Auction Rate Securities: Buyer Beware
Trust is like a vase - once it's broken, you can fix it, but it will never be the same again. For thousands of investors who were sold auction-rate securities as safe, cash-in-the-bank investments, nothing could be truer.
Auction-rate securities are municipal bonds, corporate bonds, and preferred stocks in which interest rates or dividend yields reset through auctions held every seven, 14, 28, or 35 days. For more than two decades, the $330 billion auction-rate market ran relatively smoothly. From 1984 through 2006, there were only13 auction failures.
Beginning in February 2008, however, market began to go down hill, as auction after auction failed. Two months later, more than 70 percent of bond auctions had failed, and investment banks and securities firms officially stopped using their own capital to buy the auction securities.
In turn, investors discovered their once-liquid funds were now “frozen.” For issuers of the auction bonds, including municipalities and nonprofits, they were left facing stiff penalties in higher interest rates - sometimes as high as 20 percent.
Following the collapse of the auction-market, state regulators in Florida, Georgia, Illinois, Massachusetts, Missouri, New Hampshire, New Jersey, Texas and Washington formed a task force to investigate the hows and whys of the market's failure.
Individual state investigations are underway, as well. In March, Massachusetts Secretary of State William Galvin initiated that state's ARS probe, after receiving calls from investors who said they were misled into purchasing auction-rate securities as safe, liquid investments only to later find that their money was irretrievably frozen.
Since then, Galvin's office has issued subpoenas to three major investment firms for information on how they marketed auction-rate securities to consumers. The firms included in his probe are: UBS AG, Merrill Lynch and Bank of America.
Coincidentally, on the same day Galvin's office subpoenaed the banks UBS began cutting the value of the auction debt held by its customers.
Many place the blame for the demise of the auction-rate market squarely with the brokers and banks who sold the investments as safe, cash-like alternatives. As reported in an April 26 article in the Kansas City Star, in May 2006 the Securities and Exchange Commission (SEC) alleged that 14 brokerage firms had added capital to hide risks that the auctions could freeze up. Without admitting any wrongdoing, the firms paid $13 million in fines. Even as the auction market began to fail this year, banks continued to send promotional materials to customers that referred to auction-rate securities as “ultra high-quality investments for your liquid funds.”
Meanwhile, thousands of investors are left facing the bitter truth. They are desperate for answers - and want to know how an investment they were told was safe as cash could now be frozen. Many of the investors burned by auction-rate securities are retirees, families who invested for their children's college fund and small businesses trying to stay afloat.
The alternative for these investors is to hope that the auction-rate market will rebound, which seems highly unlikely, according to financial experts. Many have opted to take an immediate loss and sell their securities - at 50 to 80 cents on the dollar - on the secondary market.
Others, however, are seeking recourse in the courts, joining a growing number of consumers who have filed class-action lawsuits against the investment banks and securities firms with whom they placed their trust, only to later find it would be broken and damaged beyond repair.
Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.
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