Capital Markets

UBS to Make Good on Bad ARS Investments

Massachusetts municipalities will get back $35 million from the bank, which allegedly misled them about the safety of the securities.
Stephen TaubMay 7, 2008

UBS has agreed to return to various Massachusetts entities $35 million for funds invested in auction rate securities, state Attorney General Martha Coakley announced.

Oakley’s office in February began investigating allegations that the Swiss bank misled towns, cities, and state and municipal entities regarding ARS were a permissible investment for them under Massachusetts Law.

“We appreciate that UBS has taken action to return the invested monies to our cities, towns and other government entities,” Coakley said in a statement. “In these tight financial times, Massachusetts municipalities need to have access to their monies and to invest them appropriately.” She added that her review of potential penalties under the False Claims Act is ongoing.

An auction rate security is a debt instrument, such as a bond, or preferred stock for which the interest rate or dividend is periodically reset through an auction mechanism. In some cases, towns and cities were persuaded to invest their cash into ARS accounts. Although these securities have long-term maturities of many years, they historically have been offered for sale at weekly or monthly auctions.

However, the market for ARS dried up early this year, and the auctions experienced widespread failures. When an auction fails, liquidity disappears from the market, as it becomes difficult to dispose of such securities at all, let alone at par value, Coakley explained. Many of these securities have been written down to reflect their reduced market value.

The failure of the auctions has also hit companies, such as 3M Corp., US Airways, and Bristol-Myers Squibb, forcing the latter into a write-downs. Some issuers were forced to pay interest rates as high as 20 percent.

Since the auction failures, the Massachusetts that invested in ARS have been forced to hold these securities in order to avoid principal losses, Coakley noted. “UBS’s action today will allow these entities to recover these frozen funds,” she statd.

Affected Massachusetts entities include: Town of Andover, Town of Merrimac, Town of Needham, City of Holyoke, Town of Whitman, Town of Hudson, Town of Westborough, City of Chicopee, Town of Barnstable, Town of East Longmeadow, Massachusetts Turnpike Authority, Town of Wayland, Town of Boylston, Town of Warren, Town of Winchester, Town of Mattapoisett, Town of Dedham, and Town of Belchertown.

Massachusetts is not the state probe the embattled ARS market. It is participating in an ARS state task force with Florida, Georgia, Illinois, Missouri, New Hampshire, New Jersey, Texas, and Washington, according to the North American Securities Administrators Association.

In addition, New York Attorney General Andrew Cuomo subpoenaed 18 banks and securities firms, including a number of well-known large ones, according to a report in Bloomberg News. The probe could lead to criminal charges, the wire service added, citing a person familiar with the investigation.

“We’re all getting complaints on a daily basis from retail investors and they all have the same the story: they were told by their brokers these were safe as cash — and they’re not,” Bryan Lantagne, securities division director for Massachusetts Secretary of State William Galvin, told Bloomberg.

Meanwhile, the inspections office of the Securities and Exchange Commission sent letters to the biggest sellers of ARS this month, seeking names of customers who purchased the notes and the identities of brokers who sold them. The regulator is interested in how Wall Street firms sold the bonds to investors and issuers, the wire service noted.

This is not the first time investment banks have been accused of wrongdoing in the ARS market. According to Bloomberg, in 1995 Lehman Brothers Holdings was fined $850,000 by the Securities and Exchange Commission for manipulating auctions conducted for American Express.

And nearly two years ago 15 securities firms paid the SEC $13 million to settle claims of bid-rigging, though they neither admitted nor denied wrongdoing, according to Bloomberg. The SEC imposed new rules on the market after the settlement.

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