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Auction-Rate Securities Update: Discovery in Merrill/Maui Case is Explosive!!

Posted by Larry Doyle on August 2, 2011 8:17 AM |

Information is everything. The appropriate use of information can be particularly powerful if not explosive.

Whether in the canyons of Wall Street, the halls of Capitol Hill, or in the most distant regions of our great nation, the value and use of timely information is critical in determining the truth as to 1. what did people know 2. when did they know it, and 3. what did they do with it?

The legal process known as discovery is critical to elevating our Sense on Cents virtues of truth, transparency, and integrity. What is discovery?  As highlighted in the ‘Lectric Law Library,

Part of the pre-trial litigation process during which each party requests relevant information and documents from the other side in an attempt to “discover” pertinent facts. Generally discovery devices include depositions, interrogatories, requests for admissions, document production requests and requests for inspection.

How appropriate that this standard legal approach was so helpful in a case in a locale where people go on expositions and outings to unearth and ‘discover’ real gems and natural beauties.

Where might this be?

Pack lightly as our next outing in pursuit of real justice in the auction-rate securities nightmare takes us to the Hawaiian island of Maui. As recently reported in the Maui NewsBrokerage May Buy Back Dormant Securities,

WAILUKU – The Merrill Lynch brokerage is prepared to buy back $32 million in auction-rate securities that it foisted on Maui County in 2007 and 2008, financial instruments that became almost impossible to sell after the auction system collapsed.

The Maui County Council Policy Committee went into closed session Wednesday to get an update from its outside attorney, Joachim Cox, who had good news and bad news: A county lawsuit is on the verge of success, and the lawyer’s bill is approaching half a million dollars.

Discovery in a civil suit started in 2010 uncovered emails from Merrill Lynch brokers that demonstrated the investment firm knew the auction-rate system was headed for a crash, but continued to assure county finance officials that the paper was as good as money-market certificates. (LD’s highlight)

Those e-mails will get you every time. What might the boys and girls at FINRA and the SEC have to say about those findings? Would this discovery rise to the level of an anti-fraud violation? You think?? Hello!!

This continued up until the day before the auctions failed in January 2008.

The ARS market actually totally failed in February 2008 but let’s give the writer a pass.

The total amount involved in the crash was $330 billion, and large amounts have been restored to purchasers, including a promise to the state of Hawaii to make it almost whole for nearly $900 million in student loan auction-rate securities (SLARS) it was left holding.

Maui’s proposed settlement is better than the state’s, Cox told the committee, because it will clear the books within weeks of signing the agreement. The state will have to wait until 2015 for its final payments. Also, although the details of the settlement are confidential for now, they will be made public after it is approved.

I can’t wait. Perhaps the public disclosures will help the thousands of other ARS investors who remain frozen with upwards of $100 billion ARS.

After the auctions failed, holders like Maui County could get their money out only by negotiated sales at steep discounts.

Merrill, under pressure from the Securities and Exchange Commission, the state attorneys general and investors, made settlement offers to holders, some as low as about 76 cents on the dollar.

76 cents? Not quite the cash surrogate that Merrill Lynch and others had promoted. Another indication of an anti-fraud violation, perhaps? You think? Why did the SEC and state attorneys general allow for anything but a full 100 cents on the dollar settlement offer?

Maui County rejected the low-ball offers, but it did agree to sell back to Merrill about $12 million of the notes at prices within a fraction of a percent of par.

When agreement could not be reached on the remaining $32 million, the county sued in February 2010. Meanwhile, the money was tied up and unavailable during several tense budget cycles when county services were cut for lack of funds.

Think of kids perhaps not being able to play publicly funded youth sports. Think of public facilities not being accessible. Think of public employees being laid off. Think of libraries shortening their hours…and so much more!!

Once Cox and his team got their hands on Merrill’s emails, the pressure on Merrill to settle increased.

Oh boy!! Those damn e-mails. Transparency is proven once again to be the great disinfectant.

One email, cited in an amended complaint in U.S. District Court in March, quoted Merrill executive John Price warning, “Market is collapsing. No more $2K dinners at CRU!!”

Cru was a Greenwich Village eatery, now closed, known for its extensive wine list.

At the same time, though, brokers were pressing Maui County to buy more of the securities and assuring officials that the auctions were working and never failed. In fact, by November, when Price was becoming alarmed about his dinners, the auctions were failing regularly, and had been since August, according to the county’s suit.

If these facts are not indicative of a blatant misrepresentation, I do not know what is. Again I ask, anti-fraud violation, you think? Hello!!

To prop them up, Merrill was accumulating billions of dollars in SLARS in its own account and was desperate to dispose of them to cut its risk.

Meanwhile, the lawsuit alleges, Merrill was violating its own policies, which supposedly erected a “Chinese wall” between the sales department and the research and analysis office.

The research department provided supposedly independent reports that were used by Merrill salespeople to push the county to buy more SLARS.

The emails revealed that when the research department issued a negative report on SLARS in August 2007, Price’s managing director for auction-rate securities, Frances Constable, exploded in capital letters: “I HAD NOT SEEN THIS PIECE UNTIL JUST NOW AND IT MAY SINGLE HANDEDLY UNDERMINE THE AUCTION MARKET. IF YOU’RE GETTING ANY CALLS, PLEASE LET ME KNOW. I HAVE ASKED FOR AN IMMEDIATE CLARIFICATION TO BE PUBLISHED AND A RETRACTION OF THIS.”

This e-mail is a BOMBSHELL. Game, set, match!!

She got her way, according to the county’s lawsuit, protecting Merrill’s capital and her staff’s commissions.In fact, the suit says, Merrill jacked up commissions and paid special incentives to salespeople who unloaded auction-rate paper.

Now why do you think Merrill’s management would have done this?

To be fair, some of Merrill’s brokers and financial advisers could very well be viewed as secondary victims of this nightmare as some advisers may very well not have known that the market was collapsing. The same could be said of many brokers and advisers elsewhere as well.

In March, Merrill was still resisting the county. A mediation failed, and the dispute was sent to arbitration by the Financial Industry Regulatory Authority (FINRA).

The FINRA arbitration was torpedoed at the last minute when Merrill challenged the arbitrator, based on tweets he had sent. Cox did not explain further in open session, but the result was that arbitration is now scheduled for, at earliest, January.

Recently, though, Merrill has become more willing to meet the county’s terms.

Is that right? Merrill is now becoming more willing to meet the terms. Hmmm…why might that be??!! Increased pressure and greater transparency are always the great equalizers in pursuing and learning the TRUTH!!

Cox did not suggest why, but news reports give hints.

Last week, according to Bloomberg News, the SEC took the side of plaintiffs in a lawsuit against Merrill that, like Maui’s, alleges the firm manipulated the ARS market.

In an appeal in the Second Circuit of the U.S. Court of Appeals, the SEC said Merrill’s disclosures failed to inform the plaintiff of its alleged role in “propping up” the ARS market.

Then on Wednesday, Raymond James Financial Inc. agreed to pay $300 million to clients who bought auction-rate securities, also following claims by regulators that it had misled investors.

News releases from the North American Securities Administrators Association (a private regulatory body) and the SEC said that Raymond James agreed to repurchase securities from customers whose holdings have been unavailable since February 2008.

This is similar to Merrill’s proposal to settle with Maui County. The offer does not include attorney costs and fees.

The committee was asked to recommend authorization for additional payments to Goodsill Anderson Quinn & Stifel, up to $437,350. It did.

Cox said that the FINRA arbitration, which is still active, could possibly result in an order to cover the county’s fees in that part of its recovery effort.

Committee Chairman Riki Hokama said accepting the Merrill offer would be “in the best interests of our people as well as the taxpayers,” and the committee agreed unanimously to pursue the settlement as described by Cox in the closed session.

I hope the citizens of Maui are fully repaid and can get on with their lives.

Let us not forget, though, that there are still thousands of investors whom are still frozen out from upwards of $100 BILLION (to the best of my knowledge) of THEIR cash.

The crusade continues until every last penny of investor funds are repaid. Accompanying penalties and interest should not be lost in the battle.

Larry Doyle

Sense on Cents Related Commentary
Sense on Cents/Auction-Rate Securities

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets, our economy, and our political realm so that meaningful investor confidence and investor protection can be achieved.

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