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Auction Rate Securities Fraud Investigators Visit Wachovia Headquarters

Jul 17, 2008 | Parker Waichman Alonso LLP

A group of state regulators probing the crash of the auction rate securities market visited the headquarters of Wachovia Securities in St. Louis today seeking to access documents and conduct interviews about the firm's sales and marketing practices, according to The Wall Street Journal.  The group, which was led by official from Massachusetts, included state regulators from Missouri, Illinois, Massachusetts, New Jersey, Pennsylvania and other states.  They were all members of the North American Securities Administrators Association, and are part of a task force looking into possible irregularities in the auction rate securities market.

Auction rate securities are long-term corporate bonds, municipal bonds and preferred stock on which the interest rates are reset periodically based on bids submitted through securities firms. Generally, rates are reset every  seven, 14, 28 or 35 days. Because they can be sold during weekly or monthly auctions, banks and brokerages often touted auction rate securities as short-term investments or cash equivalents.  

Unfortunately, because of the crisis in the credit markets,  auctions of these securities haven’t been successful because of worries that bond insurers guaranteeing many of the $330 billion in outstanding auction bonds would be downgraded. Bloomberg.com has also reported that brokers such as Goldman Sachs Group Inc. and Citigroup Inc. also purposely permitted the auctions for preferred securities, which aren’t insured, to fail by not committing their own capital to sales when there weren’t enough bidders.  As a result, the market for auction rate bonds has pretty much vanished, leaving a lot of small investors holding auction rate securities they once thought were safe vehicles with no way to sell them.  Some legal experts have asserted that  banks or brokers could be held liable for investors’ auction rate securities loses if the vehicles were represented as short-term investments or cash equivalents.

According to The Wall Street Journal, the Missouri Securities Division launched an investigation in April into Wachovia Securities and others requesting records and information about its sales of auction rate securities.  But Wachovia has not complied with those request, prompting today's visit. The state's Securities Division is also conducting investigations into auction rate securities sales at Commerce Bank N.A. and Stifel, Nicolaus & Co. Inc.   The division said it has received over 70 complaints from investors feel they were misled in their purchase of auction rate securities.

The fall-out of the auction rate securities crash has been far reaching.   It has already spawned a number of investor lawsuits against investment banks, including Morgan Stanley and Merrill Lynch.  According to The Wall Street Journal, Massachusetts' securities regulator filed a civil fraud lawsuit last month against UBS AG, which was one of the largest players in the auction rate securities market. The regulators allege the firm knowingly misled investors to buy auction rate securities knowing the market was disintegrating. Massachusetts regulators also accused UBS of books and records violations for stalling in making its business records available to regulators.  The Justice Department's U.S. attorney's office for New York's Eastern District is conducting a criminal investigation into whether two former Credit Suisse Group brokers lied to investors about how they placed their money into auction rate securities.