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The Auction Rate Securities Settlements: An Illusion of Regulation

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Merrill Lynch proclaims that it "...demonstrates its commitments to clients and shareholders through the firm's emphasis on excellence, integrity and ethical behavior."

This week it joined a who's who list of its prestigious brethren in agreeing to buy back auction rate securities it sold to its retail clients. The settling firms now include Citigroup, JP Morgan Chase, Morgan Stanley, UBS, Wachovia, Goldman Sachs and Deutsche Bank, all of whom profess to greatly value their relationship with the clients they victimized.

In a spin noteworthy for its audacity, Robert J. McCann, president of Global Wealth Management at Merrill, stated: "We have been working on behalf of our clients since this liquidity problem began. We will continue to work actively across the industry, as well as with our financial advisors, to ensure that we continue to serve our clients well."

All of the settling firms "neither admitted nor denied allegations of wrong doing", which is 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 $330 billion 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.

Effective regulation of this rogue industry will only be forthcoming with the involvement of U.S. Attorneys, who have been remarkably passive to date, leaving the heavy lifting to William Galvin, the Secretary of the Commonwealth of Massachusetts and Andrew M. Cuomo, the Attorney General of New York.

If the conduct that resulted in these settlements is true, then these firms should be prosecuted for violating the Racketeer Influenced and Corrupt Organizations Act (RICO). This criminal statute is applicable to securities frauds. It would permit a charge of racketeering, with fines of up to $25,000 and jail sentences of up to 20 years in prison for each count. If convicted, defendants would be required to disgorge all profits generated from their illegal activity.

This would be meaningful regulation. Anything less is merely an illusion.

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