Success, and failure, in auction-rate fallout

Documents show Bank of America warned California of big problems, but let small investors fend for themselves

As the auction-rate securities market fell, individuals didn't get the kind of market intelligence Bank of America gave big clients. (Chris Hondros/ Getty Images/ File 2008)

Bank of America Corp.'s investment arm warned a large bond issuer - the State of California - of trouble in the auction-rate securities market late last year, according to documents reviewed by The Boston Globe, while the firm was still selling the investments to smaller investors without such warnings.

The nation's largest retail banking firm, in a presentation to California's treasurer on Dec. 17, wrote that there had been "significant dislocation" in the auction-rate market in the preceding three weeks, and went on to detail a drop in demand for the bonds. It also said there had been "significant year-end selling" of the investments, mainly by corporate clients.

Further, the bank said there was "significant uncertainty" about pricing for the bonds for the next year. The Globe obtained a copy of the presentation, and those of other investment banks, in a public records request.

Most individual customers were not provided with the kind of market intelligence Bank of America and other brokers were giving to large institutional clients like the State of California. Michael J. Martella, a Banc of America Investment Services Inc. client in Deland, Fla., said he was sold $200,000 in auction-rate securities late last year that he now cannot sell. "It's absolutely disgusting," he said yester day.

Bank of America, the eighth-largest issuer of auction-rate securities, is under investigation by the Massachusetts Securities Division and other state and federal regulators for its sales practices in that market. The Charlotte, N.C.-based bank, whose brokerage is based in Boston, this month disclosed that it has received subpoenas from a number of state and federal regulators.

In a statement responding to a Globe inquiry yesterday, the company said the California presentation was "part of a broad market update" that focused on the interest rate environment for tax-exempt financing. "The conversation did not reference or contemplate the kind of liquidity issues that the auction-rate securities market ultimately experienced a few months later."

But Bank of America's December presentation foreshadowed a market shutdown, saying it and other brokerage firms were "in a defensive position, facing capital constraints," due to the inventories of auction-rate bonds they were carrying.

Amid a national probe of brokerage firms that underwrote and sold auction-rate securities, Bank of America is one of a few that has yet to disclose a settlement with regulators. So far, five major institutions have agreed to buy back more than $40 billion in these investments and to pay $360 million in fines. UBS Financial Services Inc. has agreed to the largest buyback, at nearly $19 billion.

Auction-rate bonds were widely issued by nonprofits and municipalities to fund operations at low interest rates. They were popular with conservative investors because they were touted as safe and cash-like, and offered returns like money markets.

But demand for the securities dried up on Feb. 13, as investors were spooked by other troubles in the credit markets and investment firms decided to stop trading the securities. Thousands of people have had their money trapped since.

Before the market shut down, the State of California had about $1.4 billion in outstanding auction-rate securities it had issued, including water and power debt. The treasurer heeded the market warning of Bank of America and other investment advisers and refinanced all but $100 million of the auction-rate bonds by May 23, according to a spokesman.

"We have a duty to protect taxpayers. We moved, we believe, with aggressive prudence to fulfill that duty," said Tom Dresslar, a spokesman for California Treasurer Bill Lockyer.

The Globe previously reported that other major brokerage firms, including JP Morgan Securities Inc., Lehman Brothers, Morgan Stanley, Bear Stearns Cos., and Merrill Lynch & Co., all warned Massachusetts' state treasurer that the auction-rate market was in trouble before it collapsed. Massachusetts had difficulty refinancing its auction-rate bonds quickly because it had to seek approval from the Legislature.

Beth Healy can be reached at bhealy@globe.com.