Auction-Rates, The Martin Act, And Wall St.’s Next Disaster

There is no law on the books anywhere in the US to rival The Martin Act for giving prosecutors a big stick. As one expert on the breadth of 1930s piece of legislation put it:

"The purpose of the Martin Act is to arm the New York attorney general to combat financial fraud. It empowers him to subpoena any document he wants from anyone doing business in the state; to keep an investigation totally secret or to make it totally public; and to choose between filing civil or criminal charges whenever he wants. People called in for questioning during Martin Act investigations do not have a right to counsel or a right against self-incrimination. Combined, the act’s powers exceed those given any regulator in any other state."

Andrew Cuomo, who folled Eliot Spitzer into the New York Attorney General’s chair has said he will use The Martin Act to go after banks and brokerages who were involved in marketing auction-rate securities to individuals and corporations saying that the paper was as liquid as cash. It did not turn out that way when the credit crisis cased the market to shut down. Some companies and people simply can’t get at their money.

Spitzer used the act to bring Wall St.’s research business to it knees. It profoundly altered the way that research was done and how it was distributed. It cost firms at the tip of Manhattan $1.4 billion.

The breadth of the auction-rate securities problem probably dwarfs the research issue. The size of the market was about $360 billion. Firms are already taking write-downs of 10% or more because the securities do not trade. At the very least the NY AG may go to the financial companies which marketed that paper and tell them to make their customers whole.

That could cost Wall St. $36 billion. Even if its can settle for less, the damage is likely to be substantial.

Douglas A. McIntyre