August 14, 2008 – Crosby & Higgins LLP Helps Lead Charge For Auction Rate Securities Settlements
August 14, 2008
Crosby & Higgins LLP Helps Lead Charge For Auction Rate Securities Settlements–Crosby and Higgins LLP has been at the forefront of aggressively pressing claims on behalf of individual and institutional investors arising out of the collapse of the auction rate security (“ARS”) market. The firm was one of the first to file arbitration claims with the Financial Industry Regulatory Authority (FINRA) and has consulted with investors on ARS claims against Citibank, Morgan Stanley, Merrill Lynch, E*Trade and Bank of America, among others. Already it has become clear that the financial institutions involved knew they were unloading illiquid investments on the unsuspecting public and thus should be held liable for the resulting fallout. Perhaps not surprisingly then, news broke this week that Citibank, Merrill Lynch, UBS and Morgan Stanley are now prepared to buy back billions of dollars of illiquid auction rate securities from unsuspecting investors that had been saddled with these investments since the market collapsed earlier this year. This major departure from their repeated denials of liability comes in large part thanks to the combined pressure of advancing private suits and intensifying regulatory actions. This is welcome news for investors.
The auction rate securities debacle erupted the week of February 11, 2008 when the nation’s leading financial institutions abruptly ended their role in supporting the auction rate securities market, causing the market to collapse. As a direct result, investors were left holding approximately $330 billion in illiquid securities that were marketed and sold to them as “cash equivalents.” Auction rate securities refer to a type of debt security with nominally long-term maturities (as long as fifty years) and variable coupon rates. Periodic Dutch auctions are held by the underwriting financial institution, usually every seven to thirty-five days, to set the coupon rate for each period and allow for bondholder redemptions in a successful auction.
Auction rate securities, however, are a fundamentally flawed product in that they rely on the historically failed model of utilizing short term borrowing for long-term financing. Prior to the decision of all of the major financial institutions to withdraw support from the ARS market, broker-dealers supported the auctions by providing a clearing bid. The clearing bid assured that when not enough competitive bidders showed up at an auction, the broker-dealer would buy the excess securities for its own account and resell them at a later auction in order to prevent a failed auction from occurring. Hence, the major financial institutions regularly provided a needed liquidity backstop to the ARS market. As such, the auction market depended upon the continued participation of broker-dealers to sustain the auctions through their purchase of any excess securities for their own accounts. When the broker-dealers ceased their participation, the market collapsed and investors were abandoned with illiquid investments. As suspected from the outset, the financial institutions knew that the collapse was imminent as they pumped up their marketing and sales efforts directed at the customers of their broker-dealer affiliates.
In response to the building pressure exerted by both regulators and pending claims, on August 7, 2008, Citibankproposed that it would redeem approximately $7.5 billion of auction rate securities from individual investors, small businesses, and charities and also use its best efforts to liquidate the approximately $12 billion worth of ARS the firm sold to retirement plans and other institutional investors. Shortly thereafter, Merrill Lynch agreed to buy back $17 billion and UBS pledged to start buying back $19 billion from individuals and charities in October and from institutional clients in 2010. Following suit, Morgan Stanley announced it plans to buy back approximately $4.5 billion in ARS, “held by all individuals, all charities and those small to medium-sized businesses with accounts of $10 million or less.”
Despite the settlements, a number of investment firms still refuse to provide restitution to their customers. Among those who continue to stonewall their customers are Goldman Sachs ($17.80 billion), JP Morgan ($15.72 billion), Bear Stearns ($12.61 billion), Bank of America ($11.03 billion), RBC Dain Rauscher ($10.25) billion, Lehman Brothers ($9.74 billion), Wachovia, Oppenheimer, E*Trade, TD Ameritrade, Allianz/Pimco and Charles Schwab. Given the massive losses reported by some of these firms with respect to write downs in connection with subprime losses, their bloated balance sheets and ability to borrow capital may actually limit their ability to redeem auction rate securities. As a result, in some instances, it will continue to make sense to bring arbitration claims seeking expedited redemptions from these firms.
While investors have reason to be relieved by the recent settlement announcements, solutions can often present as many questions as they solve. Each of these offers apparently comes with unique qualifications such as timelines and restrictions regarding investment size which need to be analyzed based on each investment. Further, some offers appear to include reimbursement for incidental costs such as interest charged on loans secured against ARS while others do not. Also, the offers mostly have not been extended to institutional investors and large businesses, which must therefore continue to press for redemptions. It is important that all investors carefully scrutinize the offers, thoughtfully considering their options to prevent any further damage to their investments, and consult legal advice on the most efficient route to recovery.
Crosby and Higgins LLP, mindful of its crucial role in helping to create the atmosphere that produced the settlement offers, is poised to continue assisting investors in understanding these offers and to continue fighting for our clients to receive immediate and complete restitution. Already involved in ongoing arbitrations, we are also uniquely positioned to assist those businesses and institutional investors that have been ignored in the recent ARS settlement offers. If you have any questions about the ARS offers or what your options are in response, please feel free to contact us at (646) 452-2300.