Bloomberg

JPMorgan Chase & Co. and Morgan Stanley are on the verge of completing settlements with government regulators to buy back auction-rate securities from clients, people briefed on the negotiations said.

State regulators, JPMorgan, the third-largest U.S. bank by assets, and Morgan Stanley, the second-biggest U.S. securities firm by market value, were initially aiming to announce the accords late yesterday, the people said. Wachovia Corp., the fourth-largest U.S. bank, also is nearing a deal, said Laura Egerdal, a spokeswoman for Missouri Secretary of State Robin Carnahan, who is in the negotiations.

``We made great progress over the weekend,'' Egerdal said late yesterday about negotiations that a multistate task force is conducting with Wachovia. ``There are a few more things to work out. They are still in discussions.''

Citigroup Inc., based in New York, and Zurich-based UBS AG last week settled state and federal claims they improperly saddled investors with the bonds. The banks, accused of fraud, will buy a combined total of about $26 billion of auction-rate bonds from clients and pay $250 million in fines.

Merrill Lynch & Co. said it would offer to buy back about $10 billion of the securities, and Morgan Stanley offered this week to buy back $4.5 billion of them from retail clients.

Regulators have said the Merrill and Morgan Stanley offerings fall short. Merrill is still negotiating a settlement, according to a spokesman for Massachusetts Secretary of State William Galvin.

`No Imminent Agreements'

``Massachusetts is in conversations with Merrill Lynch but there are no imminent agreements at this point,'' Galvin spokesman Brian McNiff said yesterday in a phone interview. Galvin sued Merrill last month.

Auction-rate securities are typically bonds with interest rates reset by periodic bidding. Several banks abandoned their routine role as buyers of last resort for the instruments in mid-February, allowing the market to implode.

Wall Street's costs to end federal and state auction-rate probes may wind up exceeding the sanctions from abuses of mutual funds and analyst research in the past decade.

The investigation of mutual-fund abuses from 2003 yielded more than $5 billion in penalties and agreements to reduce fees, while New York Attorney General Andrew Cuomo's predecessor, Eliot Spitzer, and regulators including the U.S. Securities and Exchange Commission won $1.4 billion from 10 firms accused of using tainted research to win investment-banking deals.

The auction-rate settlements come six months after the $330 billion market seized up when investors fled all but the safest government debt and bond dealers, saddled with growing losses on debt tied to subprime mortgages, stopped buying securities that bondholders didn't want.

Auction-Rate History

For more than two decades, the auction-rate market had allowed municipalities, student-loan agencies and closed-end mutual funds to borrow for the long-term at lower interest rates set through dealer-run bidding every week or month.

The periodic auctions that had allowed investors to move in or out of the securities at will fell apart when would-be sellers outnumbered buyers. In mid-February, auctions failed in unprecedented numbers, triggering penalty rates as high as 20 percent or pegged to a money-market formula, depending on language in the original bond documents.

Thus, at the same time certain states, cities, colleges and hospitals faced soaring debt costs, investors in preferred shares and student-loan securities were receiving much lower interest rates on investments they couldn't liquidate.

Largest Underwriters

UBS, Citigroup and Merrill were among the largest underwriters of auction-rate debt, according to Thomson Reuters. The other biggest banks in the market included New York-based Morgan Stanley, Goldman Sachs Group Inc., JPMorgan, Lehman Brothers Holdings Inc., Toronto-based Royal Bank of Canada, and Wachovia and Bank of America -- both based in Charlotte, North Carolina.

``UBS pushed the sales of these instruments as 'cash alternatives' without telling their customers of their vulnerabilities,'' Massachusetts Secretary of State William F. Galvin said in a June 26 release, announcing charges his office filed against the Swiss bank. ``The game was fixed; only the customers were in the dark,'' he said.

The market shrank to about $206 billion by the end of the second quarter, as municipal borrowers refinanced about 60 percent of their auction-rate bonds and closed-end mutual funds redeemed 40 percent of their preferred shares, based on an estimate by Bank of America Corp. analyst Jeffrey Rosenberg last week. Banks might have to write down a total of $4 billion as they buy back auction-rate securities, he said in a report last week.

$5 Billion

JPMorgan said its customers hold about $5 billion worth of auction-rate securities, which includes $3 billion held by retail customers, according to an Aug. 11 regulatory filing.

Cuomo, whose office sent letters on Aug.11 to JPMorgan, Morgan Stanley and Wachovia asking for immediate settlement talks, is seeking to force the firms to start auction-rate buyback programs for retail customers, reimburse consumers who sold bonds at ``below-par'' prices, and institute a claims- resolution process.

Cuomo also wants any resolution to address relief for institutional investors, refinancing fees for certain municipal issuers and substantial penalties.

Alex Detrick, a spokesman for Cuomo, declined to comment on the near settlements. JPMorgan spokeswoman Tasha Pelio also declined to comment, as did Erica Platt, a spokeswoman at Morgan Stanley, Wachovia spokeswoman Christy Phillips Brown and SEC spokesman John Nester.

``We don't comment on regulatory matters,'' said Merrill spokesman Mark Herr.

Historic Costs

UBS will buy $8.3 billion of the securities from its clients beginning Oct. 31 under a settlement with Cuomo, the SEC and a group of other state regulators, according to terms announced last week. The bank must also help its institutional clients sell an additional $10.3 billion in securities, and may have to buy back the bonds if they fail to find a market, Cuomo said. UBS also will pay a fine of $150 million.

Citigroup was the first to settle state and federal claims last week, agreeing to buy $7.3 billion of the debt from individual investors and pay $100 million in fines, as well as pledging to help 2,600 institutional customers unload $12 billion of securities.