Brokerage Firms Under Investigation for Selling Investors Illiquid Securities

In late July, the Texas State Securities Board notified UBS of expected hearings to determine whether the firm’s investment bank and wealth management business securities licenses should be suspended. The suspension is threatened due to actions related to the sale of auction-rate securities. In the midst of the current credit crisis, investors have been unable to access money invested in the securities due to freezing of the market for these securities.

Auction-rate securities are debt instruments issued by municipalities, student loan agencies, and other debtors. Unfortunately, the sale of auction-rate securities is not isolated to UBS. In fact, these investments have been sold to investors by many other large brokerage firms.

As evidence of the widespread problem, yesterday Massachusetts regulators charged Merrill Lynch & Co. with fraud related to auction-rate security sales. New York State followed suit today by threatening action against Citigroup.

As these leading brokerage firms respond to the aggressive regulatory actions, brokers employed by the firms are taking actions of their own. Many successful brokers are facing the prospect of leaving embroiled firms for competing firms, who are aggressively targeting them to leave, bringing their customers with them.

If your accounts are at any of these firms, there are several potential outcomes: your broker may solicit you to take your business to another firm, the brokerage firms will face distracting regulatory proceedings with potentially stiff fines or license suspensions, your investments may be illiquid if you were sold auction-rate securities.

A better alternative is to work with an independent advisor who only invests in liquid securities with transparent underlying equity or fixed income positions. You want your advisor’s focus to be on managing the success of your portfolio, not on fighting regulatory battles or finding his next job.