Bank of America is apparently set to become the eighth bank to agree to buy auction rate securities it sold to customers. According to Reuters, Bank of America spokeswoman Shirley Norton, said BofA is “ready and willing to enter into an agreement that follows the same basic terms of previously announced settlements.”

They may be jumping the gun by making this statement however. New York Attorney General Andrew Cuomo scolded Merrill Lynch for assuming it had reached an adequate settlement with his office without first going through the bother of actually reaching an agreement. In response to word of BofA’s “settlement” Cuomo’s office seems to have scoffed.

“Our investigation into Bank of America is ongoing,” a spokesman for Cuomo’s office said.

So far Citigroup, Deutsche Bank, Goldman Sachs Group, JPMorgan Chase, Merrill Lynch, Morgan Stanley, UBS and Wachovia Corp have settled auction rate cases, agreeing to buy back something in the order of $50 billion of the securities. Two Credit Suisse brokers face civil and criminal fraud charges for selling auction rate securities.

Bank of America: Ready to settle on auction rates [Reuters]

Is Andrew Cuomo going to force Wall Street to bailout institutional investors who bought auction rate securities? So far most of the offers to buy back auction rate securities that have come from brokers have applied to retail investors, charities and municipalities. The idea was that these investors were probably the focus of regulator protection and more sophisticated investors knew or should have known the risks in the market.

CNBC’s Charlie Gasparino is reporting that Cuomo’s dissatisfaction with the settlement offers from Merrill Lynch and Morgan Stanley stems, in part, from a concern for institutional investors. Pension funds and others own large amounts of the securities, and Cuomo may be pushing Wall Street firms to offer relief to these customers as well. This could seriously increase the cost of bailing out this market to the firms involved.

Investors in auction rate securities got some relief when UBS and Citi said they would buy back those bought by retail investors and charities. Merrill followed suit, although its buy back would be delayed until next year. But when Morgan Stanley made a similar buy back offer yesterday, the New York Attorney General’s office characterized the offer as “too little, too late.”

“Our investigation into Morgan Stanley continues,” a spokesman for Attorney General Andrew Cuomo said.

It was not immediately clear what about Morgan Stanley’s offer to settle with regulators and investors failed to satisfy Cuomo, although perhaps Cuomo rejected plans to delay the buyback until as late as September 30th. It may be that Cuomo plans to demand an immediate buyback. Merrill’s offer is also said to be under review by Cuomo. There has been some speculation that both Merrill and Morgan hope to use the delay to pressure issuers to redeem the securities, reducing their costs in any buy back.

Another possibility is the Cuomo will require Morgan and Merrill to reimburse customers who sold the securities at a discount from par. Citigroup’s offer included this provision, while Morgan’s and Merrill’s did not.

Earlier Monday, Cuomo sent a letter to Morgan Stanley, JPMorgan Chase and Wachovia, requesting the banks “immediate talks” to relieve investors. Wachovia is expected to announce a deal as early as today.

Bank Offers to Buy Back $4.5 Billion in Securities [Bloomberg]

A microchip maker is suing Credit Suisse, alleging the Swiss bank put $450 million into auction rate securities without authorization and made threats of retaliation when the company demanded its money and threatened to sue.

“Rather than siding with customers who had been victimized, Credit Suisse Group aligned itself with its wholly owned subsidiary Credit Suisse Securities and its corrupt brokers and directors,” STMicro says in the complaint filed in federal court in Brooklyn.

Credit Suisse is fighting back, calling the lawsuit “meritless,” according to Bloomberg.

Credit Suisse Sued Over Auction-Rate Securities [Bloomberg]

Across Wall Street, brokers are pressuring closed-end mutual funds to redeem their auction rate preferred securities, hoping to shift the cost of the market meltdown to the issuers before regulators and others forces those who sold the securities to make investors whole.

Yesterday we mentioned that Merrill brokers were upset that BlackRock, one of the largest issuers of ARPS, hadn’t redeemed a larger percentage. This is just one example of a dynamic playing out across Wall Street. Citigroup is reportedly considering buying out the ARPS it sold to investors, a move widely seen as an attempt to hold off regulatory scrutiny. Now other firms, especially those already laden with debt in frozen markets, are attempting to avoid incurring the costs of bailing out ARPS investors by drawing attention to the role of the issuers.

So how did Wall Street convince all those corporate treasurers to invest the cash holdings of their companies in disastrous auction rate securities? A new study shows that more than 85 percent thought that Wall Street firms would bail out the market if it failed, according to this morning’s Financial Times.

Nearly 70 per cent of corporate treasurers who bought auction-rate securities said dealer support was implied. A full 17 per cent of the treasurers said that they were “told explicitly that the investment bank would ensure that the auctions would not fail.”

For years, the firms selling auction rate securities did support the market by buying excess securities, guaranteeing the auctions would not fail. When scrambling to increase balance sheet capital earlier this year, nearly every firm on Wall Street that had sold the products decided to let the auctions fail. Since then issuers have been forced to bail out those securities paying the highest interest rates, while investors with those paying the lowest interest rates have simply been unable to access their funds.

Auction-rate securities ‘implied support’ [Financial Times]

Bank customers with funds locked up in auction rate securities are discovering that even if they find willing buyers for their securities, they may not be able to sell them. Earlier this year, nearly all the auctions for the securities failed as banks pulled their support for the auction. Customers, many of whom believed the securities were safely liquid cash-equivalents, found themselves unable to access their funds. While some issuers who faced high penalty rates following auction failures have redeemed their ARS, hundreds of millions of dollars remains locked-up.

It is an ugly situation that has bank customers bringing lawsuits against their brokers and the issuers of the securities. And it just got worse. According to Bloomberg’s Darrell Preston, Bank of America, UBS, Wachovia and at least four dozen other firms that sold ARS are blocking attempts to create a secondary market for the securities. They say they are preventing customers from selling at a discount and incurring needless losses.

Maybe the banks really do only have their customers’ best interests in mind. But the move also serves the interests of the banks. For one thing, preventing customer losses also makes it harder to sue the banks for their role in the ARS market.

“By allowing customers to sell at a discount, the banks allow customers to establish damages,” said Bryan Lantagne, the securities division director for Massachusetts Secretary of State William Galvin.

And the banks may have another reason to avoid allowing a secondary market. It’s still unclear about how much ARS are held directly by the banks themselves but some reports suggest they may hold a great deal. Since few of these default, the banks can carry these on their balance sheets at par value or close to it. But if they start trading at a discount in the secondary market, the banks will have to mark these at market value, incurring another round of write-downs. In short, the banks have an interest in preventing the formation of a transparent market in auction rate securities.

Banks Say Auction-Rate Investors Can’t Have Money [Bloomberg]

Lawyers in the two dozen or so proposed class action suits filed in connection with the failure of the auction rate securities markets may be “unable to prove their clients lost money or collect fees for themselves,” writes Bloomberg’s Thom Weidlich. We’re not so sure the defendant broker-dealers and issuers in these cases should be so confident.

Find out why after the jump.

Despite the happy headline reading “Auction-Rate Securities: How to Get Unstuck: you probably can’t get unstuck. The secondary market for auction-rate securities has all but dried up as the issuers facing the highest interest rates have refinanced. By the time you get to the end of this Business Week story you’ll find the sad tale of John Tierney, who was told by Smith Barney that he couldn’t sell his auction-rate securities.

In other news, investors in auction rate securities have filed a suit against Goldman Sachs. The lawyers representing the investors say “Goldman Sachs misrepresented the securities as cash alternatives, which turned out to b”e liquid solely because of artificial manipulation of the auction market.

Auction-Rate Securities: How to Get Unstuck [Business Week]

Most of the $37 million in investments for which UBS agreed to reimburse Massachusetts municipalities last week came from one small office within UBS known as the Flynn Financial Group, named for the group’s head, 42 year old Timothy P. Flynn, the Boston Globe is reporting.

Flynn, who grew up in western Massachusetts, has built a business of advising small-town local New England governments on investments and cash-mangement.

“He is UBS in Massachusetts,” one local treasurer tells the Globe.

With Flynn acting as an advisor, many local treasurers bought auction-rate securities. After the market for these securities went into deep-freeze, Massachusetts attorney general Martha Coakley argued that the investments were barred under state laws which require localities to invest cash only in the safest investments. Last week, as part of its settlement with the attorney general, UBS agreed that the investments were illegal.

Perhaps surprisingly, the local treasurers are defending the decision to investment in auction rate securities and Flynn’s advice. Some even seem to have understood the market for auction rate securities well-enough to pull out before the auctions began to fail. Others, however, found that their cash was trapped in the suddenly illiquid securities. They may have been misled when UBS labeled the securities “cash management” products.

Tim Flynn couldn’t be reached for comment.

Same broker tied investors to UBS [Boston Globe]

When the Culinary Institute of America needed to raise money to pay for a new building they turned to a Goldman Sachs banker for advice. He told them to issue auction rate securities. That piece of advice cost them nearly half a million dollars when the market seized up and the interest rate of the securities shot up to 14 percent, Bloomberg reports.

Auction-Rate Collapse Costs Taxpayers $1.65 Billion [Bloomberg]

Why did the market for auction-rate securities collapse so violently earlier this year? Shortly after the auctions seized up we published a “primer” on what had happened, explaining that changes in the way corporations account for the securities. With corporate demand gone, banks found themselves having to soak up more and more inventory. The capital commitment required to do this grew at the same time the banks faced challenges from other parts of the credit markets, and eventually the banks decided to let the auctions fail.

This view is echoed in a new article in Compliance Week, a weekly newsletter on corporate compliance and risk management. Most of the article is devoted to a discussion about how financial officers should value auction-rate securities. (Short answer: It’s complicated!) But there is also a good discussion why the auctions failed. And by “good” we mean: “totally agrees with us.”

Espen Robak, president of Pluris Valuation Advisers, says the jitters over credit markets aren’t entirely to blame for the ARS freeze. Guidance from the Securities and Exchange Commission and from Big 4 audit firms told investors they couldn’t view ARS as equivalent to cash, so they became less popular as a cash management vehicle for corporate treasuries, he says. That contributed to the sell-off and dwindling number of buyers.

Robak says companies went on a selling spree in the latter half of 2007, shedding some $70 billion in ARS: “That’s an awful lot of paper to change hands in such a short period of time.”

Cos. Face Auction Rate Insecurities [Compliance Week]

A key question in the liability of brokerages in the failure of the auctions for auction rate securities is what customers were told about the risks of the products they bought. The brokerages now claim they properly warned customers about the products, and that they never considered them cash or cash equivalent. Most individual brokers we’ve spoken to off the record say that this is very inaccurate, and every retail customer we’ve spoken to (including some who are friends and family of DealBreaker editors) say they bought these securities with the understanding that they were “highly liquid” or “cash equivalents.”

So what did the brokerages tell retail customers? There were lots of disclosure documents that say a variety of confusing things but almost none of them reveal the risk of systemic and perhaps permanent auction failures for the auction rate preferred securities that pay low interest rates even after auction failure. And, as the screen shot of a ARPS customer online account above reveals, the brokerages did, in fact, take actions that encouraged customers to regard the ARPS as cash. This account comes from a Merrill Lynch customer account. (Click on image for a bigger version.)

Auction rate securities, including the auction rate preferred securities that remain frozen and often pay low interest rates capped at low levels, were sold to retail customers (including some investors close to DealBreaker staffers) by retail brokers. A key question in the lawsuits that have been filed against Merrill Lynch and Morgan Stanley, among others, is what the retail brokers told customers about the the securities they sold.

At least at one firm, we know that asset managers were told that they were to regard the securities as “cash equivalents” because the auctions had not failed for decades. Indeed, it seems that some brokers were given a “script” that urged the so sell these as “cash equivalent” or akin to “money market funds” or “highly liquid” securities.

We know this because brokers and others in wealth management groups have told us. But we’d like to see training materials that spell this out. It will be an important indicator about whether the firms themselves were selling the auction rate securities based on misleading marketing or whether, as some firms are already whispering, it was just a few overeager rogue brokers who oversold the auction rate securities. If the retail brokers were provided with misleading sales materials, they should not be blamed.

Merrill Lynch, for instance, seems to admit the auction rate securities were sold as equivalent to money market type securities in some of its documents. “Auction rate securities have generally been issued as either bonds or preferred stock and are designed to serve as ‘money market-type instruments,’” Merrill says in a document describing auction rate securities on its website.

Send any information or sales materials you have to tips@dealbreaker.com. Your anonymity will be protected.

A class action lawsuit was filed in federal court yesterday against Merrill Lynch, hours after we reported that Merrill had been threatened with suits by brokerage customers whose assets were frozen in auction rate securities. Merrill is the latest entrant in a club that includes Morgan Stanley, Deutsche Bank and UBS, all of whom have been separately sued over alleged deceptive marketing of auction-rate securities.

Merrill also faces a separate arbitration claim from ASTAR Air Cargo, which seeks compensatory damages of $9.125 million and punitive damages of at least $27.375 million. ASTAR, an air carrier based in Wilmington,Ohio, filed the claim with the Financial Industry Regulatory Authority to gain access to ASTAR’s funds that currently are frozen in illiquid auction rate securities in the company’s Merrill Lynch account.

According to ASTAR, the air carrier instructed Merrill Lynch to place its cash reserves in products that would provide complete safety of principal and complete liquidity. In response, Merrill Lynch reportedly recommended the company purchase various ARS.

Update: Here’s a copy of the complaint against Merrill.

Merrill, Morgan Stanley sued over auction rates [Reuters]
ASTAR alleges Merrill Lynch fraud [Willmington New Journal]

More auction rate securities lawsuits are hitting the courts. A lawsuit was filed today in federal court in Manhattan alleging that Morgan Stanley “deceptively marketed” auction-rate securities as cash alternatives, Market Watch is reporting.

“Instead of disclosing the true nature of ARS and the substantial liquidity risks associated with them, Morgan Stanley continued to push as many ARS as possible onto its customers in order to unload the inventory off its already troubled balance sheet,” the lawsuit said.

The complaint seeks to compel Morgan Stanley to refund investor money by having it rescind millions of dollars of ARS transactions. It also seeks compensatory and punitive damages. The lawsuit is being brought as a class-action suit on behalf of thousands of investors who acquired auction-rate securities from Morgan Stanley between March 25, 2003, and Feb. 13, 2008,.

Similar suits have been filed against Deutsche Bank and UBS. Merrill Lynch has also been threatened with lawsuits by investors, although none have been filed. Goldman Sachs has been rumored to have been quietly bailing out some customers, including high ranking Goldman executives, whose assets were frozen when the auction failes.

Morgan Stanley sued over auction-rate securities marketing [Market Watch]

More than a month after the trouble started, much of the auction rate securities market remains frozen, leaving hundreds of millions of investor dollars locked-up in illiquid securities. No-one has come forward with a solution, and there is little hope that the market will unfreeze anytime soon. Brokers have offered to loan money to clients with frozen money but this has provoked outrage from customers who are being asked to pay a premium by the same brokerages that led them to invest in the frozen securities in the first place. And most brokerages are refusing to do what many customers demand: buy-out the customer positions.

Joe Mysak at Bloomberg reports that the problem stretches much deeper into the investor world than many suspected.

I’m still getting e-mail on this situation. Closed-end- fund, preferred-share holders, at least the ones I’ve heard from, are livid at the fund companies and feel betrayed by their brokers. I find it very odd that the fund companies and the brokerage houses feel that they can alienate this crowd.

Who buys auction-rate securities? It’s not just “the rich.” I’ve heard from self-employed people who thought it was a good, temporary place for their life savings, at least until they decided what else to invest in. I’ve heard from people who sold businesses and put the money there, and from people who inherited some money and did the same.

The amount of money ranges from $50,000 to several million dollars. In each case, the investors say they were advised by their brokers that their money was in a cash equivalent. The investors rarely looked at prospectuses.

He also notes that if the market for these securities ever does come back, we can expect a lot more regulation.

Auction-Market Investors Look to Regulator for Hope [Bloomberg]

Fred Wilson tells the story of how he got out of the auction rate securities he bought almost a year ago: he was fortunate to hold securities with high penalty rates.

“When risk is appropriately priced, there is a market for something. And in the case of auction rates, the risk is illiquidity and so you must focus on the penalty rates,” he writes.

We still haven’t been able to get a satisfactory explanation as to us why some auction rate securities were issued with very low penalty rates. Doesn’t this undermine the market clearing function that was supposed to guarantee their liquidity? The brokers we asked about this gave a clear and unsatisfying answer: since the auctions hadn’t failed for decades, people just stopped paying attention to the penalty rates.

Our Run-In With Auction Rate Securities - And What It Taught Me About Markets [Seeking Alpha]

It looks like the Wall Street Journal’s James Stewart got caught up in the auction-rated securities trap. And he is not happy about it.

Last year, when some money-market funds turned out to hold some mortgage-backed securities and faced a liquidity crisis, their sponsors stepped in and redeemed the shares at face value. This seemed the only decent course, not to mention a good investment in customer loyalty.

But when I asked a broker at Merrill Lynch if it would do the same for owners of these money-market equivalents, the answer was “no” — not after the multibillion-dollar write-offs Merrill has taken on illiquid assets. Merrill Lynch and the other big banks that sold these shares have stopped making a market in them, which is a major reason the auctions have failed.

Merrill Lynch, when asked for comment, told me: “We are offering our clients loans which can give them liquidity.” It wasn’t yet clear whether these would be interest-free loans, which they certainly should be, in my opinion.

He ends the column by calling for the SEC to investigate. “At least two states are investigating, and I would expect them to be joined by the Securities and Exchange Commission,” he writes. Since we know SEC enforcement lawyers get their tips from newspapers, you can bet someone has opened a file on this. And with Merrill Lynch playing a central role in Stewart’s story, they are probably on the top of the SEC’s list.

Risks of a ‘Safe’ Investment Are Found Out the Hard Way [Wall Street Journal]

When Wall Street withdrew its support for auction-rate securities, many investors discovered their cash is trapped. Their brokers told them their investments in instruments that were marketed as cash-equivalents were suddenly illiquid. Issuers who depended on the securities for financing are being told by their banks that they must refinance, and of course hand over deal fees to the very institutions that allowed the markets to collapse. And now many want to know why the auctions were in such dire condition that the banks decided the cost of supporting them was not longer acceptable.

“How long did they know the auctions were on life support?” one investor with nearly half-a-million dollars in now illiquid auction-rate securities asked DealBreaker.