Broker to return $37m to towns

Wall Street firm settles with AG

Email|Print|Single Page| Text size + By Beth Healy
Globe Staff / May 8, 2008

A major Wall Street firm agreed to return $37 million to 17 cities and towns in the state, as well as to the Massachusetts Turnpike Authority, after it allegedly misled them into buying investments they thought were as safe as cash.

UBS Financial Services Inc. reached an agreement with Attorney General Martha Coakley after she found that the brokerage had not fully disclosed the risks of the investments, known as auction-rate securities. Cities were unable to get their hands on their money when the market for these investments evaporated almost overnight.

Winchester, which had invested more than any other town, will receive $6.8 million in the settlement. The turnpike will receive $4.4 million, and the city of Holyoke and its retirement system will get $3.2 million.

"There have been a lot of new financial products," Coakley said. "There's been a heavy push by brokers to sell them, and a rush by cities and towns to take advantage of what appeared to be a burgeoning market."

The settlement was the first admission by UBS or any US brokerage that something may have been amiss in the sales of municipal debt securities. The market for these securities relied on weekly and monthly auctions run by brokerage firms. But starting in February the auctions attracted only sellers and no buyers, so the market failed.

UBS spokeswoman Karina Byrne characterized the settlement as a one-time event, based on a Massachusetts law that requires towns and cities to keep cash in only highly liquid accounts so they are readily accessible. She said the agreement followed the attorney general's finding that these securities were "not permissible" in municipal accounts.

"UBS is pleased this matter has been resolved," Byrne said. The firm is still under investigation by state and federal regulators for how it sold such investments to individuals and companies.

In Barnstable, which invested the second-largest amount in the state at $6.1 million, director of finance Mark Milne said the town first realized it had a problem in February, when it tried to sell the bonds.

"We had tried to liquidate some of the money from this investment and put it someplace else, and were told that we couldn't," Milne said in an interview. The town needed the funds to pay bills coming due, he said, and had to cash out other investments instead.

The bonds accounted for about 6 percent of Barnstable's cash account, Milne said. Not only was Barnstable treasurer Debra Blanchette told she could withdraw the funds at any time, Milne said, but, "she wasn't even told they were auction-rate securities."

Auction-rate securities were part of a wave of arcane debt products that investment firms sold heavily in the boom period before last summer's subprime mortgage meltdown. With interest rates low, firms offered these municipal bonds as a safe alternative to cash that paid a slightly better yield. Investors were supposed to be able to get out of these securities on a weekly or monthly basis.

But there was a catch many investors didn't foresee: The securities relied on constant investor demand at auctions. In February, spooked investors stopped participating in the auctions altogether, leaving sellers such as towns and public agencies unable to sell their securities.

The result was that investors in this $330 billion auction-rate market were stuck holding bonds they couldn't sell. They weren't losing money, per se, but they could not access their money. UBS is now buying back the bonds - something it and other brokers refused to do when the market collapsed.

The attorney general's action sprang from a case this year, in which Merrill Lynch & Co. agreed to repay the city of Springfield for $14 million in another type of debt that brokers were selling to municipalities, CDOs, or collateralized debt obligations. As with auction-rate bonds, CDOs were promoted as "cash-like" but investors were unable to get their money out when the market for mortgage-related debt froze.

Holyoke's mayor, Michael J. Sullivan, called news of the UBS settlement "manna from heaven." Under the agreement, UBS will buy back $3.2 million in auction-rate bonds from the Western Massachusetts city and its retirement system. Sullivan said the city had been advised by an investment consultant to buy the securities, a move he said he believed was an "honest error."

Holyoke had not been in any immediate financial risk, Sullivan said, but he added, "In the long term, we might have had some exposure to those investments evaporating."

UBS is hoping this matter is closed. This week, the firm said it's leaving the municipal finance business. But this may be just the beginning of the fallout from the collapse of auction-rate markets.

Secretary of State William F. Galvin is investigating whether UBS and other firms may have inappropriately sold these securities to individual investors and businesses. In March, Galvin, who oversees the state Securities Division, issued subpoenas to UBS, Merrill Lynch, and Bank of America Investment Services Inc.

Specifically, the division is examining whether investors were properly informed of the risks in these securities, and whether they were appropriate for the people who bought them. It's also looking into the role the investment banks may have played in causing the auctions to fail. UBS declined to comment on the investigation.

The Securities and Exchange Commission also is investigating the auction-rate markets.

Beth Healy can be reached at

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