Merrill Defrauded Auction-Rate Investors

Merrill Defrauded Auction-Rate Investors, State Says (Update2)

By David Scheer

July 31 (Bloomberg) -- Massachusetts Secretary of State William Galvin accused Merrill Lynch & Co. of fraud, claiming the investment bank sold auction-rate securities to investors while misleading them about the market's stability.

Merrill, based in New York, also ``co-opted'' its research department to help sell the securities, Galvin said in a statement today. The state's administrative claim asks the third-largest U.S. securities firm to ``make good'' on sales of now-frozen holdings, compensate investors who sold their bonds or shares at a loss and pay an unspecified fine.

``This company was aggressively selling'' the securities ``to investors and its auction desk was censoring the research analysts to make sure they downplayed'' market risks, Galvin said in the statement. ``They knew the auction markets were in trouble, but the investors were the last to know.''

Massachusetts filed a related complaint against UBS AG, Switzerland's biggest bank, in June after brokers abandoned their role as buyers of last resort for auction-rate securities, allowing the market to freeze. A related investigation of Bank of America Corp. is ``still going on,'' said Brian McNiff, Galvin's spokesman.

Auction-rate securities are long-term bonds or perpetual preferred shares with interest rates that reset typically every seven, 28 or 35 days, providing them with the characteristics of money-market instruments. Firms historically supported the markets, without contractual obligation, when demand dried up.

Market Collapse

Municipalities, student-loan agencies and closed-end mutual funds sold about $330 billion in auction-rate securities before the market collapsed in February. Investors and brokers fled as subprime mortgage-related losses mounted at bond insurance companies that had backed much of the debt.

Merrill decided to stop supporting bids with its own money five days after one of its analysts told financial advisers the bonds represented ``a good, conservative, reasonable investment,'' Galvin said.

``Our research reflected the honest belief that ARS offered higher returns in exchange for less liquidity and noted that market changes had begun to occur,'' said Mark Herr, a spokesman for Merrill, using the acronym for auction-rate securities.

The securities firm, whose market value trails Goldman Sachs Group Inc. and Morgan Stanley, made about $90 million in profit during 2006 and 2007 from its auction-rate program, Galvin said in the statement.

``Time after time, when confronted with conflicts of interest, Merrill Lynch was consistent in that it placed its own interests ahead of its investor clients,'' according to the complaint.

To contact the reporter on this story: David Scheer in New York at [email protected].
Last Updated: July 31, 2008 10:41 EDT

[link to www.bloomberg.com]