Auction-rate probe expands

Times Staff Writer

Regulators looking into the auction-rate securities debacle have turned their attention to nearly 40 brokerages that may have sold the paper to clients but didn’t underwrite it.

Investigators from the Financial Industry Regulatory Authority plan to conduct on-site examinations at the brokerages, with the first inspections beginning Monday, 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 represents a major widening of auction-rate probes that until now have centered on the big investment banks that underwrote the debt and managed auctions of the securities.


On Thursday, three more Wall Street firms joined the list of companies agreeing to make amends with customers who bought auction-rate securities.

The addition of Merrill Lynch & Co., Goldman Sachs Group Inc. and Deutsche Bank brought to eight the number of companies that have reached legal settlements regarding the securities.

The eight firms -- including Citigroup Inc. and UBS -- have agreed to repurchase about $50 billion of roughly $60 billion in auction-rate debt estimated to be held by individual investors.

The inspections of smaller brokerages are coming as New York Atty. Gen. Andrew Cuomo is trying to force those firms as well to buy back auction-rate securities held by their clients.

“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 Thursday on CNBC. “We’re now focusing on some of the mid-size players in the market.”

Cuomo’s office has sent subpoenas to brokerages such as Fidelity Investments, Charles Schwab Corp., TD Ameritrade Holding Corp., E-Trade Financial Corp. and Oppenheimer & Co.

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, the $300-billion auction-rate market froze, leaving investors unable to sell their holdings.

A bond-industry trade group representing regional brokerages has contended that they 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.”

It seems “highly unlikely that the firms had no understanding of what was happening in the [auction-rate] market,” Lawsky added.

For example, he wrote, “some evidence indicates” that Fidelity pitched auction-rate securities to its wealthiest customers.

Anne Crowley, a Fidelity spokeswoman, disputed that assertion.

“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.”