Sell Side

Missouri Officials Probe Wachovia in St. Louis

CHICAGO - Regulators from the Missouri secretary of state's office - joined by their colleagues from five other states - led a special inspection yesterday of Wachovia Corp.'s St. Louis-based securities division in an ongoing probe of its practices involving auction-rate securities following the $330 billion market's collapse.

About 10 inspectors from Missouri and other states that have formed a task force to probe auction-rate market practices participated in the inspection, during which regulators conducted interviews and reviewed various firm documents and records, according to Ryan Hobart, a spokesman for Secretary of State Robin Carnahan. Hobart said the inspection should not be considered a "raid" because the firm was notified a day earlier of the impending visit.

The St. Louis office has housed the headquarters of the North Carolina-based bank's Wachovia Securities LLC since the firm's acquisition last fall of the former St. Louis-based brokerage behemoth A.G. Edwards & Sons Inc.

"Hundreds of Missouri investors have called my office because of inability to access their money. They were told these investments were safe and easy to cash in, but now they cannot run their business, make medical payments, or pay school tuition," Carnahan said in a statement. "Our office is doing all we can to find solutions that will make these investors whole."

The office has received more than 70 complaints from investors holding about $40 million in frozen investments. The office could not immediately say how much of that figure represented securities issued by municipalities and other tax-exempt organizations.

Student loan providers, corporations, and closed-end mutual funds also make up large chunks of the auction-rate market. Missouri officials are also probing complaints involving Commerce Bank NA and Stifel, Nicolaus & Co., but declined to provide any more information on the status of those investigations.

Carnahan's securities division launched a full-scale probe in April serving subpoenas on more than a dozen Wachovia officials requesting documents, e-mails, transcripts, and other records but the bank did not fully cooperate, leading to the decision to conduct the inspection yesterday "as another way" to obtain information, Hobart said. Investigators sought information concerning Wachovia Securities' sales practices, and internal evaluations of the auction rate securities market, and marketing strategies.

Wachovia spokeswoman Christy Phillips-Brown declined to comment on the state's assertion that the firm had not fully cooperated with investigators, saying only: "Many securities firms including Wachovia are responding to inquiries from regulators about the auction-rate securities industry" and that the "discussions" yesterday with regulators were "part of this ongoing process."

Carnahan said yesterday she was pleased with the firm's cooperation in the inspection. "No enforcement action has been taken against the company at this point. We expect the information gathered today will expedite the resolution of this issue," she said.

The firm disclosed in regulatory filings in May that it had received inquiries from state and federal regulators stemming from its underwriting, sale, and auctions of municipal auction-rate securities and auction-rate preferred securities. The filing also reported that the firm had been named in a civil lawsuit filed in March in New York alleging it misrepresented auction-rate securities to investors. The firm intends to fight the lawsuit.

The Securities and Exchange Commission is probing complaints at the federal level. The state inspection comes as the firm is reportedly expected to report at least $2.6 billion of new losses when it announces its second-quarter earnings next week.

Amid the onslaught of complaints from individual investors, Missouri is one of at least nine states whose securities regulators joined together to form a task force in April to probe whether investment banks adequately disclosed the risks associated with ARS.

Massachusetts Secretary of the Commonwealth William Galvin last month filed securities fraud charges against UBS Securities LLC and UBS Financial Services for selling retail investors auction-rate paper as "liquid, safe, money-market" instruments even though the defendants allegedly knew it was not.

Late last year, as losses stemming from the subprime market collapse mounted and concerns grew over the downgrade of bond insurers who backed auction-rate securities, investors began to dump their holdings during the periodic auctions scheduled on the debt. Pressed for liquidity as they struggled with losses, the investment banks who served as auction agents began withholding their bids and auctions began to fail in February.

That left some investors unable to sell their holdings. It also drove up the interest rates paid by municipal issuers who had been sold on the auction-rate product as a means to issue long-term debt that capitalized on the lower interest rates on the short end of the yield curve without the need for liquidity as the securities do not have a put feature. Investors, including some governmental units, believed the securities were a liquid investment until the auctions began failing.

Galvin's complaint alleges that UBS did not disclose to their clients the extent to which the Swiss-based bank bid in auctions to prevent them from failing and that no true auctions in fact existed because they would have failed without support from dealers.

While Missouri is probing Wachovia, Commerce, and Stifel, Massachusetts is investigating UBS, Merrill Lynch & Co., and Bank of America Corp. The other states in the task force that has grown to 12 from nine since April includes California, Florida, Georgia, Illinois, Pennsylvania, New Hampshire, New Jersey, Texas, Washington, and Virginia, according to Bob Webster, a spokesman for the North American Securities Administrators Association.

Most have not disclosed what individual firms are under investigation. New York Attorney General Andrew Cuomo is conducting his own investigation of several firms. Regulators from Missouri, Illinois, Massachusetts, New Jersey, and Pennsylvania participated in the Thursday inspection of Wachovia.

Brian McNiff, a spokesman for Galvin, said he thinks Wachovia is the first broker-dealer that the state task force members have jointly visited in the ARS investigation.

"Missouri asked for some assistance because Wachovia and been delaying and offering some unreasonable excuses for not responding to subpoenas," he said.

The Missouri securities division is reviewing the UBS complaint, but declined to comment on its next step involving Wachovia. "Right now, the investigation is ongoing and we are still trying to gather information," Hobart said.

Detailed information on auction-rate securities marketed by Wachovia was not easily accessible, but the firm served as senior manager on $271 million of such debt in seven deals last year of linked-rate bonds, a category that includes ARS in Thomson Reuters rankings, $168 million in four deals in 2006, and $74 million in two issues in 2005.

Lynn Hume contributed to this story.


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