updated 8/22/2008 4:54:10 PM ET 2008-08-22T20:54:10

Federal regulators say Merrill Lynch & Co. will buy back up to $7 billion in auction-rate securities over its role in selling the risky bonds to retail investors.

Merrill's preliminary agreement with the Securities and Exchange Commission comes a day after the largest U.S. brokerage agreed with state regulators to hasten its voluntary buyback plan by repurchasing $10 billion to $12 billion of the securities from investors by Jan. 2. Merrill also agreed to pay a $125 million fine in that deal.

The SEC said the new agreement will enable retail investors, small businesses and charities who purchased the securities from Merrill "to restore their losses and liquidity."

Merrill Lynch Chief Executive John Thain said Thursday the New York-based brokerage, which last week agreed to repurchase the debt on a voluntary basis, would "accelerate the plans" by buying back $10 billion to $12 billion of the securities from investors by Jan. 2 and pay a fine of $125 million.

New York Attorney General Andrew Cuomo, leading the investigation on behalf of state and federal authorities, has now reached deals to buy back more than $50 billion worth of auction-rate securities from eight global banks.

"We believe that the settlement should alleviate some of the negative overhang on the stock as the uncertainty surrounding the potential downside to the auction-rate securities issue appears to behind the firm," wrote Keefe Bruyette & Woods analyst Lauren Smith wrote in a research note Friday.

Smith has a "Market Perform" rating on the stock with a target price of $26.

The auction-rate securities market involved investors buying and selling instruments that resembled corporate debt, but the interest rates on the investments were reset at regular auctions, some as frequently as once a week. A number of companies and retail clients invested in the securities because they could treat their holdings almost like cash.

But the market for them collapsed in February amid the downturn in the broader credit markets. Regulators have been investigating the collapse in the market to determine who was responsible for its demise and whether banks knowingly misrepresented the safety of the securities when selling them to investors.

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