Blau & Malmfeldt

Massachusetts Secretary of State Charges Oppenheimer

William Galvin, Secretary of State of Massachusetts, announced charges this morning against Oppenheimer in connection with its sales of auction-rate securities.  This is the first such administrative action against a "downstream" seller of ARS (i.e. a brokerage firm that sold the securities but was not involved in the underwriting process).

From the press release: “Oppenheimer executives betrayed the trust of their clients by continuing to market these auction rate securities as safe cash equivalents when they knew this was not the case. They kept their clients, and their own advisors to those clients, in the dark, even as they, themselves, got out of that tottering market.”

Posted by Paul Malmfeldt on November 18, 2008.

Auction-Rate Securities Sellers Blame Underwriters For February's Debacle

The Wall Street Journal reported today that the "downstream sellers" of auction-rate securities ("ARS") -- the brokerage firms that sold ARS but neither underwrote them nor ran the auctions -- are denying any responsibility for the ARS crisis.  Oppenheimer and Co. says that the investment banks that underwrote ARS are 100 percent to blame and should have to buy them back from Oppenheimer's own brokerage customers.  Firms like Oppenheimer argue that the underwriters concealed risks from them.  

I agree that the underwriters are largely to blame for the ARS debacle.  But it strikes me as absurd that firms like Oppenheimer and Raymond James are saying that they were completely in the dark.  Oppenheimer and Raymond James were not exactly babes in the wood -- these firms have investment banking divisions and Mathematics Ph.Ds on their staffs who analyze structured finance markets. It appears that firms like Oppenheimer and Raymond James purposefully ignored problems with these securities because they were receiving very large sales commissions.

Posted by Paul Malmfeldt on August 19, 2008.

Investment Banks Agree To Buy Back Auction-Rate Securities

Within the past month, Merrill Lynch, Citigroup, and Wachovia (among other major Wall Street firms) have agreed to buy back auction-rate securities ("ARS") at face value as part of settlements with the SEC and state regulators.  These investment banks, which underwrote the securities and built the house of cards, are largely to blame for February's ARS debacle. 

This is obviously great news, not only for the banks' brokerage customers (who are stuck with illiquid securites worth less than face value) but also for the banks' registered representatives.  Many of these representatives did not realize that they were selling snake oil and were facing angry customers and arbitration actions.  I had expected the banks to hang their representatives out to dry in the arbitration proceedings.

On the other hand, it is bad news for the investment banks; they are now facing billions in ARS write-downs on top of billions in write-downs relating to other structured securities on their books.  I imagine that their stock prices will continue to slide.  (It is also bad news for the class-action plaintiffs' firms that are pursuing ARS cases against the investment banks -- they appear to have bet on the wrong horses.)

The settlements with the investment banks will solve only part of the problem: the buy-backs that will result from these settlements account for less than half the ARS market.  It will be interesting to see what happens with respect to the brokerage firms that played no role in underwriting the securities or in running the auctions but that falsely marketed these securities to customers as money market equivalents.  Unless they agree to buy back ARS from their customers, these firms will continue to face scrutiny from the SEC and state regulators.  And brokerage customers will continue to file arbitration actions so long as their ARS remain illiquid.  

Posted by Paul Malmfeldt on August 18, 2008.

Don't Mess With Texas -- One Approach To The Auction-Rate Securities Mess

On July 22, 2008, the Texas State Securities Board announced that it may suspend the licenses of some or all of UBS's Texas-licensed brokers who sold auction-rate securities ("ARS") to brokerage customers, until their customers have the ability to liquidate the ARS in their accounts at par.  A hearing is scheduled for September.  One would have to imagine that Texas's non-nonsense approach will be effective.  It will be interesting to see whether Texas takes the same approach with the other major broker-dealers.

Posted by Paul Malmfeldt on August 5, 2008.

Update: On August 11, 2008, UBS reached a settlement with Massachusetts, New York, and Texas. 

From the Texas State Securities Board press release:

Under the terms of the settlement, UBS will buy back, no later than October 31, 2008, all illiquid auction rate securities from all UBS retail customers, including charities, who have less than $1 million on deposit. In addition, no later than January 2, 2009, UBS will buy back all illiquid auction rate securities from all other UBS retail customers, charities, and small to mid-sized businesses. These customers, who number approximately 40,000 nationwide, have been unable to sell their securities since February 13, 2008.

UBS will also:

• Fully reimburse all retail investors who sold their auction rate securities at a discount after the market failed in February 2008;
• Consent to a special, public arbitration procedure to resolve claims of consequential damages suffered by retail investors as a result of not being able to access their funds, in which UBS will not contest its liability for the illiquidity of the auction rate securities and in which UBS will pay all forum fees;
• Undertake to expeditiously provide liquidity solutions to all other institutional investors, with regular progress reports and subject to an outside deadline of June 30, 2010; and
• Reimburse all refinancing fees to municipal issuers who issued auction rate securities through UBS since August 1, 2007, and who refinanced those securities after the market failed.

As part of the settlement, UBS will pay the State of New York a civil penalty in the amount of $75 million. UBS will also pay a separate civil penalty of $75 million to the other states collectively. 

Credit Suisse Broker Who Allegedly Misrepresented Auction-Rate Securities Flees to Bulgaria

In an unusual twist to a Federal criminal probe relating to February's auction-rate securities ("ARS") meltdown, a former Credit Suisse broker facing charges has fled to Bulgaria, the Wall Street Journal reported today.  It appears that the broker, Julian Tzolov, made misrepresentations to a number of corporate clients pertaining to various ARS issues.  Tzolov allegedly told these clients that the ARS were backed by student loans when they were actually backed by mortgages.  The corporate clients have recorded paper losses in the millions and are obviously unhappy.  Under a new extradition treaty between the United States and Bulgaria slated to go into effect in September, it appears likely that Tzolov will face extradition.

Tzolov was hardly alone: thousands of securities brokers appear to have misrepresented ARS (wittingly or unwittingly) and each of the major broker-dealer firms appear to have systematically defrauded investors for years in connection with ARS.  These Federal prosecutors had many targets to choose from. 

So why have the Federal prosecutors chosen to focus on Tzolov?  And is criminal prosecution really appropriate in this context?  Why are the Feds so sure that Tzolov understood that mortgage-backed securities are riskier than those backed by student loans?       

Posted by Paul Malmfeldt on July 31, 2008.