By ERIC DASH and LOUISE STORY
Published: August 8, 2008
Two major Wall Street firms on Thursday
offered to buy back more than $17 billion of troubled auction-rate
securities that they had marketed as being as safe and liquid as cash,
moving quickly to contain the legal fallout from the credit crisis.
Citigroup will buy back $7.3 billion of the securities and pay $100
million in fines as part of a settlement with state and federal
regulators announced on Thursday morning.
Hours later, Merrill Lynch, without entering into a settlement, offered
to buy back $10 billion of similar securities that it had sold to
thousands of individuals. Neither firm agreed to reimburse institutional
The moves are likely to pave the way for other banks and brokerage firms
to take similar actions. The Securities and Exchange Commission is
examining about 20 firms over their sales of auction-rate securities,
and the New York attorney general’s office and 12 other state regulators
are conducting at least a dozen similar investigations, according to
people briefed on the situation.
Bank of America, the largest retail bank, said Thursday that it had
received subpoenas from federal and state regulators related to sales of
auction-rate securities, which are preferred shares or debt instruments
with rates that reset regularly, usually every week, in auctions
overseen by the brokerage firms that originally sold them.
UBS is also in talks with regulators about a settlement, according to
people briefed on the situation.
Firms including Goldman Sachs, Lehman Brothers, JPMorgan Chase, Morgan
Stanley, UBS and the Wachovia Corporation are also among those under
scrutiny by regulators.
Representatives for the firms did not return calls late Thursday or
declined to comment.
Auction-rate securities were invented in the late 1980s and worked
fairly well until this year, when the auctions began to fail amid the
credit crisis, and investors could no longer sell their securities.
Regulators have been examining how brokers sold the notes and whether
they fully disclosed the potential risks to buyers.
Thursday’s actions by Citigroup and Merrill suggest banks are anxious to
put the matter behind them. But with as much as $50 billion or more of
the troubled securities in the hands of individual investors, buying
back all of the securities would be a big burden for banks, many of
which have been weakened by multibillion dollar losses and write-downs
stemming from mortgage-linked investments.
The New York attorney general’s office and other state regulators said
that Citigroup would buy back, in the next three months, auction-rate
securities from individual investors, charities and small and midsize
businesses. These customers, about 40,000 in total, have been unable to
sell their securities since mid-February.
Arthur Tildesley, the administrative chief of Citigroup’s global wealth
management division, said at a news conference that the settlement
reflects a “truly favorable solution for our investors and our clients.”
In a similar case in Massachusetts, Morgan Stanley reached an agreement
with the attorney general’s office on Thursday to reimburse the cities
of New Bedford and Hopkinton $1.5 million for the investments in the
securities, Martha Coakley, the attorney general of Massachusetts, said
in a statement.
“Wall Street has been under siege lately,” said Jill E. Fisch, a law
professor at Fordham University. “Nobody wants to be under long-term
regulatory scrutiny. You want to get it behind you as best you can.”
The agreement with Citigroup, the biggest underwriter of auction-rate
notes, is a watershed for Wall Street. If Citigroup buys back all $7.3
billion of the securities, as it has agreed to do, it would represent
one of the largest amounts ever recovered by investors from a single
company as a result of state and federal regulator action. The figure
would eclipse those stemming from settlements reached earlier this
decade with Wall Street firms over conflicts with investment research,
mutual fund trading, and insurance sales practices. It is also likely to
provide a template for other firms to strike similar deals.
“We often begin with the largest industry players to make the greatest
impact,” Andrew M. Cuomo, the New York State attorney general, said in
an interview on Thursday.
Other state regulators said the Citigroup settlement would cause other
banks and brokerage firms to seek similar agreements.
“This will provide a great incentive for the other firms who sold
auction rate securities to come to settlement talks,” said Denise Voigt
Crawford, the commissioner of the Texas State Securities Board, which
led the group of state agencies on the Citigroup case. “Without this,
they are at a competitive disadvantage reputationally.”
Federal and state regulators say that the amount of securities sold to
retail investors and the severity of the conduct will be factored into
any settlements. UBS, for example, faces additional allegations that
executives sold personal holdings of the securities, even as UBS
salespeople claimed the investments were safe.
Regulators are also considering the ability of banks to absorb losses
that might result from any settlement. That is part of the reason, some
analysts said, that some deals may exclude institutional investors who
were sold riskier securities, backed by the student loan and mortgage
Citigroup’s purchases of the securities will cause the bank to take a
pretax charge of about $500 million to reflect the current value of the
The settlement leaves open the possibility that Citigroup will buy back
an additional $12 billion of securities purchased by institutional
investors, but does not require the bank to do so. It also will refund
financing fees to several, unspecified municipal governments that issued
auction rate securities from August 2007 to earlier this year.
Citigroup will also pay a $100 million fine, with half going to the New
York State attorney general’s office and half to be divided among the
states. The S.E.C. also participated in the settlement talks but elected
not to exact a penalty.
Merrill Lynch has been under investigation by the New York State
attorney general’s office and several state agencies. Mr. Cuomo said in
a statement late Thursday he was “reviewing their plan to begin
returning money to investors.”
Unlike Citigroup, Merrill Lynch has no plans to mark down the value of
the securities it buys. Mark Herr, a Merrill spokesman, said the company
views the securities as high-quality assets whose credit has not been
hurt; investors’ inability to sell them is the investments’ only
“Our clients have been caught in an unprecedented liquidity crisis,”
John A. Thain, Merrill’s chairman and chief executive, said in a
statement. Merrill said its focus on the frozen markets convinced it
that it will not need to raise more capital to back up the securities
once it purchases them from clients in January.
Morgan Stanley offered to buy back securities that the two towns in
Massachusetts had purchased in May, said Christine Pollak, a spokeswoman
for Morgan Stanley. “We are pleased to settle this matter without
penalty,” Ms. Pollack said.
She declined to comment on whether Morgan Stanley is working on a
broader plan for its clients who own the frozen securities.
Bank of America, the nation’s largest retail bank, said on Thursday that
Countrywide Financial, the mortgage lending giant it bought last month,
had responded to subpoenas from the Securities and Exchange Commission
and that the unit faced a formal investigation by that agency.
Bank of America disclosed the subpoenas in its quarterly report filed
with the S.E.C.
Countrywide is also under investigation by the F.B.I., authorities have
said. The F.B.I. last month said it had 21 corporate targets in its
investigation of potential corporate fraud in the mortgage industry.
California, Connecticut, Florida and Illinois have sued Countrywide over
its lending practices.