THIS Will Get Their Attention

UBS, pronounced oops. Last month UBS Financial Services bought back auction-rate securities valued at $37 million that had been previously sold to 17 Massachusetts cities and towns (see May 8 post, "Pain in the ARS"). At the time the firm declared the matter "resolved." Now UBS is being prodded to do the same for individual investors, who have been unable to unload their ARS since the market froze in February. All told, over $200 billion of investment capital is trapped in these illiquid securities.

The Massachusetts Securities Division will file civil fraud charges today, alleging that UBS misrepresented ARS as cash-like investments with iron-clad protection of principal. Even worse, UBS continued to market the securities to small investors even as the firm was warning larger institutional clients of potential risk. Such two-tiered treatment of customers seldom goes over well with regulators.

Passive investors who thought they were safe started to smell the coffee in May, when their monthly statements from UBS began showing ARS as "fixed income" positions, not "cash." This meant that their securities could fluctuate in value, just like bonds. Sure enough, UBS has begun marking down the value of some of these investments on customer statements. "Your future," purrs the marketing jingle, now discounted at your friendly neighborhood broker.

Banc of America and Merrill Lynch are also in the crosshairs of Massachusetts regulators. Any money firm that spells "bank" with a "c" is guilty until proven innocent. As for Merrill, its rap sheet is as long as the Nile. I had a brokerage account with Merrill's Boston office back in the late '70s and early '80s and got personal attention from a customer rep named Don Martineau. He got me into Prime Computer before the stock took off, and that's how I paid for my honeymoon. Years later, though, long after I had moved to Maine, Martineau was convicted of bilking clients of millions and did some time. The "kulture," it appears, has not changed.


[update, 1:45 p.m.--]
Remember those preferred stock offerings that Merrill, Lehman, and Citigroup issued this spring to fortify their balance sheets? Those shares are now trading at 9.5% yields, which means (1) the share prices have declined since and (2) any new deals would have to be priced with double-digit yields. The day is coming when deals cannot get done at any price, and that is when the sugar will really hit the fan.

[update, July 24--]
New York Attorney General Andrew Cuomo announced today that he is joining the posse going after UBS for pushing auction-rate securites. "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 as the securities market started to collapse, leaving thousands of customers holding the bag," said Cuomo in a press release. Cuomo is seeking to compel UBS to buy back the ARS at face value, plus penalty. His lawsuit is the latest of two dozen against brokerages in nine states alleging marketing fraud.