Mass. regulators accuse Merrill Lynch of fraud
BOSTON—Massachusetts security regulators accused Merrill Lynch of fraud Thursday for allegedly promoting the sale of auction-rate securities when they knew the investments were becoming increasingly unstable.
The administrative complaint filed by Secretary of State William Galvin claims Merrill Lynch, Pierce, Fenner & Smith -- the main subsidiary of
Auction-rate securities have their interest rates set at periodic auctions, depending on the submitted bids. The investments were once considered safe, but the market collapsed in February amid turmoil in the credit markets.
The market's failure left many investors with their cash frozen as buyers dried up.
New York-based Merrill Lynch denied it defrauded investors.
"We are disappointed that Massachusetts filed this action because it ignores the only reason our advisers sold auction rate securities: they believed they were good investments for clients willing to trade some liquidity for higher return," the company said in its statement.
"The inarguable fact is the number of auctions that had failed in nearly two decades of (auction-rate securities) sales was small. In 2007 there were no failed auctions of securities sold to retail clients and, in fact, none to these clients until late January 2008."
But Galvin claims in the civil complaint that Merrill Lynch knew several months earlier "that auction markets were not functioning properly and were, in fact, in significant danger of collapsing." He said the company continued to aggressively promote the securities as safe.
The complaint cites a personal e-mail written by one Merrill Lynch executive on Nov. 19. "Market is collapsing. No more $2k dinners at CRU," said the e-mail, referencing a Manhattan restaurant.
The complaint also alleges that Merrill Lynch "co-opted" its research department by allowing its sales and trading managers to push for written research to be published "endorsing the safety and high quality" of auction-rate securities.
Merrill Lynch also denied that allegation.
"Our research reflected the honest belief that ARS offered higher returns in exchange for less liquidity and noted that market changes had begun to occur," the company said.
Galvin said the complaint seeks an order for Merrill Lynch to make restitution to investors and pay an administrative fine.
"Our principal concern is to make people whole, particularly individuals and small businesses who have been completely upended by this," Galvin said.
"We want Merrill Lynch to undo the damage they did by selling these things knowingly to people, telling them they had liquidity ... then leaving them stranded when they knew these auction markets were in trouble."
The complaint will be heard by a hearings officer within the Securities Division of Galvin's office. Merrill Lynch can appeal any finding in court.
It is the second action brought by the Securities Division since the market collapsed. Last month, a similar complaint was brought against UBS Financial Services.
