Cuomo Opens ARS Probe

WASHINGTON - New York Attorney General Andrew Cuomo has subpoenaed Wall Street banks and broker-dealers for information about their auction-rate securities transactions and sales, sources said yesterday.

Cuomo, who is seeking information dating back as far back as 2003, wants to know the extent to which firms stepped in to prevent auctions from failing and whether they misled investors by marketing their ARS as cash-like investments, the sources said.

The list of firms that received subpoenas includes Merrill Lynch & Co., JPMorgan, UBS Securities LLC, and others, they said. However, spokesmen for these and other firms declined to comment. Spokespersons and lawyers from Cuomo's office did not return calls by press time.

Cuomo is at least the second state securities regulator to launch an investigation of these firms over auction rate securities.

Late last month Massachusetts Secretary of State William Galvin subpoenaed Merrill, UBS, and Bank of America Investment Services Inc. for information on ARS transactions and sales.

Galvin told reporters that his office had received calls from many investors who thought they were investing in safe, liquid investments only to find that they were stuck holding these securities.

In addition to the state investigations, the Securities and Exchange Commission's enforcement division and the Financial Industry Regulatory Authority are also probing whether broker-dealers misrepresented the liquidity risks of auction-rate securities when they sold them to investors.

The SEC is looking at other issues as well, such as whether broker-dealers favored certain customers by ensuring they would be able to sell their auction-rate securities, when others could not.

FINRA's inquiry is focused on sales practices and marketing, sources said.

Both agencies have sent banks and broker-dealers for questionnaires and other requests for information about the securities.

All of the probes stem from hundreds of complaints that state, federal, and FINRA officials have received from investors who have been unable to sell their ARS holdings.

Historically these securities, which typically were insured, were marketed as very liquid, cash-like investments that had higher yields than money market funds or certificates of deposits.

But when the insurers with exposure to the subprime mortgage market experienced rating downgrades because of the turmoil in that market, that lowered the value of the securities they insured.

Investors lost interest in ARS and the auctions held to periodically reset the rates began to fail when they did not attract enough buyers.

In the past, banks and broker-dealers put in bids of their own on these securities to prevent auctions from failing. But in June 2006, 15 firms agreed to pay $13 million to settle charges that they violated the securities laws by not disclosing these and other auction-rate securities practices. Some firms began disclosing their practice of putting in bids to prevent failed auctions. But the credit crunch led banks and dealers to tighten their lending standards and put a stop to this practice.

Issuers were especially hurt by the failed auctions because the rates had to be reset at pre-determined rates as high as 20% in some cases. But the higher rates may not be attractive to investors who need liquid investments.

Ted Phillips contributed to this story.

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