August 15, 2008
By Christina Rexrode and Rick Rothacker
The Charlotte Observer
Wachovia Corp. on Friday agreed to buy back up to $8.8 billion in auction-rate securities and pay a $50 million fine, the latest bank caught in a regulatory crackdown of the bonds.
The market for auction-rate securities has been quickly unraveling since the end of last week, when Citigroup Inc. announced it would buy back $7.5 billion in the securities and pay $100 million in fines as part of its settlement with state and federal regulators. Since then, UBS, JPMorgan Chase & Co., and Morgan Stanley have also settled with regulators. Merrill Lynch & Co. has said it will voluntarily start to buy back the securities.
The bonds have proven nightmarish for many investors. Regulators say that Wachovia and the other banks did not accurately represent the risks of the securities to investors, wrongly leading them to believe that the bonds were as liquid as cash. However, most clients have been unable to access their auction-rate investments since February, when banks stopped submitting bids for the investments.
Weddington resident Chris Sutton said he was glad to hear about the settlement. Sutton, who is co-trustee for his parents’ trust, invested in auction-rate securities last year, at the suggestion of his Wachovia broker. He told the broker he needed a highly liquid investment because his mother needed to withdraw money for health care expenses. The broker, Sutton says, told him that he’d be able to access his principal almost any time.
“Am I glad to hear that (the bank) is going to buy back the auction rates? Yes, I am,” Sutton said this week. “This money’s been frozen for months. We’re not wealthy people. My mom created a trust, and that’s our lifeblood.”
Wachovia, which did not admit or deny wrongdoing, said the settlement resolved investigations by state regulators led by the Missouri Secretary of State, the New York Attorney General and the SEC. Its settlement is similar to those by other banks, although some banks haven’t signed deals with as many regulators. Andrew Cuomo, New York’s attorney general, said Friday that Merrill Lynch should expect a lawsuit from his office soon.
Wachovia, under its agreement, will offer to buy back auction-rate securities from any investors who bought into the market before its February collapse. That means the bank could repurchase up to $5.7 billion in securities held by 40,000 individuals, small businesses and charities. It could also repurchase up to $3.1 billion from institutional investors.
The repurchasing program will take place in November for the first group, and next June for the institutional investors.
The bank will also reimburse investors who sold their auction-rate securities at a loss after the market’s collapse. Wachovia must provide no-interest loans for customers who need liquidity before then.
If customers have incurred other damages besides a loss of liquidity, they can participate in arbitration overseen by the Financial Industry Regulatory Authority. In those cases, Wachovia cannot contest its liability.
“We understand that unprecedented market conditions have created difficulties for our clients, particularly those holding auction rate securities,” chief executive Bob Steel said in a statement. “We are pleased to announce a comprehensive solution for the liquidity needs of clients who purchased auction rate securities at Wachovia and to resolve this matter with federal and state regulators.”
Rumors of the Wachovia settlement have been floating around Wall Street all week. On Monday, the Charlotte bank said it set aside an extra $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. In May, Wachovia said it had received inquiries and subpoenas from the Securities and Exchange Commission and several state regulators. In July, regulators from Missouri and other states showed up to inspect the St. Louis headquarters of Wachovia Securities, seeking documents related to the sale of the bonds.
Auction-rate securities are bonds with interest rates that reset periodically – usually every seven, 28 or 35 days. They can be issued by municipalities, hospitals, student-loan companies and other special entities.
Some financial advisers say they were viewed as safe and stable for years. But that ended abruptly in February, when the country’s banks, buffeted by tight credit, stopped submitting the bids that reset those interest rates. Investors were left holding bonds they couldn’t sell, which meant they couldn’t access their principal.
One problem, regulators say, is that banks led investors to believe that these bonds were as liquid as cash. Another problem, the SEC noted in its Wachovia settlement, is that Wachovia did not clarify how it is responsible for supporting the securities that it sells. Some experts say that represents an inherent conflict.
The banks “are on both sides of the trade,” said Lawrence L. Klayman, a senior partner at Klayman & Toskes in Florida. “They had their doubts about the market, but they continued to sell these to investors to the very end. They were trying to shift the loss.” Wachovia said it would add another $275 million to its legal reserves in the third quarter to pay for the settlement. The bank said it does not currently expect the agreement will have a “material effect” on capital, liquidity or overall financial results, although a measure of Tier 1 capital to assets will be reduced slightly.
Missouri regulators said Wachovia would pay $50 million in fines to be split among state regulators. Wachovia could face a fine from the SEC depending on the success of its buyback program.
The Missouri Secretary of State, Robin Carnahan, lauded the settlement as a way to make investors whole. “I have received hundreds of calls from Missourians and investors around the nation who need their money to make medical payments, run their businesses, or retire as planned,” Carnahan said. “I am pleased that six months of uncertainty and worry is over.”
Last week, Charlotte’s Bank of America Corp. said in a regulatory filing that it has “received subpoenas and requests for information from various state and federal governmental agencies” over auction-rate securities. Bank of America has said it is working with clients and will cooperate fully with regulators.