Retail brokers battle with Wall Street banks over auction-rate debt scandal

The most powerful retail brokerages in the US are waging war against Wall Street's big investment banks over the $330bn auction-rate securities mis-selling scandal.

The brokerages are arguing it was not they who misled their clients but the underwriters on Wall Street who misled them.

When the $330bn market for auction-rate securities collapsed in February, under the weight of the credit crisis, millions of people who had been told their investments were the equivalent of cash found that they could not sell them.

Andrew Cuomo, the New York attorney general who inherited the anti-Wall Street crusade of Eliot Spitzer, has brought or threatened legal action against many brokers and is investigating dozens of companies, including famous names such as Charles Schwab and Fidelity. He has wrung fines totalling hundreds of millions of dollars from firms including Citigroup and UBS, who acted both as underwriters for the securities and as brokers, selling them to their clients. Last week, he said he expected to bring suits against firms that just acted as brokers, too.

His settlements have typically involved brokers agreeing to buy back the impossible-to-sell securities from their clients – something smaller brokerages say could ruin them.

An auction-rate security is a bond whose interest rate is not fixed but set at a weekly or monthly auction, when existing holders can sell the bonds. For more than 20 years, the Wall Street banks which underwrote the securities for their issuers also acted as "market-makers", stepping in to buy the bonds at auction if demand was weak. However, amid the spiralling credit crisis, they stopped acting as buyers of last resort and since then almost 60 per cent of auctions have failed.

Retail brokers who sold auction-rate securities to their clients say that they were misled by the big underwriters. They, too, believed that the securities were as easy to sell as cash-equivalents such as money market funds.