UBS AG in $22.1 Billion ARS Settlement

WASHINGTON - UBS AG, the second-largest auction-rate securities dealer, agreed to purchase or provide liquidity for $22.1 billion of ARS and pay $150 million in fines, in a settlement with state and federal regulators.

The settlement was announced Friday as Massachusetts Commerce Secretary William Galvin told CNBC that he would pursue a lawsuit he filed against Merrill Lynch & Co. on July 31 because the firm's voluntary offer to buy back ARS at par next year does not go far enough. New York Attorney General Andrew Cuomo also said Friday that Merrill's buy-back program fails to contain certain investor projection safeguards. (Click here to read release)

UBS is the second broker-dealer to reach such a settlement, following Citigroup Global Markets Inc. Thursday. The two firms represent 40 percent of the auction-rate securities sold since Jan. 1, 2000, according to Thomson Financial. Together they have agreed to redeem or provide liquidity for $38.1 billion of ARS and pay fines totaling $250 million in settlements with the Securities and Exchange Commission, the Financial Industry Regulatory Authority, North American Securities Administration Association, New York, Massachusetts and other states.

The settlement agreements may serve as templates for as many as 10 other broker-dealers that are believed to be under investigation for selling auction-rate securities as if they were highly liquid cash investments without disclosing the risks.

Under its settlement agreement, UBS will purchase $8.3 billion of ARS at par from investors during a two-year period beginning Jan. 1, 2009. By Oct. 31, UBS will offer to liquidate at par all ARS from individual investors and charities who have less than $1 million in funds on deposit at UBS. By that same date, UBS will purchase $3.5 billion of tax-exempt auction preferred stock from all UBS investors, subject to regulatory approval.

UBS will provide liquidity for its institutional investors holding $10.3 billion of ARS, and said it will purchase any remaining unsold ARS at par beginning in June 2010. Until the firm provides for the liquidation of the ARS, it will offer customer no-cost loans.

Also under the agreement, UBS will reimburse for losses customers who sold ARS after Feb. 13. The firm will participate in special arbitration processes monitored by FINRA for customers who have incurred damages through their ARS holdings.

Similar to the Citi settlement, UBS agreed not to liquidate its own inventory of a particular ARS until it liquidates its customers' holdings in that security. The firm also faces a possible financial penalty from the SEC at a future date.

Also, as in the Citi settlement, UBS will reimburse any municipality that issued ARS after Aug. 1, 2007, for refinancing costs. David Markowitz, chief of the attorney general's investor protection bureau said that those reimbursements "would primarily be UBS fees."

As for the $150 million in fines, New York State will receive half and the other states with receive the rest. Cuomo told reporters that the decision for New York to get the lion's share of the penalty payment had been part of the negotiations of the settlement and was due to the work the state had done.

"We had commenced the lawsuit against UBS, we did a lot of work on this matter, and UBS had certain conduct that we believed was inappropriate and the penalty was assessed to reflect our concern that the inappropriate conduct be highlighted and penalized," he said.

In his interview with CNBC Friday, Galvin said the muli-state investigation into ARS sales practices is "approaching the seventh inning stretch."

Each state participating in the multi-state task force is taking the lead in examining complaints made against a specific broker-dealer or banking firms that underwrote and sold ARS. Florida officials have the lead for JPMorgan and Bear, Stearns & Co., Bill Reilly, chief of securities regulation in Florida's Office of Financial Regulation, said late last week. Reilly said state law prohibited him from commenting on the status of Florida's examination of JPMorgan and Bear Stearns, or whether a settlement with those firms is forthcoming.

"The whole idea is to determine the degree of compliance or non-compliance [with regulations] by the firms," said Reilly.

Massachusetts is continuing to investigate Bank of America, while officials in Missouri have said they are investigating Wachovia and Stifel Nicolaus & Co.

Illinois is investigating Goldman, Sachs & Co. and Morgan Stanley & Co. led by the state's securities division senior attorney, James Nix.

Regulators in Georgia, New Hampshire, New Jersey and Washington are also part of the task force but have not said which firms they are investigating. Cuomo opted out of the task force and is investigating multiple firms.

Galvin told CNBC that he is particularly concerned that Merrill trading and sales managers allegedly pressured researchers to change negative reports about the ARS market. Galvin said he did not expect to see such conduct in the wake of a muli-million dollar settlement that federal and state regulators reached with 10 firms, including Merrill, in April 2003 over research that was influenced by trading desks.

Market participants noted Friday that the settlements do not resolve the billions of illiquid auction-rates still held by many nonprofit student loan lenders. Of the roughly $80 billion of auction-rate debt backed by student loans, less than $3 billion has been restructured, sources said.

Peter Warren, executive vice president of the Education Finance Council here, said it remains prohibitively expensive for nonprofit student loan issuers to refinance out of ARS and into other issuance modes, such as variable rate demand obligations.

"Even if a dealer buys the outstanding auction-rate securities, on the surface that doesn't immediately change things for issuers," Warren said. "It doesn't change the rate they're paying."

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