Wachovia agrees to auction-rate securities buyback

The St. Louis-based investment company has agreed to redeem auction-rate securities purchased before Feb. 13 for customers who are stuck with inaccessible assets due to the freeze in the auction market brought on by economic pressures.

Auction-rate securities are long-term bonds that investors can purchase as an alternative to stocks, which have no guaranteed rate of return.

While investors’ money is tied up for a period of many years when purchasing an auction-rate security, investors are usually able to access their money fairly quickly because the bonds could be put up for auction frequently – as often as every seven days.

If investors needed access to their money, they could put their bonds up for auction and, once sold, recover the money and keep whatever dividend or interest had been paid out on the investment up to that point.

The problem for investors came when the economy weakened and interest rates began to rise, making other types of investments more attractive than the auction-rate securities. Institutions stopped buying the bonds at auction, leaving the bondholders stuck.

“The problem arises when there’s no liquidity – you can’t determine what the market value (of the securities) is because there’s no market,” said Jeff Jones, finance professor at Drury University’s Breech School of Business. “That’s when bad things happen.”

The settlement

Some investors have argued that when the market changed, big institutions tipped off their largest investors.

“The big institutional banks like Wachovia started explaining in the fall of 2007 to their big institutional investors that, ‘Hey, we’re not sure these auctions will be successful, and you probably ought to decrease your exposure,’” said Chip Sheppard, an attorney with Carnahan, Evans, Cantwell & Brown PC and member of the Public Investors Arbitration Bar Association. Sheppard said the banks shifted the focus of their auction-rate security sales to smaller institutions such as municipalities and school districts. Sheppard said he’s been approached by several clients who claim institutions marketed auction-rate securities as being as liquid as cash, allowing quick and easy access to funds.

Allegations similar to those led to the formation of a national investigative task force, headed by the Missouri secretary of state.

That task force negotiated a settlement with Wachovia, whereby the company agrees to repurchase at face value auction-rate securities purchased through Wachovia on or before Feb. 13. Individuals, charities, religious organizations and small businesses can sell their securities beginning Nov. 10, while larger institutions can sell theirs beginning June 10, 2009.

Wachovia also will pay a $50 million fine to be split among the 12 states involved in the investigation.

“I have received hundreds of calls from Missourians and investors around the nation who need their money to make medical payments, run their businesses or retire as planned,” Carnahan said in the Aug. 15 settlement announcement. “I am pleased that six months of uncertainty and worry is over and that these investors will soon get their money back.”

Wachovia, in its own Aug. 15 news release, neither confirmed nor denied allegations of wrongdoing, but did say the company is pleased to have reached a settlement.

“Since this issue arose in February when auctions first started to fail, we have played a leading role in encouraging ARS issuers to restore liquidity to all of our clients,” Wachovia Securities President and CEO Daniel J. Ludeman said in the release.

Wachovia estimates that the outstanding bonds eligible for repurchase are worth about $8.5 billion.

A Wachovia spokesman declined further comment.

The impact

Despite the agreement, the legal wrangling may not be over; attorney Sheppard said he has several clients considering litigation.

“The giant investment houses … all decided not to go to the auctions,” Sheppard said, noting that similar agreements have also been reached with investment houses UBS and Merrill Lynch. “The circumstantial evidence is overwhelming that once they got their biggest clients out, they just quit supporting (the auctions) and let their smaller clients take a hit.”

Sheppard added that any action taken by investors would most likely be settled through arbitration with the Financial Industry Regulatory Authority.

Wachovia reiterated its desire to make sure all auction-rate securities buyers are taken care of, noting that more than half of Wachovia’s auction-rate securities notes have since been sold.

“We understand that unprecedented market conditions have created difficulties for our clients, particularly those holding auction-rate securities,” Robert K. Steel, president and CEO of Wachovia Corp., said in the release. “We are pleased to announce a comprehensive solution for the liquidity needs of clients who purchased auction-rate securities at Wachovia.”

The Details

Under the terms of the agreement between St. Louis-based Wachovia Securities and numerous secretaries of state, Wachovia agrees to several stipulations. Among them, the company will:

• offer to purchase at par auction-rate securities held by all individuals, charities and religious organizations, as well as those held by small and medium-size businesses with account values and household values of $10 million or less, that were purchased at Wachovia on or before Feb. 13. These purchases will commence no later than Nov. 10 and conclude no later than Nov. 28, 2008, for clients who accept this offer;

• offer to purchase at par auction-rate securities held by all other clients that were purchased at Wachovia on or before Feb. 13. These purchases will commence no later than June 10, 2009, for clients who accept this offer and conclude no later than June 30, 2009;

• reimburse investors who can reasonably be identified and who would have been covered by the offer but who sold their auction-rate securities below par, between Feb. 13 and the date of entry of the settlement, for the difference between par and the price at which the investor sold the auction-rate securities;

• offer loans to affected clients in need of liquidity until the auction-rate securities repurchases occur; and

• pay a total fine of $50 million to the state regulatory agencies, which will be distributed by the North American Securities Administrators Association.

Sources: Missouri Secretary of State and Wachovia Securities