Merrill Lynch charged with auction rate securities fraud in Massachusetts

02 August 2008

Authorities from the American state of Massachusetts sued Merrill Lynch & Co on Thursday, charging the Wall Street firm with fraud over its dealings in the troubled auction-rate securities market.

Auction-rate securities are preferred shares or debt instruments with rates that reset regularly, usually every week, in auctions overseen by the brokerage firms that originally sold them. But the $300-billion market for these instruments collapsed in February, trapping investors who had been told that they were safe and the instruments were easy to liquidate.

February's meltdown began in July 2007, when MBIA Inc. and Ambac Financial Group Inc., the two largest insurers of auction- rate debt, reported lower profits because of losses on securities backed by sub-prime mortgages. Losses at the insurers prompted auctions for $1.8 billion of their own securities to fail, according to Fitch Ratings.

The complaint, filed by Secretary of State William F Galvin's office, cites e-mails from Merrill Lynch management urging research staff to write positive reviews of the securities - which brokers at many firms were selling as safe alternatives to money market funds, right up until the collapse of the market.

''Research analysts routinely soft-pedaled significant negative events affecting liquidity in the auction markets,'' he said in the complaint. At the same time, managers knew ''the auction markets were not functioning properly and were in fact in significant danger of collapsing,'' he said.

Merrill is the second Wall Street firm Galvin has targeted in his auction-rate probe. In June he filed fraud charges against UBS Financial Services Inc., alleging the brokerage misled customers about the auction-rate market. The Swiss investment bank also faces charges in New York and Texas. (See: New York attorney general charges UBS with securities fraud)