Archive for August, 2008

For the moment, Jefferson County, Alabama, has successfully avoided filing for the largest municipal bankruptcy in the United States. Jefferson County commissioners will find out next week if their proposal to restructure the county’s $3.2 billion sewer debt at lower, fixed interest rates over a longer term meets the approval of creditors.

The temporary reprieve allows the county to delay making further interest payments to lenders.

Jefferson County commissioners were joined by Alabama Governor Bob Riley when they presented the proposal at an Aug. 29 meeting with creditors. Reportedly, lenders and others involved in the sewer project plan to hold off in taking any legal action against Jefferson County until Sept. 30 while they study the proposal’s merits.

Today was a critical day for Jefferson County, with county commissioners facing the possible end of its financial road. At 5 p.m., a forbearance agreement between Jefferson County and lenders for the sewer debt was set to expire. Following months of trying to work out a new financing deal with lenders, bondholders and others - as well as having taken several forbearances to delay making interest-rate payments on the debt - county officials were set to file for bankruptcy.

A bankruptcy for Jefferson County would almost double the previous municipal bankruptcy record set in 1994 by Orange County, Calif., which had debts of $1.7 billion.

Our affiliation of securities 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.

With a 5 p.m. deadline looming for Jefferson County commissioners to make an interest payment on $3.2 billion in sewer debt, Alabama Governor Bob Riley is heading to the negotiating table with Wall Street creditors.

If the governor’s last-ditch effort to strike a deal fails and Jefferson County is unable to extend its forbearance agreement or make a payment, the county becomes left with no alternative but to file the largest bankruptcy ever sought by a municipality.

As reported Aug. 29 in The Huntsville Times, the consequences of a bankruptcy move would not only affect Jefferson County, but potentially the entire state of Alabama.

“The municipal bond market has a long memory and would penalize the county, the state and other Alabama local government jurisdictions, raising borrowing costs for all for many years,” according to Lamont Financial Services Corp., a New Jersey-based company that prepared a recent report for one of the bond insurers involved in the sewer project.”

The Lamont report went on to say that if Jefferson County does in fact go broke, it impairs the state’s efforts to recruit jobs, as well as creates possible interest rates increases on taxpayer debt for public improvements in the future.

If Jefferson County can’t meet its 5 p.m. deadline on Friday and files Chapter 9 bankruptcy, it would join a small roster of municipalities to default over the years. Earlier in the day, the Wall Street Journal reported that since 1934, when the first municipal bankruptcy legislation was passed, there have been fewer than 600 total Chapter 9 filings.

High-Finance Deals

Jefferson County’s financial troubles began innocently enough. In 1996, the county decided to update some 3,000 miles of sewers to stop the discharge of raw sewage into nearby streams. Wall Street banks were called in to devise a financing plan. Using a strategy that involved refinancing fixed-rate bonds into variable-rate bonds and then hedging the debt through complex interest-rate swaps, the plan ultimately went haywire.

Today, more than $3 billion of the bonds, including $2.2 billion of auction-rate securities, have interest rates that reset periodically, leaving Jefferson County unable to pay its debts.

Things are so bad that Jefferson County’s long-term debt-sewer, school and general obligation bonds - is now more than $7,000 for every man, woman and child, according to The Birmingham News. That’s 30 times Mobile’s long-term per capita debt of $236, and 38 times Montgomery’s $186 per capita debt, the paper says.

Our affiliation of securities 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.

Hit hard by the subprime crisis fallout, Asset Management Fund’s Ultra Short Fund is going the way of a number of ultra short bond funds this year: down the tubes.

Pitched as a conservative, low-risk investment that mimics the safety of money-market funds, the AMF Ultra Short Fund proved to be the opposite for investors. Heavily invested in toxic subprime-backed securities - in this case, hybrid adjustable rate mortgages (ARMs) - the fund plummeted in value when things began to go haywire in the housing market.

Most unsettling to irate investors who put their money into the AMF Ultra Short Fund is the fact that it did not begin to truly decline in value until May 2008, yet until that time, its managers - Shay Assets Management, Inc. - continued to invest heavily in the risky hybrid ARMs.

A hybrid ARM offers a combination of adjustable-rate and fixed-rate features. For an initial period - typically one to three years - it carries a fixed rate, followed by rate adjustments once every year for the balance of the loan term. Many people who sign up for hybrid ARMs do so to reap the benefits of the fixed-rate period. However, at the end of the fixed-rate period, many of these same homeowners are unprepared to see their monthly mortgage payment jump upwards of 30 percent or more.

In its product literature, AMF Asset Management describes its Ultra Short Fund as designed to provide current income with a very low degree of share-price fluctuation. Instead, the fund has declined more than 15% this year.

Several investors who suffered losses in the AMF Ultra Short Fund are going to court, charging the fund’s managers and AMF with not only misrepresenting the fund but also for knowingly keeping information from them about the concentration of risky mortgage-backed securities that the fund contained.

Our affiliation of securities 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.

The clock is ticking for Jefferson County, Alabama. Unable to pay $3.2 billion in sewer-system debt bills, Jefferson County, Alabama, Commissioners have until August 29, at which time a forbearance agreement with Wall Street creditors, led by JP Morgan Chase, expires.

The next likely step for Jefferson County is to file for Chapter 9 bankruptcy, a move which will go down as the biggest municipal bankruptcy in U.S. history, surpassing the financial mess and bankruptcy of Orange County, California, in 1994.

As financial troubles go, Jefferson County’s are beyond serious. In 2002, needing to repair an outdated sewer system, local officials were wooed by a group of savvy investment banks to take on a financing arrangement that involved converting the county’s debt from fixed interest rates to adjustable rates and using exotic interest-rate swaps.

The financing plan was supposed to protect Jefferson County from rising interest rates on its sewer bonds. That didn’t happen, and county commissioners were forced to pay interest rates as high as 10 percent.

In the process, the county turned over more than $120 million in fees and commissions to the Wall Street banks that initially concocted the disastrous financing arrangement.

Now unable to negotiate another payment extension with lenders, Jefferson County commissioners are considering filing Chapter 9 bankruptcy. As reported Aug. 26 in The Birmingham News, the county says it fully expects to default on its $3.2 billion sewer debt this Friday. The next step is to authorize attorneys to begin bankruptcy proceedings, according to Jefferson County Commission President Bettye Fine Collins.

Jefferson County’s filing of Chapter 9 would be the largest municipal bankruptcy in the nation’s history. Currently, the record is held by Orange County, California, which declared Chapter 9 bankruptcy on Dec. 6, 1994, following massive losses of at least $1.5 billion from complex investments in financial derivatives. Federal criminal charges eventually were brought against the county’s treasurer at the time, Robert Citron, who pled guilty to six felony counts. Citron was sentenced to five years of supervised probation, and ordered to perform 1,000 hours of community service. He served no time in prison.

According to The Birmingham News, extending the forbearance agreement set to expire on Aug. 29 for Jefferson County means Alabama’s Governor Bob Riley must call a special session of the Legislature to consider property and sales taxes, among other revenue increases. Riley declined to invoke that session because of strong opposition from lawmakers and the public.

If an extension is not signed, Jefferson County faces higher interest costs, penalties and principal payments on its sewer debt.

In the event Jefferson County defaults on its payment obligations as expected, its bond insurers - Financial Guaranty Insurance Corp. (FGIC) and Syncora Guarantee, Inc. - are required to cover the payments under a previous agreement with the county. Both insurers say they expect the county to reimburse those payouts in full, as outlined in that agreement.

If the county cannot honor the agreement, FGIC and Syncora contend they will consider legal action, and sue the county for reimbursement. The county must then either make payments as scheduled or file for protection under Chapter 9 bankruptcy.

David Bronner, who heads the Retirement Systems of Alabama, thinks the county should take the latter step, selling him the sewer system and putting the losses firmly with the bond insurers that he says reaped countless benefits over the years when Jefferson County renegotiated bond swaps in order to get a better - yet more expensive - rate and ultimately created the financial mess it is in today.

In the meantime, Aug. 29 is fast approaching. Unable to pay the piper - in this case, Wall Street banks and creditors - default appears to be the most likely scenario for Jefferson County. For its residents, that unfortunate reality could mean yet another string of troubles - this time in the form of possible tax increases, spending reductions or job cuts.

All of which sounds like a repeat performance of Orange County, California, in 1994. While in bankruptcy, nearly every county program budget was cut, approximately 3,000 public employees discharged and other community services drastically reduced.

Our affiliation of securities 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.

The lack of mea culpa from “downstream” brokers over the state of auction rate securities and the predicament of investors stuck with the now-illiquid securities may speak volumes. At least New York Attorney General Andrew Cuomo appears to think so.

In an Aug. 20 letter to the Regional Bond Dealers Association (RBDA), the New York attorney general’s office blatantly dismissed earlier claims by the RBDA that brokerage firms such as Fidelity Investments and Charles Schwab shouldn’t be held liable for the demise of the auction rate market or the illiquidity of their clients’ auction rate investments.

In the letter, Benjamin Lawsky, deputy counselor and special assistant to the attorney general, wrote:

Attorney General Cuomo’s investigation has already begun to uncover some disturbing facts that seem to belie the innocent picture of downstream brokerages you paint . . . For example, some evidence indicates that Fidelity was actively marketing auction rate securities to its high net worth clients. . . “If downstream brokerages deliberately stuck their heads in the sand but continued to actively market these products to unknowing investors, that will certainly be relevant to our calculus of the firms’ culpability.”

In early August, Fidelity Investments and Charles Schwab were among a number of brokerages to contend that state and federal regulators should focus their investigations of abuses concerning auction rate securities solely on the major investment banks that underwrote the securities, rather than the smaller brokerages. As “supporting evidence,” the brokerages suggested they were unaware of the potential pitfalls of auction rate securities and had no prior knowledge that the auction market was in trouble.

Such excuses may not hold water, however. As licensed brokers, having knowledge and information about a particular investment product is a standard part of the job. That point was reiterated in Lawsky’s letter, in which he stated that the attorney general believes it is highly unlikely that the brokerages were, as they claim, “in the dark with investors” regarding the liquidity risks of auction rate securities.

The growing concern by secondary dealers for their auction rate securities fate stems to recent settlement announcements by Cuomo’s office - settlements that do not include some $60 billion in outstanding auction rate securities purchased through smaller brokerages. Now, the brokerages fear the onus will be on them.

Indeed, next week the Financial Industry Regulatory Authority (FINRA) is planning a series of on-site inspections at approximately 40 downstream brokerages, where it will try to determine exactly what they knew in advance of the auction market’s collapse and whether they knowingly represented auction rate securities as safe and liquid investments to clients.

Meanwhile, Citigroup, JPMorgan Chase, Morgan Stanley, UBS and Wachovia all have agreed to buy back $35 billion of auction rate securities and pay more than $360 million in fines. As reported Aug. 22 in the New York Times, three other banks - Merrill Lynch, Goldman Sachs and Deutsche Bank - also plan to buy back at least $12.5 billion in the securities and pay more than $160 million in fines as part of settlements reached late in the day on Aug. 21.

Beginning in October, Merrill Lynch will buy back at least $10 billion of auction rate securities from investors holding less than $4 million of the investments. A $125 million fine also was imposed on the firm.

Separately, the Securities and Exchange Commission (SEC) is continuing its investigation into Merrill Lynch for possible corporate and individual violations.

Goldman Sachs agreed to buy back about $1.5 billion of auction rate securities from investors by mid-November, and pay a $22.5 million fine, while Deutsche Bank will buy back $1 billion of auction rate debt by mid-November and pay a $15 million penalty.

Our affiliation of securities 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.

Pummeled from overexposure to subprime mortgages and the credit crunch, seven Regions Morgan Keegan (RMK) mutual funds are changing their business strategy. As of Aug. 1, management of the funds has been handed off to New York-based Hyperion Brookfield Asset Management.

The shakeup in management illustrates the depth of losses posted by the Morgan Keegan funds in recent months. Since June, six of the seven funds lost more than 75 percent of their value.

It’s very rare that an asset management firm gives up assets in this kind of way, said Lawrence Jones, an analyst with Morningstar Inc., in a May 7, 2008, article in the Memphis Daily News. Even with the depleted level of assets, they were still making an expense ratio on it.

The dismal performance of the RMK funds - and the resulting impact on investors - is well documented. The New York Times featured a front-page story on the subject in December, when it wrote about an Indiana charity that grants wishes to children and teenagers who suffer from life-threatening illnesses. The Indiana Children’s Wish Fund had lost thousands of dollars in an RMK mutual fund because of the fund’s substantial investments in risky mortgage securities. Faced with legal action and a public relations nightmare - nine children’s wishes were set to go unfulfilled - Morgan Keegan opted to settle the charity’s arbitration claim for an undisclosed amount of money.

Now the job of reviving the mutual fund portfolios - as well as repairing their public image - rests with Hyperion Brookfield Asset Management. As reported in the Memphis Commercial Appeal on Aug. 16, Dana Erikson will serve as the new portfolio manager.

In the past two weeks, Erikson says he has begun the process of repositioning the funds, with the intent to diversify into an array of investments to produce better predictability of income and more stability of net asset value.

Hyperion’s management role includes three open-end funds (investors buy or sell directly with the funds) and four closed-end funds in which shares are bought and sold via the New York Stock Exchange (NYSE).

Erikson, along with John Feeney, Hyperion’s chief executive officer, plans to provide additional details of their strategy to revive the funds on Sept. 4 during a 3:30 p.m. shareholder conference call.

Details aside, Hyperion likely faces an uphill battle in the coming months - and possibly years - as it attempts to turn around the beleaguered mutual funds. And on the sidelines will be the funds’ former manager: Morgan Asset Management, Regions, Morgan Keegan, their directors and several Morgan Keegan brokers who sold shares of the funds all face lawsuits and arbitration claims over the collapse in value of the funds.

Our affiliation of securities 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.Â

Jefferson County, Alabama, serves as a prime example of Wall Street financing gone bad. Money troubles for the county, which is home to the state’s largest city, Birmingham, began in 2002. It was then that several Wall Street investment banks, including JP Morgan Chase, devised an elaborate financing arrangement to pay for the county’s new sewer system.

The $5.8 billion arrangement that JP Morgan and other banks designed for Jefferson County was a risky venture - and one that rejected fixed-rate debt and borrowed at variable interest rates using interest-rate swaps. Failing to anticipate a future credit crunch, the plan backfired miserably. More than $3 billion of the sewer bonds have interest rates that reset frequently, with rates going as high as 10 percent.

Today, Jefferson County is on the brink of financial disaster. By some reports, the county has become one of the most indebted municipal governments in the history of the United States, with a current debt of approximately $9,000 for each resident in the county.

Meanwhile, the Wall Street banks that arranged the initial financing deal for Jefferson County have been rewarded to the tune of $120 million in fees and commissions - six times the standard rate.

Faced with few options to resolve its $3.2 billion sewer debt crisis, Jefferson County is now looking at filing Chapter 9 bankruptcy. In doing so, the county would be able to hold off paying banks and creditors while it figures out a restructuring plan for its debts.

On August 15, David Bronner, head of the Retirement Systems of Alabama, said his pension fund would be willing to buy the sewer system for up to $1.4 billion. The deal would require the county to file bankruptcy but essentially leave banks, investors, and insurers with the losses.

Bronner says in seven years he would sell the sewer system back to the county for the same price he initially paid.County commissioners are debating Bronner’s proposal. Some says the move could potentially create even more problems for Jefferson County, including tax increases, job losses, and lessen its ability to finance future infrastructure projects.

On Aug. 1, Jefferson County succeeded in winning a fourth forbearance agreement from the various Wall Street banks. In the end, however, many say the county is simply prolonging the inevitable fate of bankruptcy.

Until then, Jefferson County’s reputation is on the line. As a steward of taxpayers’ money, its future decisions have monumental consequences - and serve as a costly lesson for other municipalities to learn from.

Our affiliation of securities 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.

“Nobody gets a pass.” That’s apparently the verdict from Christopher Cox, chairman of the Securities and Exchange Commission (SEC), who says investigations into the collapse of the auction rate securities market will indeed extend beyond major Wall Street investment banks to include secondary dealers who sold the securities.

Cox’s clarification follows recent criticism by smaller brokerages like Fidelity Investments and Oppenheimer & Co., which contend they should not be obligated to buy back billions of dollars of auction rate securities from investors based on the fact they didn’t underwrite the securities nor run the auctions for the securities. The big investment banks did.

Moreover, the brokerages say that when it came to knowing about potential problems brewing in the auction rate market, they were kept in the dark right along with investors.

The finger pointing over who’s at fault over auction rate securities has gained momentum in the past week after several of Wall Street’s biggest players - including UBS, Citigroup, JP Morgan Chase and Wachovia - agreed to settle claims of auction rate fraud with New York Attorney General Andrew Cuomo and buy back more than $42 billion of auction rate securities from their customers. Now, smaller brokerages say even though some of Wall Street’s larger investment banks are agreeing to Cuomo’s terms, it doesn’t mean they need to follow suit.

As reported Aug. 19 in the Wall Street Journal, secondary dealers of auction rate securities like Fidelity and Oppenheimer believe regulators should put the onus of blame for the auction market’s demise - as well as any agreements to buy back auction rate securities from investors - solely on the underwriters of the securities and the controllers of the auctions: Wall Street investment banks.

“None of the rest of the market knew about how auction dealers allegedly controlled the whole auction process for 25 years,” said Michael Decker, chief executive of the association that represents regional brokerages, in the Wall Street Journal article.

Whether regional brokers had prior knowledge about the inner workings of the auction rate process may be irrelevant. At the heart of the state and federal investigations regarding auction rate securities is the issue of whether the securities were presented and sold to investors as “safe” and “liquid” when, in fact, they were not. In many cases, investors contend brokers sold them the instruments as cash alternatives - investments they could cash out of at will.

It was only when the auction market collapsed in February - and their auction securities became illiquid - that investors learned their “cash alternative” investments strayed far from the promises of brokers.

Moving forward, the issue of culpability for smaller brokerage houses will be contingent on what regulators uncover in their investigations. Period. Interestingly, several of the brokerages mentioned in the Aug. 19 Wall Street Journal story, including Oppenheimer, E-Trade Financial Corp. and Fidelity Investments, have refused to specify the dollar amount in auction rate securities their clients hold.

Our affiliation of securities 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.

Just when you thought the auction rate securities ordeal might be nearing an end - and investors who’d been pitched the instruments by Wall Street as cash alternatives finally would receive their money back - think again.

In the past two weeks, New York Attorney General Andrew Cuomo has succeeded in getting several major Wall Street players - Citigroup, UBS, JP Morgan Chase, Morgan Stanley and Wachovia, among them - to pony up billions of dollars to buy back the auction rate securities they sold to investors. The catch is in the fine print of the agreements orchestrated by Cuomo: The Wall Street firms only have to pay back the auction rate bonds they sold, not the billions more they actually underwrote.

That small detail could have big repercussions for millions of investors holding illiquid auction rate securities bought through mutual fund firms or individual brokers. As reported Aug. 18 on CNBC.com, a number of regional firms and discount brokerage houses say the blame for the auction rate securities scandal rests firmly with the major underwriters of the securities - Wall Street powerhouse firms that decided to no longer support the auction rate market and dropped out entirely in February.

According to the CNBC article, the Regional Bond Dealers Association, a brokerage trade association, has written a letter to Cuomo and the Securities and Exchange Commission (SEC) in which it claims the real auction rate fraud was conducted by the underwriters of auction rate securities. The Wall Street firms dominated the auction rate market, the letter says, and sold the auction bonds to regional firms and discount brokerages with the promise to hold auctions. The brokers who sold the securities to customers contend they acted in good faith and relied on information about liquidity risks from those underwriters.

And that’s where problems arise. Many regional firms and brokers do not have the financial prowess of major Wall Street banks. Forcing them to buy back auction rate securities from investors at par value could financially bury many of them. The Regional Bond Dealers Association, in its letter to the SEC, said that the only practical solution for making investors whole is to include ARS customers of distributing firms in the settlements with large lead managers.

For his part, Cuomo reportedly stated in an Aug. 16 interview with CNBC that he has no plans to become involved in what could be a he said/she said dispute between brokers and the big Wall Street firms over who is culpable for misleading investors.

“I represent the investor,” he said, “and that’s why I’m treating this as a sales practice issue.” That’s all well and good. But until the fine print in the settlement agreements involving auction rate securities is worked out, thousands of ARS investors are no better off today than they were six months ago.

Our affiliation of securities 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.

When several major Wall Street investment firms - including Citigroup, UBS, Wachovia and JP Morgan Chase - agreed to settle claims of auction rate securities fraud by state and federal regulators, many investors thought their financial problems finally were solved.

As it turns out, that may not be the case. According to an Aug. 18 story on Bloomberg.com, the recent deals that New York Attorney General Andrew Cuomo struck with some Wall Street institutions to buy back billions of dollars of action rate securities they sold directly to individuals do not include investors who hold auction rate debt purchased through mutual fund firms or brokers that didn’t actually underwrite the securities.

And that leaves a lot of unanswered questions. These investors hold some $160 billion of auction rate securities.

“This is a glaring oversight,” said Jonathan Kahn in the Bloomberg article. Kahn is an investor who holds auction rate debt underwritten by Goldman Sachs Group Inc. and purchased through a different brokerage.Investors like Kahn have been in a holding pattern over their auction rate investments since February, when the market for auction rate securities seized up as Wall Street investment banks abruptly stopped offering financial support to buy the securities.

Investors, who previously had been told by their brokers that auction rate securities were cash equivalents, suddenly found themselves with illiquid investments.

Following the auction market’s collapse, several states, including New York, began looking into how Wall Street firms marketed and sold auction rate securities to investors. In August, settlements were reached with some of the biggest underwriters of the securities, with Citigroup, UBS, Morgan Stanley, JPMorgan Chase and Wachovia Corp. agreeing to buy back a combined $42 billion of auction rate securities they sold directly to individuals.

So far, about 30 companies have been subpoenaed by Cuomo’s office for their alleged mishandling of auction rate securities sales. Other states, as well as the Securities and Exchange Commission (SEC), also are involved in ongoing investigations.

Eventually, Cuomo says action against smaller brokerages will come to fruition.

But, as everyone knows, “eventually” on Wall Street could be a long time in coming. Until then, the light that so many investors thought they saw at the end of the auction rate tunnel has fallen dark once again.

Our affiliation of securities 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.