In 2010, regulators recovered $3.4 billion in restitution for Connecticut investors, most of it in the second half of the year as banks agreed to settlements over their role in the collapsed auction-rate securities market.
The Connecticut Department of Banking reached settlements with more than 60 investment companies in 2010, involving both small firms and giants like Goldman Sachs, Merrill Lynch and UBS.
The largest of those settlements involved multi-state agreements over investment banks”™ marketing of auction-rate securities (ARS), debt instruments that feature interest rates that are reset via recurring “Dutch auctions.”
As the mortgage crisis became apparent in 2007 and 2008, the market for ARS auctions froze, despite investment banks”™ assurances that the investments carried liquidity akin to cash. Regulators subsequently stepped in to force banks to repurchase the securities at face value, resulting in a loss for the banks that placed them.
The Connecticut Department of Banking and other agencies say the resulting market “dislocation” should have been evident to banks, which resorted to “covering” bids in the absence of those spurred by the free market to sustain the impression that the marketing was function as normal.
Banks ended that pretense in February 2008 leaving investors on the hook with notes they could not redeem, seven months before the domino-effect collapse on Wall Street sparked by the bankruptcy filing of Lehman Brothers Holdings.
According to the New York Times, Goldman Sachs & Co. introduced the first auction-rate security in 1988. Fast forward to 2010, when the Connecticut Department of Banking capped a vigorous year of recovering ARS investment dollars with a $1 million fine against Goldman Sachs over the company”™s marketing of ARS instruments, part of a total $22.5 million in fines across multiple state jurisdictions. The state did not immediately specify how much Goldman Sachs might return to investors, but noted the company had agreed to arbitration for any investor seeking to recoup money.
The Connecticut Department of Banking has pegged dollar amounts to other bank agreements, however. On the eve of its conversion to new parent company Wells Fargo, Wachovia agreed to pony up $219 million. UBS, which is one of Fairfield County”™s largest employers via its large wealth management and investment banking operation centered in Stamford, agreed to return $575 million to Connecticut investors. In February, UBS agreed to pay $1.5 billion to holders of ARS instruments in New Jersey, where it similarly maintains a large employment center.
Merrill Lynch, which was acquired in 2009 by Bank of America Corp., paid the largest fine of any bank in Connecticut, agreeing to a $3.3 million penalty of some $125 million in total fines nationally. In February a federal judge dismissed a lawsuit against Merrill Lynch over auction-rate securities.
If fines levied in the ARS market collapse paled to the billions of dollars recovered for investors ”“ the Connecticut Department of Banking collected $12.5 million in monetary sanctions last year, nearly triple the level of 2009 ”“ state regulators noted that investment banks cooperated with their investigations, and said the problem was one sparked by inadequate oversight of their marketing arms.
