Category Archives: Auction Rate Securities

Three days and counting. That’s the time remaining before Jefferson County Commission must decide whether it will pursue more talks with creditors over a $3.2 billion sewer bond debt or opt for the largest-ever U.S. municipal bankruptcy.

The problems for Jefferson County, Alabama, date back to the 1990s, when the county began a huge upgrade of its outdated sewer system. Acting on the recommendations of consultants from JP Morgan and others, the county entered into a series of disastrous deals that involved complex and risky variable-rate investments, auction-rate debt and interest rate swaps.

The deals later backfired, and the county became stuck with huge loan payments. Meanwhile, then-Birmingham Mayor Larry Langford and a former president of the Jefferson County Commission, ex-Commissioner Chris McNair and others were convicted of rigging the transactions responsible for Jefferson County’s financial downfall.

In 2009, the Securities and Exchange Commission (SEC) charged JP Morgan Securities and two of its former managing directors – Charles LeCroy and Douglas MacFaddin – for their roles in an unlawful payment scheme that allowed them to win business involving municipal bond offerings and swap agreement transactions with Jefferson County.

As part of the settlement, J.P. Morgan agreed to forfeit $647 million of interest-rate swap termination fees, as well as pay a penalty of $25 million to the SEC and $50 million restitution to Jefferson County.

The Financial Industry Regulatory Authority (FINRA) has fined SunTrust Robinson Humphrey (SunTrust RH) and SunTrust Investment Services (SunTrust IS) $5 million for violations connected to sales of auction-rate securities.

According to FINRA, SunTrust RH, which underwrote the investments, failed to adequately disclose to investors the fact that the auctions for the products could fail. Moreover, the company did not share material non-public information with investors, use sales materials that properly described the risks associated with auction-rate securities or have adequate supervisory procedures and training in place concerning the sales and marketing of auction-rate securities.

FINRA says SunTrust IS also had deficient ARS sales material, procedures and training.

Beginning in late summer 2007, FINRA says that SunTrust RH became aware of certain stresses in the ARS market and the risk that auctions might fail. At the same time, SunTrust RH was told by its parent, SunTrust Bank, to reduce its use of the bank’s capital and to examine whether it had the financial capability in the event of a major market disruption to support all ARS in which it acted as the sole or lead broker/dealer.

As the stresses in the ARS market increased, FINRA says SunTrust failed to adequately disclose those increased risks to its sales representatives. Instead, it encouraged them to sell SunTrust RH-led ARS issues in order to reduce its inventory. Consequently, certain SunTrust RH sales representatives continued to sell auction-rate securities as safe and liquid investments.

In February 2008, SunTrust RH stopped supporting ARS auctions, knowing that those auctions would fail and the auction-rate securities would become illiquid.

Additionally, FINRA found that on Feb. 13, 2008, SunTrust RH shared material non-public information regarding the potential refinancing of certain ARS issuers with SunTrust Bank, which were contemplating investing in ARS. This information was material because SunTrust Bank was assured that if the auction market froze, it would likely be able to dispose of the illiquid investments on the date the auction-rate securities were refinanced.

The fate of the Columbia Strategic Cash Portfolio Fund was sealed on Dec. 10, 2007, when losses on investments in mortgage and certain asset-backed securities combined with a $20 billion withdrawal from a single institutional investor forced Bank of America to shutter one of the largest U.S. short-term funds catering to institutional investors.

The Columbia Strategic Cash Portfolio Fund is run by Columbia Management, a unit of Bank of America. Described as an enhanced cash fund and a suitable substitute for money market accounts, the Columbia Strategic Cash Portfolio Fund went from $40 billion in assets to about $12 billion in a matter of months.

The reasons behind the forced liquidation of the Columbia Strategic Cash Portfolio can be traced to its exposure to risky asset-backed securities and structured investment vehicles (SIVs) tied to real-estate mortgages. Some of the SIVs associated with the fund were later downgraded by credit-ratings agencies, creating more losses for the fund.

Unlike traditional money-market funds, the Strategic Cash fund didn’t provide investors with a guarantee to maintain a $1-per-share net asset value.

At the time the Columbia Strategic Cash Portfolio was shuttered, only a few investors found themselves able to liquidate their positions. Other investors were given a pro rata share of the fund’s underlying securities in lieu of cash. And still other shareholders were told they could cash out at the fund’s current share price at a loss.

The liquidity problems associated with enhanced cash funds like the Columbia Strategic Cash Portfolio are reminiscent of those found in auction rate securities, investments once deemed as a safe haven for individual and institutional investors to park their cash. When the market for auction rate securities collapsed in February 2008, however, investors quickly discovered that their investments were far from cash-like.

And that’s exactly what many investors in the Columbia Strategic Cash Portfolio Fund have discovered. Case in point: Costco Wholesale Corporation. As reported May 16, 2008, by the Puget Sound Business Journal, Costco unsuccessfully tried to pull out of several enhanced cash funds in 2008, with $371 million that remained frozen in the Columbia fund and two similar funds. In turn, Costco was forced to report a $2.8 million write-down on investments in those funds because of the decline in their value, according to the company’s 2008 10-K filing with the Securities and Exchange Commission (SEC).

Other companies affected by the Columbia fund include Getty Images. As of March 31, 2008, Getty had $20.4 million invested in the Columbia Strategic Cash Portfolio Fund. According to the Puget Sound story, Getty reported a $400,000 loss because of the decline in the value of the fund.

Another company, SonoSite, Inc., had $8.2 million tied up in the Columbia fund as of March 31. Ultimately, the medical devices company reported $300,000 in losses from that investment.

In the wake of the collapse of the auction rate securities market in February 2008, many of the nation’s largest financial institutions quickly agreed to settlements with state securities regulators as a way to resolve charges they misled retail and institutional investors about the liquidity risks of the instruments they underwrote.

The latest state to order a Wall Street institution to buy back auction rate securities from investors is Pennsylvania, which on Aug. 11 ordered Wells Fargo & Co.’s Wachovia unit to buy back $324.6 million of auction rate securities from an estimated 1,300 Pennsylvania retail investors.

Wachovia also will pay a $2.52 million assessment to the state for its role in the auction rate securities market.

In a press release on the ARS agreement with Wachovia, Pennsylvania Securities Commissioner Steven Irwin said the bank “marketed and sold these securities as safe, liquid and cash-like investments when, in fact, they were long-term investments subject to a complex auction process that failed in early 2008, leading to illiquidity and lower interest rates for investors.”  

The Pennsylvania Securities Commission is continuing its investigation of other investment firms and their sales of auction rate securities. In July, the regulator ordered TD Ameritrade to repurchase $26.5 million of auction-rate securities. That same month, Pennsylvania also reached a settlement with Citigroup over ARS sales. That settlement, which was part of a larger deal agreed to with 12 states, required Citigroup to buy back $978.1 million worth of auction rate securities from Pennsylvania investors. In addition, Citigroup paid a $2.31 million fine to the Pennsylvania Securities Commission.

Citigroup did it, followed by Morgan Stanley, UBS, Merrill Lynch, Wachovia, Bank of America (BofA) and, most recently, Morgan Keegan and Ameritrade. The “it” concerns settlement agreements with the Securities and Exchange Commission (SEC) to repurchase billions of dollars worth of auction-rate securities from retail investors. Scores of Wall Street firms agreed to the deals with regulators, with only a few holdouts. One of those holdouts: Raymond James Financial. 

Raymond James Financial is the subject of Gretchen Morgenson’s Aug. 1 column in the New York Times. In the article, she writes that clients of the Tampa-based brokerage currently hold some $800 million of illiquid auction-rate securities, down from $1 billion earlier this year.

The decline is tied to redemptions by issuers of auction-rate securities, such as closed-end funds and municipalities. So far, Raymond James has shown no interest in redeeming customers’ holdings. Its reasoning? Buying back $800 million of auction-rate securities at par is equal to more than 4% of the company’s total assets and 42% of its shareholder equity. 

On the other hand, Raymond James apparently had the financial stability last year, at the height of the credit crisis, to raise its dividend 10%. The move proved especially beneficial for Thomas James, CEO of Raymond James Financial. James owns 12.2% the company shares outstanding. Dividends on those shares generated a handsome profit totaling about $6 million for James and another total another $6.5 million this year if the company continues to pay the current rate of 44 cents a share.

The payments are in addition to James’ salary and pay package, which is valued at $3.55 million, according to the New York Times story.

Then there’s the money Raymond James came up with to fund its corporate branding campaign. In 2008 and 2009, the company spent $6.3 million to acquire the naming rights to the stadium where the Tampa Bay Buccaneers play. The contract runs until 2016, and the costs rise 4% every year.

Meanwhile, as the “financially strapped” Raymond James funds million-dollar salaries, raises its dividend and outlays millions of dollars on corporate advertising and marketing efforts, its clients remain permanently caught in an auction-rate securities nightmare.  

Region Financial Corp.’s brokerage arm, Morgan Keegan, was sued on July 21 by the Securities and Exchange Commission (SEC) on charges that the Memphis-based firm left clients stranded with more than $1 billion in auction rate securities.

According to the SEC, Morgan Keegan failed to tell customers about the growing risks associated with auction rate securities. Instead, it reportedly encouraged brokers to ramp up their efforts to sell the instruments prior to the market’s collapse in February 2008.

The SEC is demanding that Morgan Keegan buy back any auction rate securities sold before March 2008 from retail investors and small businesses, as well as pay fines. In addition, the regulator wants Morgan Keegan to forfeit any proceeds from its auction-rate business. From June 2007 to February 2008, the SEC says Morgan Keegan earned more than $4 million in underwriting, brokerage and distribution fees.

 “Morgan Keegan was clearly aware that the ARS market was deteriorating, but it went so far as to actually accelerate its ARS sales even after other firms’ ARS auctions began to fail,” said SEC Enforcement Director Robert Khuzami in a statement.

TD Ameritrade has become the latest brokerage firm to repurchase auction rate securities (ARS) from retail investors as part of a settlement agreement with state and federal regulators. New York Attorney General Andrew Cuomo announced the deal with Ameritrade yesterday, stating the online brokerage would buy back $456 million of auction rate securities from about 4,000 customers.

The announcement with TD Ameritrade comes on the heels of Cuomo’s plans to sue Charles Schwab for allegedly misrepresenting the safety of auction rate securities to clients.

TD Ameritrade’s settlement, which was jointly made with the New York Attorney General, the Pennsylvania Securities Commission and the Securities and Exchange Commission (SEC), requires the company to repurchase any auction rate securities bought before February 2008 from individual investors, charities and small businesses. 

The company has until March 2010 to return the money to customers, although it could take until late June to fully complete the buybacks. For clients with accounts under $250,000, TD Ameritrade says the buybacks will be done within 75 days.

In addition, TD Ameritrade must reimburse investors who sold their auction rate investments at a discount following the market’s collapse in February.

Thousands of investors across the country initially bought auction rate securities on the basis that the instruments were safe, cash-like investment products. In February 2008, however, the Wall Street firms that once supported the auction market suddenly pulled out, leaving retail and institutional investors holding an illiquid investment.

Over the past year, New York Attorney General Cuomo has spearheaded settlements with more than 20 investment firms and banks to buy back more than $60 billion of auction rate securities from investors. Those institutions include the majority of Wall Street’s biggest firms, including Citigroup, Merrill Lynch, Wachovia, Morgan Stanley and JPMorgan.

Charles Schwab, the “Talk to Chuck” online brokerage firm, has the ear of New York Attorney General Andrew Cuomo. A July 20 article in the Wall Street Journal is reporting that Cuomo warned Schwab on July 17 of his plans to sue the company for civil fraud over its marketing and sales of auction-rate securities to individual and institutional investors.

In the letter sent Friday, the New York Attorney General said he will move forth with the lawsuit unless Schwab agrees to buy back the auction-rate securities from investors. 

Last summer, many of Wall Street’s major investment firms, including Citigroup, Merrill Lynch, and UBS, agreed to repurchase more than $50 billion in auction-rate securities to avoid state and federal charges that they misrepresented the instruments as conservative, liquid investments. In February 2008, the $330 billion market for auction-rate securities came to an abrupt standstill, after the banks and investment firms that once managed the auctions suddenly backed out of the market.

As a result, thousands of retail and institutional investors were unable to sell their securities.

According to the Wall Street Journal article, e-mails and testimony cited in Cuomo’s July 17 letter to Charles Schwab show brokers had little idea of what they were actually selling to investors and then later failed to tell clients that the auction-rate market was on the verge of collapse.

A downturn in the economy, coupled with bad investments in auction rate securities and other risky financial instruments has left many foundations, universities and nonprofits with record low endowments. A March 2009 study from the Commonfund Institute showed that endowments at colleges, universities and independent schools saw their worst performance ever at the end of 2008, losing an average of 24.1%. Previously, endowments had their worst year in 1974, with an average loss of 11%.

The Commonfund survey included 235 institutions that lost $28 billion in asset value from July 1 to Dec. 31, bringing their endowments to $87 billion. About 51% of endowment assets were allocated to alternative investments, such as hedge funds and buyout funds as of Dec. 31, which is an increase from 46% six months earlier.

The collapse of the auction rate securities market in particular has created a firestorm of trouble for many foundations and nonprofit organizations. ARS buy back programs, which were announced last summer by some of Wall Street’s biggest investment firms and banks did not cover institutional investors, only retail investors and small businesses. 

As result, many foundations and nonprofits have been stuck with investment portfolios of hard to value and difficult to sell assets. Among these investments are mortgage related securities and collateralized debt obligations (CDOs), high risk products that are not trading on viable secondary markets.

For some entities, the plunging asset value of their endowments has forced them to close their doors. Others have reduced services or cut staff.

A March 20 article in the News and Observer offers another grim reality for universities, nonprofit organizations and foundations: The value of their endowments is being pulled so far down that they’re now worth less than the original donations. In other words, they’re under water. Adding to their financial woes are state laws that prevent nonprofits from tapping into their principal.

No one can say exactly how many foundations and nonprofits are struggling with under water endowments but, by all accounts, it is grave. Says Harvey Dale, director of the National Center on Philanthropy and the Law at New York University, in the News and Observer article: “Anecdotally, it is a serious problem. And if the current financial downturn continues, the problem will only get worse.”

Missouri Secretary of State Robin Carnahan had harsh words for the brokerage firm Stifel, Nicolaus & Company and its plan to give investors holding auction-rate securities only $25,000, or 10%, or their frozen savings. 

On Feb. 11, Carnahan told Stifel it needed to immediately come up with an alternative solution that will buy back all frozen auction-rate securities from clients, many of whom have had their savings frozen since the collapse of the auction-rate market in February 2008.

Last August, a class-action lawsuit was filed against Stifel, Nicolaus & Company and its parent company, Stifel Financial Corp., by investors who claimed the companies deceived them about the investment risks of auction-rate securities and the auction market in which the securities were traded. Specifically, the lawsuit said that Stifel Financial and Stifel Nicolaus sold and represented auction-rate securities as “cash equivalents or better than money market funds.” 

Following the break-down of the auction-rate market one year ago, a number of Wall Street investment firms and banks agreed to buy back auction-rate securities for the prices their clients had paid for them. The buy-back settlements, which totaled more than $50 billion, put to rest state and federal charges that investment firms had improperly marketed and sold auction-rate securities to investors.

Stifel, the third-largest brokerage based in St. Louis, wasn’t part of the settlements, however. Until recently, the firm refused to buy back auction-rate securities from clients, claiming it did nothing wrong. Other regional brokerages, including Raymond James Financial, also have resisted ARS buy-back programs.

Those decisions have had a devastating effect on ARS investors like Glenn Linke, 80, and his wife, Norma, 73. As reported Jan. 11 in the St. Louis Dispatch, the elderly couple had decided to add a first-story bedroom to their house because they were no longer able to easily climb stairs. When the construction bills came due, they called their broker at Stifel Nicolaus, instructing him to sell some of their weekly CDs.

That’s when the Linkes’ were hit with news no investor wants to hear: Their money was frozen. The weekly CDs actually were auction-rate securities. 

The Linke’s story is typical of many investors stuck in auction-rate securities. Today, at least 33 formal complaints have been filed by Stifel’s auction-rate customers with the Missouri Secretary of State’s office. All report that they were promised auction-rate securities would be the “same as cash.”

On Feb. 11, after hearing Stifel’s plan for its auction-rate customers, one investor called Missouri’s Secretary of State to express his frustration. “Ten percent is nothing but an insult,” said the 60-year-old. “If it wasn’t for Stifel’s misleading sales tactics, I would have all of my savings right now.”

In a press statement released in response to Stifel’s auction-rate plan, Secretary of State Carnahan said the following:

 “After nearly a year, Stifel is finally beginning to address this issue but it is too little, too late for those who desperately need their frozen savings. It is time for Stifel to follow the lead of other major investment banks and give their customers the access to their money that was promised. In these uncertain economic times, my office will continue taking the necessary steps to help these investors get their savings back.”