clients beginning Oct. 31 under a settlement with Cuomo, the SEC and a group of other state regulators, according to terms announced last week. The bank must also help its institutional clients sell an additional $10.3 billion in securities, and may have to buy back the bonds if they fail to find a market, Cuomo said. UBS also will pay a fine of $150 million.

Citigroup was the first to settle state and federal claims last week, agreeing to buy $7.3 billion of the debt from individual investors and pay $100 million in fines, as well as pledging to help 2,600 institutional customers unload $12 billion of securities.

To contact the reporter on this story: Karen Freifeld in New York State Supreme Court in Manhattan at

Last Updated: August 14, 2008 05:30 EDT


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