The ARS saga: Wider and wider….

There’s no stopping him: the office of New York attorney general Andrew Cuomo is now probing the relationship between Fidelity Investments and Goldman Sachs as part of its investigation into the sale of auction-rate securities, the Wall Street Journal reports. The implications of this latest widening of Cuomo’s investigation are significant.

As the FT noted last Friday, Cuomo is already investigating the role of brokerages that sold the offending securities, including Fidelity, Charles Schwab, TD Ameritrade, E-Trade Financial and Oppenheimer, as well as underwriters including Bank of America.

But the fresh angle is the examination of whether Fidelity’s relationship with Goldman may have given Fidelity “an incentive” to sell the instruments to individual investors, according to the Journal. The investigators began focusing on the relationship after learning that most of the ARS sold by Fidelity were underwritten by Goldman.

The question, according to the Journal, is whether Fidelity may have marketed Goldman-underwritten ARS because it was getting other services from the investment bank, including possible underwriting of private offerings that Fidelity develops for “accredited,” or wealthy, investors, and financial-counselling services that Goldman’s Ayco unit provides to Fidelity executives.

A Fidelity spokesman wouldn’t comment on regulatory issues, but she did tell the Journal that Fidelity’s relationship with Ayco predates Goldman’s purchase of that company in 2003, and that 600 Fidelity accounts held the auction-rate securities. Oh, and there was “no incentive for Fidelity to promote auction-rate securities,” she added.

Wall Street firms sold some $330bn in ARS before the market collapsed in February, when banks stopped supporting the market with their own bids, leaving customers unable to cash out.

So far, a mini “who’s who” of Wall Street firms, including Citigroup, JP Morgan Chase, Merrill Lynch, Morgan Stanley, UBS, Wachovia, Goldman Sachs and Deutsche Bank, have agreed to repay – mainly retail – customers on their ARS investments.

In a key settlement, Merrill, Deutsche Bank and Goldman agreed to buy back $50bn of the securities, and to pay $525m in penalties. Last week, in a settlement with regulators representing 49 states, Goldman agreed to a $1.5bn buyback from retail investors, and to pay a $22.5m penalty to states.

Goldman’s agreement does not cover customers who bought ARS from Fidelity, notes the Journal, adding that Massachusetts’s top regulator, William F. Galvin, has called on Fidelity to buy back all the securities it sold.

No firms have admitted wrongdoing in the settlements, a fact that commentator Dan Solin on Huffingtonpost describes as “lawyer speak for permitting them to defend private lawsuits by third parties who would otherwise be entitled to use the settlement as evidence of liability”.

This escape hatch is meaningful, because the settling defendants have agreed to purchase back only ARS sold to their clients. Why not do the right thing and purchase back all the ARS that were sold to all investors who were harmed because these firms perpetuated the myth of a legitimate auction?

These investors, who make up the bulk of the $330bn ARS market, will need to prove their claims in private arbitration proceedings, before industry panels, where they are unlikely to be awarded any meaningful damages.

Solin’s response is similar to other commentary in the blogosphere – although the reasons for criticism range from outrage about the “little guy” to the kind of criticism from Risk News, which complains in a (subscription only) comment that Merrill’s deal, just like Goldman’s, “leaves the larger purchasers uncovered”.

Inevitably, the probe, as it widens and becomes uglier, promises to yield something for everyone to bitch and moan about.

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