Wachovia in talks on bond sales

August 12, 2008
By Rick Rothacker
The Charlotte Observer

Wachovia is negotiating with regulators to settle allegations involving its sale of supposedly safe bonds to investors, and it has set aside $500 million toward the cost of an agreement.

The Charlotte bank would join New York-based Citigroup and Swiss Bank UBS in forging huge settlements that required the banks to buy back billions of dollars of the investments, called auction-rate securities. Citi and UBS also were required to pay big fines.

The auction-rate securities mess is the latest blow for Wachovia, which hired new chief executive Bob Steel last month to revamp a company reeling from mortgage losses and a series of regulatory run-ins.

Wachovia, which is negotiating with agencies led by the Missouri secretary of state, says its customers have about $8.7 billion in these securities. In the largest settlement so far, UBS agreed to buy back nearly $19 billion in securities from individual and institutional investors and pay penalties totaling $150 million.

Morgan Stanley on Monday announced it will voluntarily buy back about $4.5 billion in securities, following a similar move by Merrill Lynch. Charlotte’s Bank of America is also being investigated for its role in selling auction-rate securities. The bank has said it’s cooperating.

The securities are long-term bonds with short-term interest rates that reset periodically. They can be issued by municipalities, hospitals, student-loan companies and other special entities. They were once seen as a safe investment, but the market crashed in February when banks stopped submitting bids that reset the interest rates amid the credit crunch.

Without an active market, investors have been left holding bonds they can’t sell, meaning they can’t access their principal. Regulators are investigating whether banks misled customers about the risk of these investments, pitching them as “safe, liquid and cash equivalent.”

New York Attorney General Andrew Cuomo secured the settlements last week with Citigroup and UBS, setting the stage for agreements with other banks. On Monday, he said he had expanded his investigation to include Wachovia, JPMorgan Chase and Morgan & Stanley and that he was seeking similar results. JPMorgan said it’s cooperating.

Laura Egerdal, a spokeswoman for the Missouri secretary of state, said the state is coordinating the Wachovia investigation with Cuomo and other states. The goal is to get an agreement “as soon as possible,” Egerdal said. Missouri’s probe began in April and escalated last month when investigators arrived at the St. Louis headquarters of the bank’s brokerage arm, Wachovia Securities, seeking documents and records related to the sale of auction-rate bonds. Marathon settlement talks began Friday and extended through the weekend.

“Investors should be able to access their money as promised, and I am committed to finding a solution that will make them whole as quickly as possible,” Missouri Secretary of State Robin Carnahan said in a statement.

In its filing Monday, Wachovia said it was in active negotiations to reach a possible settlement with various state regulators and the Securities and Exchange Commission “concerning the underwriting, sale and subsequent actions of certain auction rate securities.” The bank said it recorded an additional $500 million in legal reserves in the second quarter because of the probability of a settlement, including the cost of writedowns related to auction-rate securities that have decreased in value.

The extra $500 million, taken before taxes, means the bank’s second-quarter loss increased to $9.1 billion from a previously reported $8.9 billion. In the filing, the bank said it didn’t expect a settlement to have a “material effect” on the bank’s capital, liquidity or overall financial results. A Wachovia spokeswoman confirmed the talks but declined to comment beyond the filing.

In a research note last week, Bank of America analysts said the latest settlements “appear to provide an end point to one of the credit crisis chapters.” The analysts estimated that banks have taken losses of $4 billion so far on auction-rate securities and could take another $4 billion in additional settlements.

Eileen Selkis has been trying to get her money out of the frozen auction-rate market for months. She invested money from the sale of her Connecticut home in 2006, because her Wachovia broker told her the securities were as liquid as cash, she said. Selkis, of Fort Mill, S.C., said Monday’s news was encouraging but she’ll feel better “when they’re redeemed.”

Steven Toskes, a partner at Klayman & Toskes in Boca Raton, Fla., said his firm plans to move forward with most of its auction-rate lawsuits. That’s because investors suffered consequential damages such as having to take out loans to pay their taxes.

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