A Fast Knock

Back in April I wrote about the New York State Attorney General's investigation into the collapse of the auction rate securities market. Last week the Wall Street Journal reported that the New York AG filed a law suit against UBS, the global financial services conglomerate, alleging a significant consumer and securities fraud. The law suit claims that UBS brokers used fraudulent sales tactics to convince retail customers to purchase the securities despite knowledge that the market itself was near failure. Auction rate securities are a type of debt or bond instrument issued typically by groups such as municipalities or student loan providers in which the interest rate is reset at an auction held periodically by Wall Street firms. The auction process gives what otherwise would be long term "buy and hold" investments the tradable features of shorter term securities.

The law suit further alleges that UBS executives who feared a market breakdown dumped their own auction rate securities for a handsome profit and left their retail clients holding the bag to the tune of $37 billion dollars of withering investments. Karina Byrne, a UBS spokeswoman, said, "UBS does not believe that there was illegal conduct by any employee." After an internal investigation into personal sales of auction-rate securities she stated, "we have found cases of poor judgment by certain individuals and are evaluating appropriate disciplinary measures for these individuals." Citigroup, Wachovia, Merrill Lynch, and Credit Suisse all face similar probes.

Once again, regulators and prosecutors investigate a collapse of a financial market and lay blame at Wall Street's door despite powerful market forces at work beyond anyone's prediction or control. Many of the auction rate securities at issue were backed by sub-prime mortgage debt. The sub-prime market itself disintegrated in a swift and completely unforeseeable manner. This is not an example of greed and high pressure sales tactics but rather the collateral consequences of widespread financial turmoil. Moreover, despite the fact that UBS is attempting to assist clients who hold the beleaguered securities, it is sued for its trouble. I predict that once again we will see individuals at these companies scapegoated for ecomonic problems over which they had no control. CR

Going once, going twice.

In an investigation that could lead to criminal charges, New York State Attorney General Andrew Cuomo has issued subpoenas to 18 banks – including Citigroup, Merrill Lynch, Morgan Stanley, and JPMorgan Chase – that underwrote and brokered investments in the now-collapsed auction-rate securities market. The AG is seeking information dating back to 2003 on the extent to which the banks artifically supported the market and how they disclosed the risks of auction failures to investors.

Auction-rate securities are long-term bonds that were often marketed as short-term investments because buyers could sell them at periodic auctions. For two decades, securities dealers had routinely bought unwanted bonds at auction to prevent failure. The $330-billion market collapsed in February, when dealers suddenly stopped bidding in an effort to conserve capital in light of the subprime mortgage crisis.

The investigation was reportedly instigated when more than fifty lenders had to stop making federally guaranteed student loans. Now nine other state attorneys general have formed a task force to investigate whether brokers misrepresented ARSs as an alternative to money-market investments when they sold them to individuals.

The subpoenas were issued under New York’s Martin Act, a sweeping and broad statutory scheme dating to 1921 that criminalizes misrepresentation in connection with the purchase and sale of securities. The Act has been used regularly by both the New York County DA’s office and former AG Elliot Spitzer to police securities trading on Wall Street. Now it is being used yet again, and institutions and individuals face tremendous potential criminal liability. Intense and powerful market forces provide explanation, mitigation, and defenses for those ensnared in the AG’s latest effort to blame someone – anyone – for the sorry state of our economy. CR