Firms warned of auction-rate market's failure

At least five Wall Street firms warned Massachusetts officials _ but not most individual investors _ before February's collapse in the market for a type of bond that many had viewed as safe investments, The Boston Globe reported Thursday.

The newspaper said documents it obtained in a public records request show the firms sent e-mails and made presentations to the state treasurer's office indicating the auction-rate securities market was in distress in the weeks before its collapse. The firms included JP Morgan Securities Inc., Lehman Brothers, Morgan Stanley, Bear Stearns Cos. and Merrill Lynch & Co.

Massachusetts Treasurer Timothy Cahill said the investment banks were doing their job by warning the state.

"The fact that they weren't providing the same advice to smaller investors, and even some smaller state entities, is unforgivable, really," Cahill said.

Until last winter, the $330 billion auction-rate securities market had been seen by many investors as a safe. They were promoted by brokers as cash-like investments, because customers normally could get out of them every seven or 28 days. The interest rates on the debt reset at each of those auctions.

But starting in mid-February, the auctions failed to yield buyers, as investors sought to avoid risk amid turmoil in credit markets. The market's failure left many investors including local governments with their cash frozen as buyers dried up.

The Globe said that as early as Jan. 10, Bear Stearns told the state: "As discussed in previous meetings," credit and liquidity concerns have "resulted in a dislocation in the market for auction-rate securities."

Among the five firms that warned the state, only Merrill Lynch commented for the Globe's story. Its Jan. 11 notice to the state was milder than those from the other firms, warning that interest rates were rising on the debt, due to "weakening demand."

The Globe said Merrill Lynch and the other firms that warned Cahill's office urged the state to refinance its $565 million in auction-rate debt into other kinds of bonds.

In a statement, Merrill said, "Given the increasing interest rates on the state's debt, we believed the refinancing would reduce the state's borrowing costs and save taxpayers money."

In May, another investment bank, UBS, settled with Massachusetts Attorney General Martha Coakley by agreeing to buy back $37 million in auction-rate securities sold to Massachusetts cities and towns and the Massachusetts Turnpike Authority. Last week, the Massachusetts Securities Division last week filed civil fraud charges alleging UBS misrepresented the risks of auction-rate securities to customers and failed to disclose its conflicts in selling them.

Harry S. Miller, a lawyer at Burns & Levinson in Boston who is representing some investors, said brokerage operations of some Wall Street firms continued to promote the investments without warnings before the market's collapse.

But Miller said the state also bears some responsibility for not warning investors.

"They've got the citizens of the state to be concerned about," Miller said.