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New York AG Close to Filing Suit Against USB Over Auction Rate Securities

Jul 23, 2008 | Parker Waichman LLP

The New York State Office of Attorney General is said to be close to filing a civil lawsuit against USB AG for its handling of auction rate securities.   Massachusetts regulators had already filed suit against the investment bank over the same issue in June.

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. 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 investors holding auction rate securities they once thought were safe vehicles with no way to sell them.

New York is investigating USB and other investment banks to see if they told investors that auction rates securities could become illiquid.  USB clients hold about $25 billion worth of auction rate securities.  

According to The Wall Street Journal, the New York auction rate securities lawsuit could include allegations of malfeasance by senior UBS executives.   Because UBS's trading operations for auction rate securities are based in New York, the New York lawsuit could seek a broad resolution for UBS auction rate clients nationwide.

According to The Wall Street Journal, the New York attorney general's office has now subpoenaed 30 entities and 100 individuals, seeking information about the sales of auction rate securities. Among those subpoenaed are Citigroup Inc., Merrill Lynch & Co., J.P. Morgan Chase & Co. and Goldman Sachs Group, Inc., and high-ranking executives at various firms as well as heads of municipal-bond desks, risk managers, financial advisors and others.

Last week, under pressure from regulators, USB agreed to repurchase up to $3.5 billion of tax-exempt auction-rate securities from clients, package them and sell new debt backed by those securities to money-market funds.   USB also settled in May with the Massachusetts attorney general's office and agreed to return $37 million to the Massachusetts Turnpike Authority and 17 municipalities that invested in auction rate securities.  They were not permissible investments under the municipalities' official investment mandates.

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