Archive for July, 2008

Just when you thought the auction-rate securities scandal had reached a peak, another Wall Street investment bank is accused of putting its own interests before investors. The top securities regulator in Massachusetts is now accusing Merrill Lynch of securities fraud, claiming that the New York-based investment firm promoted and sold auction-rate notes to investors while downplaying the market’s risks.

Massachusetts Secretary of State William Galvin charges that Merrill Lynch knew several months prior to auction market’s collapse in February that auction-rate securities were not functioning as they should, yet the company’s sales force ramped up efforts to unload the ARS on investors.

The complaint also alleges that Merrill Lynch censored research that foreshadowed problems in the auction market, and instead made sure investors received materials endorsing the safety of auction-rate notes.

As with the complaint Galvin filed against UBS last month over its sales of auction-rate securities, e-mails also are an integral part of Merrill Lynch’s legal troubles. The Massachusetts complaint cites a personal e-mail written by a Merrill Lynch executive on Nov. 19, which reads: “Market is collapsing. No more $2k dinners at CRU.”

On February 7, 2008, Merrill Lynch Research Analyst Kevin Conery told financial advisers that auction-rate securities were a “good, conservative, reasonable investment.” Five short days later, Merrill Lynch pulled out of the auction-rate market entirely.

The complaint further alleges that Merrill Lynch created a “false impression” that deep pools of liquidity were available in the auction market by submitting support bids to prop it up.

Auction-rate securities are long-term bonds with interest rates that reset every seven, 14, 28 or 35 days. Prior to the auction market seizing up in February, municipalities, student-loan companies and closed-end mutual funds had sold about $330 billion of auction-rate securities. Once buyers fled the market, however, auctions failed, freezing billions of dollars of investments held by individuals and institutions.

The Massachusetts complaint against Merrill Lynch wants it to make good on the sales of frozen auction-rate notes, as well as pay restitution to investors who were forced to sell their securities at a loss. The complaint also would impose an unspecified fine.

“This company was aggressively selling the securities to investors and its auction desk was censoring the research analysts to make sure they downplayed market risks,” said Massachusetts Secretary of State William Galvin in a statement. “They knew the auction markets were in trouble, but the investors were the last to know.”

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.Â

A former Credit Suisse broker who is the target of a federal investigation into an auction-rate securities scam has been declared missing and likely left the United States for his home in Bulgaria.

Bulgarian-born Julian Tzolov and Eric Butler are two former Credit Suisse brokers accused of lying to investors about how they invested their money in auction-rate securities. The two men resigned from Credit Suisse on Sept. 7, 2007.

In other auction-rate securities news, UBS has agreed to pay Massachusetts $4.4 million as part of a settlement involving allegations by the state that it misrepresented the securities to municipalities.

Massachusetts securities regulators launched an investigation into UBS and its marketing practices of auction-rate securities in February, following complaints that the Swiss-based bank had deceived clients when it sold them the securities.

Of the $4.4 million settlement, $1 million will go toward state fees and to educate government officials about appropriate investments for their money.

The remaining funds will allow Massachusetts cities and agencies to redeem the full value of their securities from UBS, according to Massachusetts Attorney General Martha Coakley.

The $4.4 million settlement now brings the total amount that UBS has paid to Massachusetts over its mishandling of auction-rate securities to $41.3 million, following a $37 million partial settlement that the bank agreed to in May.

Meanwhile, Texas is now on the trail of UBS. The securities board in the Lone Star State is considering barring the bank from doing business in Texas, in which UBS’ wealth management unit has approximately $65 billion in assets under management.

Auction-rate securities are municipal bonds, corporate bonds, and preferred stocks in which interest rates or dividend yields reset through auctions held every seven, 14, 28, or 35 days. In February 2008, Wall Street investment banks and securities firms pulled out of the auction market, thereby setting off a chain reaction of auction failures.

As a result, thousands of investors have been left in limbo. Initially sold on auction-rate securities because of their supposed cash-like nature, they now find themselves holding illiquid investments.

Many investors have since taken their frustration out in court. According to a study by NERA Economic Consulting, a New York economic-consulting group, shareholder class-action filings have risen substantially in 2008, and expected to reach a 42% increase by year end - the largest annual rise since 2002.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.Â

When Merrill Lynch - one of the world’s largest brokerage houses - announced plans to sell $31 billion of collateralized debt obligations (CDOs), it put a price tag on the sale at $6.7 billion. Less than two weeks earlier, the Merrill Lynch CDOs had been valued at $11.1 billion.

The value inconsistency of the Merrill Lynch CDOs is troubling on several fronts, a fact that investors are all too aware of. Not only does it create controversy regarding the accuracy of the Merrill Lynch balance sheets but also begs the question of whether the write downs haunting Wall Street will ever be put to rest.

The Merrill Lynch CDO sale was a pivotal moment for the financial world - one that is sending a loud and clear message that the problems plaguing CDOs and other mortgage-backed securities is not liquidity in the market but rather how the underlying assets are being valued by investment firms.

A July 30 article in the Wall Street Journal highlights the increasing difficulty that investors face in deciphering fact from fiction when it comes to the valuations of CDOs touted by Wall Street. “Are executives basing valuations on realistic market prices, rather than a rosy, ‘trust us – these will be good money’ view,” says the story.

Valuing complex, asset-backed securities like CDOs is a tricky and oftentimes convoluted process. That’s because investment firms employ their own statistical models, not market prices, to assign value. And that can spell trouble - in this case, trouble comes in the form of write downs. Investment banks and securities firms have posted nearly $500 billion in losses and write downs after the subprime crisis unfolded last year.

Since then, dozens of Wall Street’s biggest players have dug themselves into the proverbial CDO hole based on the simple fact they failed to acknowledge the true scale of their CDO exposure. Others overvalued their CDO assets so they could prolong the period of time before they eventually had to take the losses onto their books. And still others have simply chosen to believe the market for CDOs will eventually return to normal.

That hasn’t happened, as evidenced by the Merrill Lynch CDO sale, July 29, and its subsequent write down of $5.7 billion. Some analysts predict other financial firms will soon follow Merrill’s lead and rid themselves of their own toxic CDO holdings to free up their balance sheets once and for all. When all is said and done, the extra losses could potentially double the write downs that financial institutions have taken thus far.

The Wall Street Journal article cites the example of Citigroup, which at the end of the second quarter had nearly $30 billion in gross CDO holdings, of which $9.8 billion was hedged. According to the article, a portion of the bank’s net holdings are valued in line with Merrill’s recently announced CDO sales price. But about $14.4 billion are asset-backed commercial paper CDOs valued at approximately 62 cents on the dollar.

Citigroup stands behind the higher value, saying it hasn’t suffered cash-flow losses on the holdings and that they are high quality. However, in a report issued July 30, a Morgan Stanley analyst harshly criticized Citigroup’s pricey valuation, stating the bank may need to reduce the value of the CDOs by an additional 21%.

The same scenario is being played out at Bank of America, which has $11 billion in CDOs backed by subprime mortgages. Of that amount, $5.1 billion are CDOs made up of other CDOs. These are called “CDOs squared,” and are considered the most toxic of debt products. Nonetheless, Bank of America has valued these “CDOs squared” at 35 cents on the dollar, which is far more than what Merrill Lynch received for its higher-grade and better-quality CDOs.

Again, is it any wonder investors are growing more and more leery every time Wall Street talks?

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.Â

Merrill Lynch, the third-largest securities firm in the United States, will liquidate $30.6 billion of toxic collateralized debt obligations, CDOs, at fire-sale prices as it attempts to shore up a balance sheet hit hard by the credit crunch.

The Merrill Lynch CDOs will be sold to an affiliate of Lone Star Funds, a Dallas-based private equity firm, for $6.7 billion, or about 22 cents on the dollar. Only two weeks ago, at the end of its second quarter, Merrill said these assets were worth $11.1 billion, or 36 cents on the dollar.

Moreover, Lone Star apparently needs to come up with just $1.7 billion to close the deal. It will borrow the remaining amount - 75% - from Merrill.

The struggling investment bank also will raise $8.5 billion in a public stock sale. The announcement comes less than two weeks after John Thain, Merrill’s chief executive, claimed the firm’s resources were more than adequate to weather the ongoing credit crisis. Temasek Holdings, a Singapore-owned fund that is Merrill’s largest shareholder, will buy $3.4 billion of the new stock, according to a statement issued by Merrill Lynch on July 28.

The CDO and stock sale means Merrill will record a pre-tax write down of $5.7 billion in its upcoming third quarter. A total of $4.4 billion of the write down stems from the CDO sale.

For months, Merrill Lynch has been plagued with problems. In mid-July, the firm announced a $4.6 billion second-quarter loss, after a write-down of $9.4 billion. The second-quarter losses marked Merrill’s fourth straight quarterly loss. In total, Merrill has lost $19.2 billion over the past year and suffered more than $40 billion of write-downs from subprime-linked mortgages.

New York-based Merrill Lynch has been one of the biggest losers in the subprime game. When the housing boom went south last year, Merrill - the leading underwriter of CDOs - was forced to take billions of dollars of the securities onto its books as buyers fled the market. Ultimately, Merrill’s overexposure to subprime-related securities cost Stanley O’Neal his job.

Meanwhile, Merrill’s disastrous missteps into subprime territory have exacted a severe financial toll on investors. Trading continues at it lowest level in a decade, with shares losing more than half their value since January. In order to raise capital, the company sold its 20% interest in Bloomberg, a financial-information provider, in July. At the time, Chief Executive John Thain assured analysts and investors alike “that the firm was now in a very comfortable spot in terms of capital.”

Ten days later, Thain announces more write-downs and additional efforts to ramp up the company’s finances - a move that not only leaves investors who thought the worst was over doing a double take, but also ignites questions as to whether Merrill Lynch and its new chief executive may indeed have a credibility problem.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.Â

The once “implicit” guarantee of a government bail-out has become an explicit reality for Fannie Mae and Freddie Mac. A landmark bill officially establishing a government rescue plan for the mortgage titans was overwhelmingly passed by the Senate on July 26 and is on its way to the President for his signature.

The precedent-setting legislation speaks to growing concerns over the meltdown of the nation’s housing market. An estimated 2.5 million U.S. households are expected to face foreclosure this year, pushing the country into the worst housing slump since the Great Depression.

The housing bill, though expected to be signed promptly by President Bush, has not been without controversy. Sen. Charles Grassley, R-Iowa, referred to it as having “fallen prey to the special interests on Wall Street and K Street at an unjustifiable expense to taxpayers and homeowners on Main Street.”

The basic premise of the bill is to provide up to $300 billion in loans for troubled homeowners and prop up Fannie Mae and Freddie Mac with temporary financial support. Earlier this month, Treasury Secretary Henry Paulson sought approval from Congress to give the financially troubled mortgage companies access to the government’s discount lending window.

Now, it’s apparently necessary. Provisions were added to the housing bill that will allow Fannie Mae and Freddie Mac an unlimited line of credit for the next 18 months. The Treasury also will have the authority to buy stock in both companies.

Critics and supporters alike have both said that the government’s rescue of Fannie Mae and Freddie Mac has several drawbacks, not the least of which is the considerable financial risk it places on taxpayers.

In a July 28 article on Forbes.com, Steve Forbes writes that the Treasury/Fed/Congressional rescue of Fannie Mae and Freddie Mac is nothing more than a “stopgap.” And unless fundamentally restructured, “these two debt-bloated giants will sooner or later blow up.”

Forbes goes on to say that, “The once implicit, now explicit, government guarantee for these two quasi-government entities was the reason that they could be leveraged to the hilt, with a debt-to-equity ratio of almost 25-to-1. Instead of just packaging mortgages and selling them off, the companies kept hundreds of billions in these instruments in their own portfolios to fatten profits - and enrich their politically connected managers and political allies. They also went into the junk-mortgage business, buying more than $170 billion worth of dodgy paper.”

Forbes suggests - and others agree - that the Bush administration would be wise to vigorously push for Fannie Mae and Freddie Mac to be recapitalized and broken up into 10 to 12 new companies, with their ties to the government severed. The move would require the government to provide some $300 billion in equity capital, but such an investment would enable the companies to have a sound debt-to-equity ratio in the vicinity of 4-to-1, according to Forbes. Shares in Fannie Mae and Freddie Mac would then be exchanged for shares of common and preferred stock in the new, solvent firms, says Forbes. Current shareholders could ultimately recover their losses, and taxpayers could eventually get most, if not all, of their money back. According to the article, there might even be a profit in store for Uncle Sam.

Forbes could have a point, because clearly the Fannie Mae and Freddie Mac of today are not working. The business model driving their operations all these years has been fueled by a belief the government would never allow them to fail. As a result, they ran wild, racking up astronomical accounting errors and making poor lending decisions that ended up costing billions. And, all the while, the government and the Office of Federal Housing Enterprise Oversight (whose mission it is to promote housing and a strong national housing finance system by ensuring the safety and soundness of Fannie Mae and Freddie Mac) remained quietly on the sidelines and did nothing to rein either company back in.

Adding further insult to injury: the exorbitant salaries and bonuses that Fannie Mae and Freddie Mac’s executives are paid, while shareholders watch the value of the companies’ stock plummet more than 60%. In 2007, 10 of the 100 top-paid executives came from Fannie Mae or Freddie Mac, including Freddie Mac’s chairman and CEO, Richard F. Syron. Styon raked in $14.5 million, including a $2.2 million performance bonus that year.

Some of these issues may be addressed in the Senate-passed housing bill, which creates a new regulator for Fannie Mae and Freddie Mac that will have power over the companies’ capital levels, as well as executive compensation and internal financial controls. Now it’s a question of whether the damage can be undone.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.Â

UBS has placed David Shulman, head of the firm’s U.S. fixed income unit, on “administrative leave,” as state and federal probes continue to heat up over the Swiss-based investment giant’s mishandling of the UBS failed auction rate securities.

E-mails between Shulman and other UBS executives are at the center of a lawsuit filed by Massachusetts Secretary of State William Galvin. Galvin, who filed the UBS lawsuit on June 26, says the bank committed securities fraud by selling the auction-rate notes as cash equivalents without telling investors the many risks associated with them.

Shulman ran the auction securities business for UBS, which is the second-largest underwriter of municipal auction-rate securities in the country.

UBS, as well as other Wall Street firms, has been the subject of state and federal investigations following the collapse of the $330 billion auction securities market in February. For years, investment banks like UBS promoted auction-rate notes as secure and liquid investments that were issued by municipalities, student loan companies and not-for-profits. The interest rates on auction-rate securities are reset at weekly or monthly auctions.

As the credit crunch worsened, however, investment banks began to pull back their support from the auction-rate market, leaving tens of thousands of investors stuck with auction-rate notes no one wanted to buy.

Cuomo says his goal with the UBS lawsuit is to force UBS to make those assets liquid again for some 50,000 customers who have been unable to access $37 billion.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.Â

Auction-rate securities fraud is growing more prolific by the minute, as Wall Street investment banks keep digging themselves deeper and deeper into the mess. At the center of the auction securities crisis is Swiss-based investment giant UBS, which New York Attorney General Andrew Cuomo has accused of multibillion-dollar consumer and securities fraud.

The state of New York filed charges against UBS on July 24, alleging the firm used misleading and deceptive practices to push auction-rate securities on corporate and retail investors.

According to a July 25 story in the Wall Street Journal, the New York complaint also alleges that several high-level UBS executives sold approximately $21 million of their own holdings in auction-rate notes at the height of the market’s turmoil last winter. Meanwhile, more 50,000 UBS customers were left with $35 billion worth of the illiquid investments.

Cuomo’s suit, which names as defendants UBS Securities LLC and UBS Financial Services Inc., both units of UBS AG, is demanding UBS pay back the profits it made from auction-rate securities, make investors’ assets liquid again and pay damages.

UBS already faces similar civil charges in the state of Massachusetts.

The New York case against UBS follows a number of state probes into auction securities, with securities regulators scrutinizing Wall Street’s role in selling the instruments to investors and its potential part in the collapse of the market in February when investment banks abandoned the market altogether.

Auction-rate notes are long-term securities issued by municipalities, student loan companies and others to raise capital to finance their operations or projects. The interest rates on the securities are reset at auctions, held weekly or monthly, and run by Wall Street investment banks.

At the center of the investigations is the belief that many Wall Street firms staged an all-out marketing war to push auction-rate securities out of their own inventory and into the hands of investors after it became clear the auction market was headed for failure. Rather than take write downs on the holdings, the companies pushed them off on investors, all the while sugar-coating the risk levels of the securities.

As reported in the Wall Street Journal article, before the collapse of the auction-rate market six months ago, several Wall Street firms significantly raised brokers’ commissions to unload auction-rate securities. Massachusetts regulators uncovered documents created by one UBS executive, Edward Hynes, which laid out an apparent marketing strategy that included specific language to use with clients about auction-rate securities backed by student loans.

In part, the document read: “We need them to walk out and believe this is a strong credit with strong UBS commitment to support the liquidity.”

Meanwhile, UBS has issued a statement in response to the recent charges by the New York attorney general in which it states that while some of its employees exercised “poor judgment,” none had engaged in illegal conduct.

Apparently for UBS, “poor judgment” is an acceptable part of doing business, despite the fact tens of thousands of investors face untold financial losses because of promises made by brokers that auction-rate securities were safe and liquid as cash.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

Citigroup hedge fund investors who put their faith - and dollars - in the ASTA Fund and MAT Fund are now thinking of a Citigroup lawsuit. Marketed as a conservative investment, the Citigroup hedge funds ultimately plummeted in value. As compensation for their ASTA Fund and MAT Fund investment, the company offered a “settlement” to investors - a payout worth less than one half of the initial Citigroup investment. There was one catch: Investors had to forfeit all rights of bringing legal action for their Citigroup problems later down the road.

The Citigroup ASTA Fund and MAT Fund were highly leveraged municipal bond funds that borrowed approximately $8 for every $1 raised. By March, Citigroup problems - and its losses - became evident: Both funds were worth approximately 10 percent of their original value. Despite the obvious, hedge fund investors were repeatedly told the situation would rebound.

That wasn’t the case. Even after Citigroup plunked more than $660 million into the ASTA Fund and MAT Fund, they continued to go downhill.

Citigroup first offered the ASTA Fund and MAT Fund in 2002 to Smith Barney brokerage clients and private bank customers. Their strategy worked something like this: Trusts run by Citigroup and other financial institutions borrowed money by issuing tax-exempt commercial paper, then used that cash to buy municipal bonds with slightly higher yields and kept the difference.

The trusts then hedged against interest rate changes by basically reversing that trade, using taxable securities. To ramp up returns, the trust piled on pools of leverage, with Citigroup buying the riskiest pieces of the bonds issued.

Investors in the ASTA Fund and MAT Fund thought they were putting their money into a conservative investment - an investment where losses were not to exceed 5%. Instead, the funds’ management invested their assets in the most risky and speculative of investments. When it became clear the hedge funds were in trouble, Citigroup assured both brokers and investors it was only a matter of time before they would bounce back.

More than likely Citigroup will have the chance to tell its story again - this time in court. The company is facing a myriad of lawsuits over the ASTA Fund and MAT Fund, with plaintiffs charging Citigroup management of misrepresenting the funds and putting their investments at grave risk.

The bottom line: The ASTA Fund and MAT Fund are a prime example of what happens when a company fails to exercise risk management - and now investors, once again, are paying the price.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

Auction-rate securities are becoming a major headache for UBS. New York Attorney General Andrew Cuomo made it official on July 24, filing a civil lawsuit against the Swiss-based investment bank regarding the auction-rate securities.

UBS is accused of using deceptive marketing practices to steer clients into auction-rate securities, telling them the instruments were “cash equivalents.” Since the market froze up in February, investors have been unable to sell their holdings, which then lost value as illiquid investments.

“Not only is UBS guilty of committing a flagrant breach of trust between the bank and its customers, its top executives jumped ship as soon the securities market started to collapse, leaving thousands of customers holding the bag,” said Attorney General Cuomo in a press statement. “Today we bring the first nationwide lawsuit against UBS, seeking to recover billions of dollars for customers and sending a resounding message to the rest of the industry that this type of deceptive behavior will not be tolerated.”

Following Cuomo’s announcement, UBS shares dropped more than 3 percent on the New York Stock Exchange.

Cuomo’s lawsuit against UBS is expected to turn up the heat on other Wall Street firms over their handling of auction-rate securities. The attorney general also is looking into the role investment banks may have played in the collapse of the $330 billion market in February after they pulled back their financial support entirely.

A copy of the UBS complaint can be read online at: http://www.oag.state.ny.us/press/2008/july/UBS.pdf.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.Â

Wall Street investment banks have come under fire lately, prompting U.S. Securities and Exchange Commission Chairman Christopher Cox to ask lawmakers to ramp up the agency’s authority to officially oversee them.

Cox told the House Financial Services Committee today that the nation’s biggest names in the investing world should have mandatory SEC oversight of their capital, liquidity and risk management practices. Currently, the SEC has a supervisory role over four of the largest investment firms - Goldman Sachs, Merrill Lynch, Morgan Stanley and Lehman Brothers - but it is on a voluntary basis only.

The SEC’s move to garner more oversight of Wall Street has been underway since the Federal Reserve’s bail-out of Bear Stearns in March. At that time, fears of similar scenarios playing out at other investment banks caused the Federal Reserve to open its discount lending window. Since then, the Federal Reserve has maintained that more oversight of investment banks is needed in the event it becomes obligated to lend them money again in the future.

The collapse of Bear Stearns and the U.S. subprime-mortgage market has contributed to almost $470 billion in write-downs and credit losses since the start of 2007.

Earlier this month, the Federal Reserve and the SEC formally agreed to an information-sharing pact in which the two agencies would exchange information and resources on common issues.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.Â