Still sorting out the auction-rate mess

Galvin's office addresses conflicts

In reviewing securities records, Secretary of State William Galvin said his office found conflicts of interest.

Massachusetts Secretary of State William F. Galvin oversees the state Securities Division and has long been an ally of ordinary investors. He spoke recently with Globe reporter Beth Healy about Wall Street's latest scandal, involving auction-rate securities, and the division's investigation of a number of firms involved in that business. Firms have agreed to buy back more than $50 billion of these investments from customers following lawsuits brought by Galvin's office and other state and federal regulators.

Secretary, your office has been deeply involved in investigating brokerage firms that sold auction-rate securities. How did these problems first come to your attention?
We got calls in mid-February from individuals who had a history of investing successfully in these instruments. Mysteriously, in February, all these major [Wall Street] houses stopped supporting these auctions. They said they 'failed.' That meant people were stuck. It was kind of like a game of musical chairs and the music suddenly stopped. People started calling my office, and not just individuals, some were businesses. And very quickly we started hearing about government entities having the same problem. It was widespread across the industry.

What are auction-rate securities? They were investment notes or securities or bonds - financial commitments - that had a history of paying slightly better interest rates than money markets. At the same time, they had a high degree of liquidity because of a process of periodic rebidding. People, businesses, and government entities treated these things as cash-like. The problem was, to make this work successfully, as it had for a long time, required the support of these large financial houses that were the makers of these deals. They were the ones that supported the auctions, and made sure these instruments moved.

You've brought lawsuits against UBS Financial Services Inc. and Merrill Lynch & Co., both of which have settled. What have you found in your investigations?
We began looking for documentation - e-mails, correspondence. It became clear to us that there was an inherent conflict of interest for some of these houses. And they continued to sell these instruments when they knew there was trouble in the marketplace, and the market for these instruments had dried up. Some of them, as we showed in our complaint, were trying to unload their own inventory, in other words put the risk in the hands of their customers, instead of in their own hands.

Did this freeze of the auction-rate market only affect wealthy investors?
Many of the people who were in these investments weren't super-rich. They were people who were trying to get a slightly better interest rate. Sure, they were comfortable, they were people of means. But I think it would be a mistake to envision this as people who could afford to lose the money. Oftentimes, they were people who had ceased earning money. They were trying to make the most out of their money. Consider someone who sold their house at the height of the real estate market and sold for $1 million and were living off that money. It was important that we come to their rescue if we could.

You've settled with two firms and you've said you're still investigating Bank of America. What's next?
We're still trying to deal with some of the large financial houses. And some of the settlements require payouts over some months - it still means people are without access to their money since February - so there's going to be a monitoring process required. We're also looking at the secondary sellers, like Fidelity. (Fidelity Investments denies any wrongdoing in the sales of auction-rate securities but has said it is cooperating with regulators.) They did not make the market, but they did sell them. They weren't in the same position of control as the Wall Street firms. The challenge with the secondary market is, from a regulatory point of view, greater. Did they know? Did they have a fiduciary duty? Our goal is to help everybody who got caught up in this to get access to their money as soon as possible.

Is this investigation expanding nationally? The nagging concern is where the interests of the firms are at odds with the interests of their customers. That's a bigger problem. That's a national problem, and that's something Congress may want to look at. What troubles me is, why do we continue to see these problems? Special rules for special people, conflicts of interest. We saw it in the dot-com bubble, we saw it in market timing, we've seen it with mortgages. How do you police the market effectively for people? Why is this allowed to happen? We're seeing this now in the commodities market as well. There's oil, which has had the most devastating effect. And there's wheat, and people buying up cotton commodities. There's not adequate supervision. We're all committed to a free market economy. But a free market only works when it's truly free and it's not rigged. We do keep ending up in a rigged market, where somebody constantly has their thumb on the scale against the average investor, and that's had a devastating effect on our economy.

Your office has always been aggressive in protecting investors. How have you found the process of having to coordinate this time with other state and federal regulators? Is it a help or a hindrance?
It can be helpful. It also can be challenging. Every regulator doesn't look at a case the same way. There's been an improvement at the Securities and Exchange Commission in general, especially over the last two chairmen. That doesn't mean that I'm totally satisfied, nor that other people should be satisfied. There needs to be more aggressive action. But the SEC is much better than it was even three or five years ago, when we found them ignoring problems altogether. I'm proud to say in this current case, Massachusetts led the way. We brought the first complaint in this area. There's a variation of emphasis by state regulators. It is a problem from time to time - some states are more focused on fining than return of moneys. Some states don't work as quickly as others. There are egos and personalities to be dealt with. But we're the safety net for consumers.