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RBC, U.S. watchdogs talk securities settlement


August 22, 2008 at 12:00 AM EDT

NEW YORK Royal Bank of Canada [RY-T] is in settlement talks with U.S. regulators over its role in the troubled $330-billion (U.S.) auction-rate securities market, a move that will likely result in the bank repurchasing some of these investments from retail clients.

In an internal memo to brokers, RBC confirmed it has been in discussions with New York Attorney-General Andrew Cuomo, who has single-handedly pursued some of the world's largest investment banks over the way they sold these complex securities to investors before the market froze this spring.

RBC's exposure to the retail market is smaller than that of these players, according to one source, who estimated the bank has approximately $1-billion of auction-rate securities held by individuals and charities.

Mr. Cuomo has already wrung settlements out of seven global banks, which collectively have committed to buy back almost $50-billion worth of auction-rate securities from small investors and pay $360-million in fines.

Merrill Lynch & Co., Goldman Sachs and Deutsche Bank were the latest to bow to Mr. Cuomo's pressure, reaching agreements yesterday afternoon.

The Attorney-General appears to have taken a page from the playbook of his crusading predecessor, Eliot Spitzer, and is working his way down the list beginning with the largest players in this distressed market.

In its note to brokers, RBC said it has not moved yet to repurchase these securities because the structure of any buyback is dependent upon the approval of regulators.

"RBC is committed to addressing the problem of retail clients who hold auction-rate securities," the bank's letter stated.

"We have expressed our willingness to work with regulators to develop and implement a program to provide liquidity to certain individual clients, and small businesses and charities."

A spokeswoman for RBC declined to comment. The timing of a possible settlement is also unclear, given that Mr. Cuomo is said to be focusing on reaching a deal with Bank of America, one of the few large U.S. banks that has been a holdout.

Auction-rate securities are long-term bonds, often backed by municipal debt or student loans, that reset their interest rates every few weeks through an auction. Although the maturities of these bonds can stretch up to 30 years, the frequent auctions provided investors with a convenient way to cash out their holdings at least until the credit crunch earlier this year, when buyers stopped showing up and the auctions were cancelled.

That left investors stuck with hundreds of billions of dollars worth of investments they couldn't cash out, even though regulators claim that many banks marketed the products as a cash-like investment.

UBS AG, Citigroup, Morgan Stanley, JPMorgan Chase & Co. and Wachovia Corp. have also struck settlements with Mr. Cuomo. The Attorney-General had threatened to take Merrill Lynch to court today, but that was averted after an eleventh-hour deal that will see the firm buy back $12-billion of securities by the end of the year and pay a $125-million fine. Goldman, by contrast, will repurchase just $1.5-billion, and pay a $22.5-million fine.

While the fines themselves aren't huge, the buybacks can be punishing for firms like Merrill, which have already seen their capital position erode amid the collapse of the subprime mortgage market.

The bulk of the regulatory focus thus far has been on the major banks that created these products and ran the auctions. Yesterday, however, there were signs the probe is widening.

The Financial Industry Regulatory Authority has reportedly sent letters to almost 40 brokerages, including TD Ameritrade, saying they will begin on-site inspections of sales practices, marketing materials and disclosure. The entrance of FINRA suggests that regulators will now move beyond the big banks to look at whether brokerage firms that sold the paper directly to retail customers properly communicated the risks. Reports said that Charles Schwab, Fidelity Investments and E*Trade also received letters.

With files from Bloomberg News

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