Fidelity eyed as N.Y. probe into auction-rate debt widens

Fidelity neither issues nor sponsors auction-rate securities. (JB Reed/Bloomberg News/File 2007)

As part of a broadening probe into the auction-rate securities market, Fidelity Investments is being investigated by New York Attorney General Andrew Cuomo's office.

News of the investigation of the Boston mutual fund giant came as Cuomo stepped up pressure on Merrill Lynch & Co. and Goldman Sachs Group to settle claims they misled investors about auction-rate securities and as Wachovia Corp. agreed to buy back $9 billion of the bonds. The office is also investigating discount brokerage Charles Schwab Corp.

Fidelity spokesman Vincent Loporchio said the company generally doesn't comment on regulatory matters. But Fidelity neither issues nor sponsors auction-rate securities, Loporchio said, which would put it in a different situation than companies that have so far struck settlements with regulators over the instruments.

Auction-rate securities are a form of debt that nonprofits and municipalities used to fund their operations because it was inexpensive. For years, rates on the bonds were reset at weekly or monthly auctions, which drew investors looking for returns slightly better than money market funds. Brokerages pitched the investments as safe as cash, but auction markets shut down in February amid broader tur moil in the credit markets that spooked investors.

"The larger the firm, the larger the portfolio, the more intense our effort," Cuomo said of the Merrill and Goldman probes. "We have an ongoing investigation with Goldman Sachs. In the course of investigations, we're also having discussions."

Merrill faces an "imminent" lawsuit from New York because the firm's offer last week to buy back $10 billion of the debt was inadequate, Cuomo said yesterday. New York has subpoenaed about 25 firms involved in sales of auction-rate securities, including five that have already settled. Merrill has five days to explain why the attorney shouldn't act, according to a letter from Cuomo's office.

"We were surprised that New York sent us a letter threatening legal action on auction-rate securities," Mark Herr, a Merrill spokesman, said. "We have been discussing this issue with New York and other regulators since we announced last week our plan to purchase our retail clients' ARS and we thought we were making progress. We anticipated further talks."

Goldman spokeswoman Andrea Raphael said the New York-based investment bank was "cooperating fully with all regulators" and "working with clients to address their liquidity needs."

Other securities firms have already settled with state and federal regulators.

In an agreement with officials, including Cuomo and Massachusetts Secretary of State William F. Galvin, last week Swiss bank UBS AG said it would pay $150 million in fines and buy back nearly $19 billion of the investments. A day before that settlement, Citigroup Inc. said it would buy back $7 billion in securities from individuals, nonprofits, and small businesses and work with institutional clients that want to exit another $12 billion of the investments. And on Thursday, Morgan Stanley and JPMorgan Chase & Co. said they would buy back more than $7 billion of the debt and pay a combined $60 million in fines.

Separately, in New Hampshire, UBS faces its first lawsuit brought on behalf of a bond issuer it advised: The state's Bureau of Securities Regulation claims the bank violated its fiduciary duty to the New Hampshire student-loan agency by encouraging it to continue to issue debt when UBS knew the auction market was near collapse.

Securities firms have little defense against regulators because of incriminating documents and the risk to their reputations, said William Shepherd, a Houston attorney whose firm has met with more than 500 investors.

"The regulators had these firms dead to rights," said Shepherd, who worked as a bond market salesman in Texas for 20 years. "All the firms will be shamed or forced to do something, even Goldman, which seems to be saying that all of their clients are rich and sophisticated."

Wachovia, the fourth-largest US bank, will pay a $50 million fine to settle claims by the Securities and Exchange Commission and states led by Missouri that it misled investors.