Merrill, Goldman Pressured by Cuomo on Auction-Rate Debt

By David Mildenberg and Karen Freifeld

Aug. 16 (Bloomberg) -- Merrill Lynch & Co. and Goldman Sachs Group Inc. face increased pressure by New York State Attorney General Andrew Cuomo to settle claims they misled investors on auction-rate debt as Wachovia Corp. agreed to buy back $9 billion of the bonds.

Merrill's prior offer to repurchase $10 billion of the securities was inadequate and the firm may face ``imminent'' legal action, Cuomo said yesterday. New York has subpoenaed about 25 firms involved in sales of auction-rate securities, including five that then settled. Goldman is among the firms being probed, he said.

``I want to do it my way,'' he said.

Wachovia joined Citigroup Inc., Morgan Stanley, JPMorgan Chase & Co. and UBS AG in settlements stemming from a nationwide investigation into why auction-rate securities were marketed as safe as cash until the $330 billion market collapsed. Regulators have sought auction-rate buybacks for customers, reimbursement for consumers forced to sell securities at prices below face value and relief for institutional investors.

``All the banks want to put these things behind them quickly so they can move on,'' said James Cox, a professor at Duke University Law School in Durham, North Carolina.

Merrill spokesman Mark Herr said the firm was ``surprised'' to find it faced legal action, saying, ``We thought we were making progress.'' At Goldman, spokeswoman Andrea Raphael said the bank was ``cooperating fully'' in an attempt to meet the ``liquidity needs'' of clients. Both banks are based in New York. Wachovia is based in Charlotte, North Carolina.

Fidelity, Schwab

Cuomo is investigating retail brokerages such as Fidelity Investments and Charles Schwab Corp. that sold auction-rate securities underwritten by investment banks, according to Alex Detrick, a Cuomo spokesman.

``There's no doubt on that list you have many retail brokerage firms who sold securities and our belief is those firms are also liable to the investors,'' Cuomo said, referring to the group of 25 subpoenaed firms. ``If a retail brokerage firm sold them the security, we believe they're liable.''

Securities firms have little defense against regulators because of incriminating documents and the risk to their reputations, said William Shepherd, a Houston attorney whose firm, Shepherd, Smith Edwards & Kantas, has met with more than 500 investors holding the securities.

``The regulators had these firms dead to rights,'' said Shepherd, who worked as a bond market salesman in Texas for 20 years. ``All the firms will be shamed or forced to do something, even Goldman which seems to be saying that all of their clients are rich and sophisticated.''

`Blue in the Face'

Wachovia, the fourth-largest U.S. bank, will pay a $50 million fine to settle claims by the Securities and Exchange Commission and states led by Missouri that it misled investors. It also will take a $275 million pre-tax charge because of higher legal costs in the third quarter. The move follows a similar $500 million writedown in the second quarter that was disclosed Aug. 11.

``If it wasn't for the secretary of state in Missouri and others, I don't think we would have gotten anywhere,'' said Tom Nagel, a St. Louis insurance agent who has more than $750,000 in auction-rate securities with Wachovia. ``I dealt with Wachovia people until I was blue in the face and they categorically denied selling this as a money market. But if they don't want to admit they did wrong, shame on them.''

In addition to reimbursing its clients, Wachovia agreed to a public arbitration process to resolve ``claims of consequential damages suffered by retail investors'' and provide ``liquidity solutions'' to its institutional investors, Cuomo said in a statement on the Wachovia settlement.

`Didn't Do Right'

Wachovia's purchases of auction-rate securities from its individual and small-business clients will start by Nov. 10, and conclude by Nov. 28, the company said. Investors who sold the securities between Feb. 13 and today will be reimbursed for their loss by Nov. 28. The securities held by other Wachovia clients will be eligible for repurchase between June 10 and June 30 of 2009, Wachovia said.

``Wachovia clearly didn't do right by their customers,'' Missouri Secretary of State Robin Carnahan said in a Bloomberg Television interview. ``I'm as excited as I can be that these 40,000 investors will have access to money that they haven't had before.''

Auction-rate securities are typically bonds with interest rates reset by periodic bidding. Banks and securities dealers that ran the auctions abandoned their routine role as buyers of last resort in mid-February, causing the market to collapse and leaving holders frozen in the securities.

`No Place to Hide'

UBS AG and Citigroup Inc. last week agreed to redeem about $26 billion of the securities and pay fines of a combined $250 million, while Morgan Stanley and JPMorgan & Co. yesterday said they would buy back more than $7 billion of the debt and pay a combined $60 million in fines. The firms neither admitted nor denied wrongdoing.

Wachovia ``didn't have any choice,'' said Gary Townsend, a former bank analyst and co-founder of Hill-Townsend Capital Management in Chevy Chase, Maryland. ``When everyone else is settling, there is no place to hide.''

States will divide the fines based on the amount of securities sold in each state. The North American Securities Administrators Association, which represents state regulators, will distribute the money.

The periodic auctions that had allowed investors to move in or out of the securities at will fell apart when would-be sellers outnumbered buyers. In mid-February, auctions failed in unprecedented numbers, triggering penalty rates as high as 20 percent or pegged to a money-market formula, depending on language in the original bond documents.

Nagel, the St. Louis investor, needed to withdraw money in February to pay for a medical device required by his wife that cost almost $100,000. ``I called my broker on Feb. 12 and they said it would be no problem. Two days later, the broker called and said, `I've got a little problem,'' Nagel said. He hasn't been able to withdraw the securities since then.

To contact the reporters on this story: David Mildenberg in Charlotte, North Carolina, at dmildenberg@bloomberg.net.