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Fidelity Should Buy Back Auction Rate Securities, Massachusetts Officials Says

Aug 20, 2008 | Parker Waichman LLP

Fidelity Investments is being urged to buy back auction rate securities it sold to some of its clients.  In a strongly worded letter, Massachusetts Secretary of State William F. Galvin, said he hoped the Boston-based brokerage would follow the lead of several large investment banks, and repurchase the now-illiquid securities.

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 two weeks, UBS AG, Citigroup Inc., J.P. Morgan Chase & Co., Morgan Stanley, Merrill Lynch & Co. and Wachovia Corp. have reached settlements with regulators, and have agreed to buy back more than $40 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. Some investors still stuck with the worthless investments are looking to the brokerages to buy back the auction rate securities they sold.

But brokerages are not too interested in that idea. Like investors, the brokerages say they were deceived about the condition of the auction rate securities market.  According to The Wall Street Journal. the Regional Bond Dealers Association sent a letter Monday to regulators including New York Attorney General Andrew Cuomo, the Securities and Exchange Commission and the North American Securities Administrators Association asking that investment banks be required to buy back all the securities for which they conducted auctions, not just all the securities they sold to their own clients.

In his letter yesterday, Galvin said, "I am sure that Fidelity understands the seriousness of this situation to its customers. Therefore, I request that Fidelity take immediate steps to resolve this matter on behalf of those customers."  Fidelity has also received inquiry letters from New York Attorney General Andrew M. Cuomo, whose office is investigating auction-rate fraud at several major firms.

Fidelity is a discount brokerage and does not provide investment advice; it mainly places buy and sell orders on behalf of customers.  According to The Boston Globe, Fidelity has allowed customers to buy auction rate securities online since 2006.  Before that, customers bought them after talking to a Fidelity representative.

In response to Galvin's letter, Fidelity said it did not actively market auction rate securities and said it had an "extremely small" number of customers who brought them. Spokeswoman Anne Crowley told The Boston Globe that "we believe the underwriters should stand behind their securities."

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