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Fidelity Offers Auction Rate Securities Buy Back

Sep 16, 2008 | Parker Waichman LLP

Despite its claims that it bared no responsibility for the auction rate securities meltdown, discount broker Fidelity Investments has agreed to buy back $300 million worth of the securities to appease state regulators.  Several Wall Street investment banks have struck similar deals with regulators, but unlike those  institutions, Fidelity did not underwrite or issue the bonds.

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.  Bank of America, UBS AG, Citigroup Inc., J.P. Morgan Chase & Co., Morgan Stanley, Merrill Lynch & Co. Citigroup, and Wachovia Corp.  all reached settlements with regulators, and  agreed to buy back more than $60 billion of auction-rate securities from their clients.

But those deals do not cover an additional $160 billion worth of auction rate securities bought through mutual fund firms or brokers that didn’t underwrite the debt. In the past, discount brokers like Fidelity and Charles Schwab - which usually do not give their clients investment advice - has said that it should not have to meet the same obligation as the Wall Street firms that issued the auction rate securities.  But many Fidelity investors have claimed that it was one of  the firm's reps who first suggested auction rate securities as an investment.

Last month, Massachusetts Secretary of State William F. Galvin, sent a strongly-worded letter to Fidelity which said he hoped the Boston-based brokerage would follow the lead of the large  investment banks, and repurchase the now-illiquid securities. Last week, in a letter to Galvin, Fidelity President Rodger A. Lawson said that the firm pledged to buy back the securities within 90 days.  

Despite the buy back plan, Fidelity is not taking any responsibility for the auction rate mess.  "Fidelity’s involvement with auction rate securities is very different than the role of investment banks and underwriters with whom you have settled previously,”  Lawson wrote.  The Fidelity auction rate buy back, the letter said, is being done because the firm has a “long history of going above and beyond to serve our customers.”

Galvin said last week that he hoped other brokers would follow Fidelity's lead.  "I think it's significant that this is the first downstream vendor of these instruments that's come up with a plan, and I think it sets a standard for the others,"  he said.


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