This article first appeared in the St. Louis Beacon: August 12, 2008 - Controversial securities marketed by Wachovia Corp.'s St. Louis-based brokerage unit could cost the banking giant $500 million in legal settlements.
The company has set aside $500 million, before taxes, in reserves to cover "active settlement negotiations" with state regulators and the Securities and Exchange Commission over its selling of auction-rate securities, Wachovia said in a document filed with the SEC Monday just as the markets were closing.
One state is Missouri, which announced on Monday its settlement talks with Wachovia. Missouri began investigating Wachovia's practices in April, and it is the lead state in examining Wachovia auction-rate marketing.
Missouri Secretary of State Robin Carnahan said Monday that Wachovia's customers hold approximately $9.5 billion in auction-rate securities.
The $500-million settlement price tag "includes amounts reserved for estimated market valuation losses on auction rate securities associated with a potential settlement," Wachovia told the SEC. "We do not currently expect that the possible settlement would have a material effect" on future financial results or capital.
Auction-rate securities are municipal bonds, corporate bonds or preferred stocks whose interest rates are periodically reset -- from seven days to 35 days -- through an auction. Sellers market these products as having better yields than Treasury securities and money-market funds while enabling investors quick access to their funds.
However, the success of these securities depends on finding enough buyers at the auctions. As the economy has deteriorated, there have been more sellers than buyers. If the sellers find no takers, the auction fails and they must hold their securities. They also tell customers they can't gain immediate access to their money. Last month, Carnahan said consumers had issued formal complaints saying they were denied access to more than $40 million in auction-rate securities.
Wachovia also told the SEC Monday that establishing the auction-rate securities led to restating second-quarter financial results, which had been released July 22. The company lost $9.11 billion, or $4.31 a share, rather than the previously reported $8.9 billion, or $4.20 a share.
Wachovia also said it would fire 600 more people than the 6,350 it originally cited for dismissal when it issued its second-quarter results. Wachovia also won't fill 4,400 open positions.
The firings and job freeze are linked primarily to Wachovia mortgage-lending business and won't affect the brokerage business, Wachovia Securities, which acquired A.G. Edwards in October.
Wachovia Securities is now the nation's second largest brokerage, behind Merrill Lynch. Wachovia says it will take until the third quarter of 2009 to integrate A.G. Edwards fully into Wachovia Securities.
Problems with auction-rate securities have rippled through the investment-banking industry. On Aug. 7, Andrew Cuomo, the attorney general of New York, announced an agreement with Citigroup calling for the banking giant to buy back about $7 billion in auction-rate securities from individual investors, charities and small to mid-sized businesses.
Cuomo said these customers, estimated at 40,000, had been denied access to their money since mid-February. Citigroup also will pay a $50 million civil fine to the state and another $50 million fine to the North American Securities Administrators Association.
The next day, the Swiss banking giant UBS announced a settlement with state regulators and the SEC to buy back $8.3 billion in auction-rate securities from individual investors, charities and small- to mid-sized businesses. These customers had been denied access to their funds since mid-February. The buybacks will start in October for clients with household assets under $1 million and in January for other clients. Starting in June 2010, UBS will offer to buy back $10.3 billion in auction-rate securities from institutional clients.
UBS said the cost of the fines and buybacks will result in a pre-tax charge of $900 million recorded during the second quarter. It agreed to pay a $75 million civil fine to New York and a $75 million fine to the North American Securities Administrators Association.
And on Monday, Cuomo said he had written Wachovia, Morgan Stanley and JP Morgan Chase asking to "enter into immediate talks about resolving the investigation."
Auction rate securities "were marketed as safe, liquid, and cash equivalent securities," said Cuomo's letter to Wachovia. "These representations were false....Across the industry, customers who bought auction rate securities based on representations that they were cash equivalents have been unable to cash or sell the securities."
Also on Monday, Morgan Stanley said it would buy back $4.5 billion in auction-rate securities held by individuals, charities and small to medium sized businesses with accounts of $10 million or less. Last week, Merrill Lynch said it would buy back auction-rate securities held by some 30,000 retail clients holding $10 billion to $12 billion in these investments.
In late morning trading Tuesday, Wachovia stock was off 7.4 percent to $16.87. Stocks of many large banks and investment banks -- including JP Morgan Chase, Morgan Stanley, Bank of America and Citigroup -- also were down.
Robert W. Steyer, a freelance journalist in New York, was a business reporter for the St. Louis Post-Dispatch.