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Bank of America, Royal Bank of Canada Reach Agreement with SEC to Buy Back Auction Rate Securities

Oct 9, 2008 | Parker Waichman LLP Two more financial institutions, Bank of American and the Royal Bank of Canada, have agreed to buy back illiquid auction rate securities they sold to investors.  Under agreements with U.S. federal and state regulators, Bank of America will buy back $4.7 billion worth of the securities, while the Royal Bank of Canada will redeem $850 million worth.  Both institutions will also  pay multi-million dollar fines to the settle with the Securities and Exchange Commission (SEC).

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 credit crises, the market for auction rate securities crashed earlier this year. Thousands of investors have been bewildered to find out that the investments they were sold as cash equivalents are now illiquid.

Various state and federal agencies have been investigating the auction rate securities crash, amid suspicions that investment banks misled their clients about both the liquidity of the vehicles and safety of the market.  In the past several months, various institutions have reached agreements with regulators, including UBS AG, Citigroup Inc., J.P. Morgan Chase & Co., Morgan Stanley, Merrill Lynch & Co. Citigroup, and Wachovia Corp., to buy back more than $60 billion of auction rate securities from their clients.

Under its agreement with  the SEC, as well as the New York state attorney general’s office and a coalition of other state regulators represented by the North American Securities Administrators Association, Bank of America will repurchase $4.7 billion in auction rate securities it sold to about 5,500 investors.  The agreement also requires Bank of America  to “use its best efforts” to provide up to $5 billion in liquidity to businesses and institutional investors with accounts valued at $15 million or more, and charities with accounts valued at $25 million or more. Bank of America, which neither admits nor denies wrongdoing, also will pay a $50 million penalty.

Last month, Bank of America  agreed to purchase an estimated $4.8 billion in auction rate securities under a settlement with Massachusetts Secretary of the Commonwealth William Galvin.

Royal Bank of Canada, the largest bank in Canada, said it will buy back about $850 million (U.S. Dollars) of auction rate securities from more than 2,000 retail clients in the U.S. and pay a $9.8 million  fine as part of an agreement with the SEC and New York attorney general's office. The Royal Bank of Canada also said it would participate in an arbitration process overseen by the Financial Industry Regulatory Authority, where retail investors may seek further legal damages from the bank.  Finally, the bank has pledged to assist with "liquidity solutions" for institutional clients that were sold the securities but are not covered by the settlement.  

The Royal Bank of Canada is still facing a class-action law suit from aggrieved clients who claim they were suddenly unable to access holdings they believed were liquid and similar to cash.


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