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Auction-rate probe expands to nearly 40 brokerages

August 21, 2008 | 11:47 am

From Times staff writer Walter Hamilton:

The search for the guilty in the auction-rate securities debacle has become a nationwide manhunt.

Investigators from the Financial Industry Regulatory Authority plan to conduct on-site examinations at nearly 40 brokerages -- with about half beginning Monday and the rest in early September -- to determine whether the firms were aware of the problems in the auction-rate market and adequately warned customers about the risks, according to a person familiar with the issue.

The regulatory sweep will focus heavily on brokerages that sold but did not create the securities. That represents a major widening of the auction-rate probe that until now has centered primarily on investment banks that underwrote the debt.

The inspections come amid an intensifying effort by New York Atty. Gen. Andrew Cuomo to force so-called downstream brokerages to buy back auction-rate securities from their clients.

Cuomoandrew "We're starting with the largest banks, in terms of number of people involved ... and we're working our way down the list," Cuomo said in an interview on CNBC this morning. "We're now focusing on some of the mid-size players in the market."

Auction-rate securities are long-term debt instruments that were designed to trade like short-term securities. They were issued by many municipalities and closed-end mutual funds in recent years, and were pitched by brokers to small investors as safe and easily redeemable.

When the credit crunch worsened early this year, however, the $300-billion auction-rate market froze, leaving investors unable to sell their holdings.

Cuomo has reached settlements with Citgroup Inc., UBS and three other investment banks to repurchase auction-rate instruments sold to individual investors, small businesses and charities. UPDATE: Cuomo reached settlements late today with Merrill Lynch & Co., Goldman Sachs Group and Deutsche Bank. See this post.

Cuomo also has sent subpoenas to brokerages such as Fidelity Investments, Charles Schwab Corp., TD Ameritrade Holding Corp., E-Trade Financial Corp. and Oppenheimer & Co. He's also investigating other investment banks including  Bank of America Corp. . . .

A bond-industry trade group representing regional brokerages has argued that the firms have no obligation to repurchase auction-rate securities because they simply facilitated purchases at the request of clients and took no role in the creation of the securities.

However, a top lawyer in Cuomo's office sent a letter to the trade group Wednesday rebutting those claims.

Benjamin Lawsky, a Cuomo special assistant, said Cuomo's probe "has already begun to uncover some disturbing facts that seem to belie the innocent picture of downstream brokerages" and that it seemed "highly unlikely that the firms had no understanding of what was happening in the [auction-rate] market."

For example, Lawsky wrote, "some evidence indicates" that Fidelity pitched auction-rate securities to its wealthiest customers.

Anne Crowley, a Fidelity spokeswoman, disputed that charge.

"We don't actively market auction-rate securities," she said. "There's no incentive for our representatives to sell auction-rate securities or another product."

Cuomo also is stepping up the pressure on Merrill Lynch. The giant brokerage pledged two weeks ago to repurchase $10 billion of the securities at face value from roughly 30,000 investors, but said it wouldn't start the process until January even though some other big firms have agreed to finish their buybacks by November.

Merrill reportedly reached a deal today with regulators in Massachusetts to begin buying back the securities starting in October.

"Today is the last day" to reach a settlement, Cuomo said on CNBC. "If we don't settle today, tomorrow at this time we'll be in court."

Photo: New York Atty. Gen. Andrew Cuomo. Dima Gavrysh / Bloomberg News

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