JPMorgan Chase & Co. and Morgan Stanley yesterday became the latest firms to reach auction-rate securities settlements with New York State Attorney General Andrew Cuomo and other states, agreeing yesterday to buy back at par a total of $7.5 billion of the illiquid securities from retail investors and pay fines of $60 million.
The "agreements in principle" mean the four largest ARS underwriters have now reached tentative settlements over allegations that they misled investors while marketing the ARS as liquid, cash-like investments without disclosing the risks. The four firms have agreed to buy back or provide liquidity for a total of $36.4 billion of ARS and to pay $310 million in fines to New York and other states involved in the investigations. Citigroup Global Markets and UBS AG reached ARS agreements in principle with state and federal regulators last week.
Cuomo said in a press conference yesterday that "the nightmare will end" for investors who have been unable able to redeem their ARS since February, and that they "will be made whole" under these two latest settlement agreements.
JPMorgan and Morgan Stanley are the third- and fourth-largest ARS underwriters, according to Thomson Financial, who will buy back ARS from retail investors who purchased them before mid-February. Retails investors includes individuals, charities, and small businesses with accounts of $10 million or less in assets. JPMorgan agreed to buy back $3 billion by Nov. 12, which includes any ARS that was sold by Bear, Stearns prior to Feb. 12, and Morgan Stanley will buy back $4.5 billion by Jan. 11.
The other terms in the settlement agreements followed the blueprint established by the Citi and UBS agreements. Both JPMorgan and Morgan Stanley will consent to an arbitration process, conducted by the Financial Industry Regulatory Authority, that will allow investors to claim consequential damages as a result of frozen ARS. Both firms agreed to use their "best efforts" to provide "liquidity solutions" for their institutional investors holding ARS by the end of 2009. Those would be investors holding $10 million or more in assets with the firms.
JPMorgan will pay a fine of $25 million to New York and the North American Securities Administrators Association, while Morgan Stanley will pay $35 million. The fines will be divided on a pro rata basis according to the size of ARS holdings in each state, according to Cuomo.
The fines for JPMorgan and Morgan Stanley are much smaller than the $100 million and $150 million that Citi and UBS are to pay, respectively, under their settlements. Cuomo said the fine amounts were determined by the size of the banks' ARS portfolios and the number of complaints his office received from investors.
A spokesperson for Morgan Stanley said yesterday that the firm is "pleased" with the settlement. The firm announced a voluntary $4.5 billion buy-back offer on Monday, which did not include any fines, but it was rejected by Cuomo's office at that time, possibly because it did not include a fine.
Illinois, the lead state investigating Morgan Stanley in the NASAA coalition, will receive a significant amount of the $35 million fine, but regulators have not yet worked out a dollar amount, said James Nix, senior attorney in the securities division of Illinois Secretary of State Jesse White's office. Nix said he expects Illinois' portion of the fine to be comparable with New York's amount and estimated that Illinois investors could hold "billions" of dollars in frozen ARS.
Florida led the state investigation of JPMorgan headed by Bill Reilley, chief of the state's Bureau of Securities Regulation.
Municipal issuers will be compensated by JPMorgan and Morgan Stanley for refinancing costs resulting from the failed ARS auctions. ARS debt issued between Aug. 1 2007, and the auctions' failure date that was subsequently refinanced by issuers to relieve high interest payments, is to be refunded by the firms. Each firm is obligated to provide notice to the municipal issuers of refund options.
Municipal issuers were required to pay higher interest rates, as much as 20%, to ARS holders if the auctions failed. When underwriting firms stopped buying ARS to sustain the auctions in February, issuers rushed to refinance their ARS debt and avoid the high interest rates.
White was "insistent on taxpayers not funding the refinancing of auction-rates," Nix said.
Other firms are still under investigation by Cuomo and the NASAA coalition states. Illinois continues its investigation of Goldman Sachs Group, Wachovia NA and Missouri regulators from Secretary of State Robin Carnahan's office have been trying to finalize a settlement agreement since Friday. Officials from both states said they could not comment on their investigations.
Florida's Reilley said the state received complaints from investors at other firms and is working to identify those firms.
Georgia's director of the securities division said Monday that his state also is pursuing a settlement with a firm, but he declined to identify that firm or comment further.
Cuomo's office continues to pursue a lawsuit filed against Merrill Lynch Cuomo yesterday acknowledged Merrill's voluntary offer last Thursday to buy back $10 billion worth of ARS, but said the offer is not "the solution we think is necessary."
Merrill allegedly altered a research note sent to investors claiming that the ARS market was safe and liquid, according to a lawsuit that William Galvin, secretary of the commonwealth of Massachusetts filed against the firm.
Internal e-mails from Merrill disclosed in the lawsuit suggested the report was altered by traders. Cuomo has said this kind of interference should never have occurred in the wake of a $1.4 billion settlement between 10 securities firms and then-Attorney General Eliot Spitzer in April 2003 that was intended to prohibit such practices.