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Banks Lining Up to Settle Auction Rate Securities Charges

Aug 8, 2008 | Parker Waichman LLP Since yesterday, two large investment banks- Citigroup and UBS - have agreed to buy back billions of dollars worth of auction rate securities they sold to investors when the market for the vehicles was on the verge of collapse.  The Citigroup and UBS auction rate security buybacks are part of settlements with the Securities and Exchange Commission (SEC) and state regulators.   A third bank, Merrill Lynch - perhaps sensing which way the wind is blowing - said yesterday it will also buy back auction rate securities it sold.

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.  Thousands of investors have been bewildered to find out that the investments they were sold as cash equivalents are now illiquid.

Various federal and state investigations have been trying to determine if investment banks mislead their clients on the liquidity of auction rate securities.

The Citigroup settlement with the SEC, New York Attorney General Andrew Cuomo and other state regulators was announced yesterday.  It involves the buyback of $7 billion worth of auction rate securities from some 40,000 individual investors.  The settlement also includes payment of $100 million in fines.  The fine will be paid to New York state and the North American Securities Administrators Association, which represents securities regulators in the 50 states and the District of Columbia.  The SEC is also considering additional fines against Citigroup,

Today, it was announced that UBS, the largest bank in Switzerland, had also settled with the SEC and state regulators.  Under terms of the settlement, UBS will buy back $19.4 billion of failed auction-rate securities and pay a $150 million fine.

One investment bank, Merrill Lynch, isn't waiting for securities investigators to come after it.  Hours after the UBS settlement was announced, Merrill offered to buy back $10 billion of auction rate  securities that it had sold to thousands of individuals.

It is not surprising that investment banks are suddenly anxious to appease investigators and investors over auction rate securities.  Emails and other evidence obtained by investigators has indicated that the banks knew for months that the auction rate securities market was on the verge of collapse, but continued to represent them as safe investments.  What's worse, as the market for the vehicles became more unstable, they marketed the securities even more aggressively, and touted them as cash equivalents.  

The rush to settle by so many banks indicates the evidence against them was damning.  As one securities lawyer told Bloomberg News, "There is no way for the institutions to win this fight, and they know that."

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