UPDATE 2-Mass. regulator probes banks on muni CDS

By Svea Herbst-Bayliss

BOSTON, May 14 (Reuters) - Massachusetts' top securities regulator has asked Wall Street's 10 biggest banks for data to determine whether, when they helped towns and cities raise money, they created conflicts of interest by betting that some of those deals would fail.

Merrill Lynch, Goldman Sachs, Morgan Stanley, Bank of America, Citigroup, Deutsche Bank , Wells Fargo, UBS, JPMorgan Chase and Barclays have until Friday, May 28, to tell state investigators about the bond offerings they underwrote and any municipal credit-default swaps (CDS) they may have created.

Deutsche Bank spokesman Ted Meyer said the bank would not comment on the investigation and said the bank does not have a municipal bond underwriting business.

These contracts essentially offer insurance to holders of the municipal bonds if the issue should fail. They recently became available on municipal debt allowing investors to effectively bet against the bonds that states and cities and towns raise to finance themselves.

'We are interested in the matter,' William Galvin, the Massachusetts secretary of state, said in a telephone interview. 'Is there a fundamental conflict of interest in asking to be the underwriter and get a good rate and betting against the instruments you are promoting?'

Galvin said that at this point his office is only requesting information. However, in past cases, his office has often followed up with charges.

The Wall Street Journal reported in its Friday edition that federal and state officials are examining Wall Street's role in trading derivatives that bet that municipal bonds the underwriters helped create would ultimately flop. The newspaper did not say, however, that Massachusetts is one of the states investigating the matter.

Over the past years, Galvin's office has investigated mutual fund industry abuses like market timing and the sales of auction rate securities, establishing his reputation as a tough regulator who is often at the forefront of issues.

The Massachusetts investigators are demanding data on all municipal bond deals underwritten since 2003. 'It will be a fairly exhaustive list,' Galvin said.

In the letter sent to the banks on Friday, Galvin's investigators asked for the names and titles of everyone who helped create the CDS for each bond offering and the names of the people who sold them.

The Wall Street Journal reported that California is also investigating the matter after the banks sold $43 billion worth of California state bonds in the past three years. The newspaper also said that during that time, the banks traded $27.5 billion worth of credit default swaps.

(Reporting by Svea Herbst-Bayliss; Editing by Gary Hill) Keywords: MASSACHUSETTS/PROBE ([e-mail]; [phone]; Reuters Messaging: [e-mail]) COPYRIGHT Copyright Thomson Reuters 2010. All rights reserved. The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.