Category Archives: Investor Beware

Many investors are feeling handcuffed to their auction-rate securities (ARS) as the struggle to get money back from the Wall Street banks continues. Bank of America, UBS AG and Wachovia Corp, (three of the firms that sold $330 billion worth of these securities) are now preventing efforts to create a second market. This market would provide investors access to their cash.

One investor, who has not had access to his invested money since February when the auction rate market began to freeze, is upset the bank is unwilling to release his bonds. Bank of America refuses to let him sell $100,000 of securities to Fieldstone Capital Group, claiming the deal is not in his interest. Brokers rejecting these transactions claim they are saving their customers from further unnecessary losses on the securities that they marked as cash-like instruments to begin with.

According to Vincent Dicarlo, formerly a lawyer at the SEC’s enforcement division, “if an investor finds a buyer, he should be able to move his securities to another dealer or take possession to complete the transaction.”

UBS has refused to find buyers for customer’s auction-rate securities because, in their opinion, the secondary market is “inefficient”. What could the secondary market be inefficient to if the primary market no longer exists?

“For someone needing their cash, the only choice is to go to the secondary market and sell them with a haircut,” said Steven Caruso, an attorney at Maddox Hargett & Caruso, who is representing investors in lawsuits against dealers.

According to Darrell Preston’s June 6, Boomberg.com article, since March at least 24 proposed class action suits have been filed over claims investors were told the securities were almost as liquid as cash. These investors have been caught for months with auction rate debt since the buyers that ran the bidding could no longer support the market due to losses linked to subprime mortgages. Before investors believed they could get their money back right away because dealers always bought the unsold securities.

Not only has Wall Street misrepresented these products to their customers, it appears some firms are now preventing these same customers from getting the relief and access to their money that many desperately need.

Preferred holders are fed up with waiting for Pacific Investment Management Co. (Pimco) to figure out a course of action to help those suffering after the collapse of $330 billion auction-rate securities market.  

Pimco is struggling to find a comfortable medium between their preferred holders and investors in the funds’ common shares, which trade on exchanges like stocks. The two groups have competing interests, therefore, making it difficult for the fund managers to refinance ARS without hurting the common holders by increasing costs.  

Municipal-bond issuers control a majority auction-rate market, so when the companies insuring these bonds were threatened by reduced credit-ratings, the market failed. The crisis left investors alarmed and with $63.4 billion of illiquid preferred shares.  

One holder told Bloomberg.com he bought “several hundreds of thousands of dollars” in the auction- rate preferred shares issued by Pimco’s closed-end funds before the freeze in February. Shareholders similarly situated are disappointed in Pimco’s lack of communication and failure to develop a solution. They have a just reason to be frustrated.  Pimco is the only top five manager of publicly traded closed-end funds without a plan for their investors to cash out.  

According to a company spokesman in Christopher Condon’s May 30, 2008 article, Pimco is “devoting considerable time, energy and attention to finding an approach that, consistent with our fiduciary obligation, reconciles the competing considerations facing common and preferred shareholders.”  Only time will tell how Pimco ultimately decides to treat investors.

Effective today, Fidelity Investments has been notified by Interactive Data, its third-party pricing vendor, that they will discontinue evaluating approximately 1,100 student loan auction rate securities (ARS) and 26 asset-backed securities. 

What this likely means for investors is that their next monthly statement will reflect “N/A” for the value of their action rate securities.  This will come as a tremendous shock to many investors who had been told by their brokers not to worry about the frozen auctions because the value of their positions was still there, it was only unavailable for a time.  Now many investors are going experience their greatest fears, the value will disappear from their statements (and possibly from their portfolio).

For investors already on edge due to the auction rate markets freeze, they now will have to deal with the realization that these products are in fact not as they were sold.  They are not cash equivalents.  They are in fact risky investments that can and will cause significant losses to their holders.

Media reports regarding auction rate securities have been widespread over the last several months.  And although many investors were not happy that their investments were tied up due to the failed auctions, many believed that things were only temporary.  Wall Street and its brokers perpetuated these feelings.  Now the truth is coming out.

It is not just Fidelity clients who are likely to witness N/A on their statements.  Investors with auction rate securities at other firms are likely to experience the same fate.  For investors waiting to see what is going to happen in this market, the shock of seeing the loss of value from these positions should move many to action.

The best course of action for an investor concerned with the performance of their ARS is to contact an attorney.  Many cases have already been filed on behalf of investors whose securities have lost all or part of their value.  Clearly these investments were misrepresented to investors.  Now, unfortunately, the losses are being recognized.  

Today’s Wall Street Journal reports that while the freeze in the auction-rate securities market struck many individual investors and their financial advisors as a surprise, Wall Street firms that marketed one type of auction security scrambled to prevent auction failures several months before the market collapsed.

Ian Salisbury writes that UBS AG, Citigroup Inc. and Bank of America requested at the end of last year that several student-loan authorities issue waivers that would make these securities easier to sell.

What this says is that Wall Street firms were aware of the potential for auction failures months before the failures began.  The question then becomes what were these firms telling their brokerage clients about risk during this time.

Investors were sold auction-rate securities as liquid, cash equivalents.  Once the auctions began failing, the market for these securities froze and investors have been left holding their investments ever since.     

While the firms highlighted in the WSJ piece refused comment, it is likely that they  will have to answer questions soon as investors who suffered losses start litigating their claims.

New York Attorney General Andrew Cuomo has launched an investigation into auction rate securities.  Just last week, the Attorney General’s office issued subpoenas to 18 Wall Street institutions.  It has been reported that more subpoenas are expected. 

The investigation is looking into the way these securities were marketed and sold to both municipalities for financing and to individuals as investments.  As has been reported by a number of media outlets, the auction rate securities markets have been largely frozen since February.  The lack of liquidity in a product sold as a cash alternative has raised red flags with regulators.  

In addition to the NY Attorney General, a task force of other state securities regulators has been created to investigate the actions of Wall Street firms relative to the auction rate market.    

In SmartMoney’s May 2008 issue, James B. Stewart writes an insightful article regarding auction rate preferred shares (ARPS).  Mr. Stewart calls on Wall Street to “do the right thing” and redeem investors positions.

ARPS are shares in closed-end mutual funds that own various kinds of triple A-rated bonds.  These shares were sold as “cash equivalents” to investors concerned with liquidity and preservation of capital.  Brokers told investors that these investments offered little or no risk because rates were set at regualr auctions, often every seven days.  However, due to the ongoing credit crisis, these auctions began failing in February.

At that time, Goldman Sachs and Citigroup stopped bidding in these auctions.  Other Wall Street firms soon followed suit.  The result was an evaporation of liquidity.

Now thousands of investors in the $330 billion auction rate securities market are left holding investments that were sold as safe, cash equivalents.  Three months into this crisis and many auctions remain frozen.

Mr. Stewart asks that Wall Street step up and take care of its customers.  But to date, Wall Street has refused to do so.  Many firms have offered their valued clients loans to cover any liquidity concerns, but none are redeeming these shares at par.  As Mr. Stewart points out, there is somehting wrong with the way Wall Street has chosen to handle this issue.

Clearly brokerage firms did not appropriately represent these products.  Although historically ARPS have performed similar to money markets, they are not money markets.  There are risks with auction rate securities (as many investors have now become aware).  Wall Street knew these risks existed. 

Should these auctions remain frozen and Wall Street not step up and redeem investors’ shares, the only recourse for aggreived investors will be filing claims for their losses.  If past actions of Wall Street are any indication, it appears that many investors will have no choice but file claims to recover their funds.  Funds that were supposed to be safe and liquid.  

Quoting Mr. Stewart, leave it to Wall Street to “turn a plain-vanilla product into a nightmare for investors.”          

Bear Stearns, the fifth largest investment bank on Wall Street, has fallen.  The end was exacerbated by Bears’ exposure to the subprime markets and the ongoing credit crisis. 

Just days before the Fed and JP Morgan stepped in to rescue Bear, most on Wall Street would have said that it was unthinkable that a major investment firm would fall.  In fact, even as rumors of Bears’ liquidity problems surfaced, no one was speaking of total collapse.  However, within days of the rumors, the Fed and the Treasury Department were working to put a deal together to bail out Bear Stearns.  

On a long Sunday, government officials met with officers and directors of Bear and JP Morgan in an attempt to broker a deal that would prevent the bankruptcy of a major Wall Street player.  At the end of the day, a deal had been reached.  JP Morgan would buy Bear Stearns for $2 a share. 

In the aftermath of the announcement, Bear shareholders were crying foul.  Bear was, afterall, trading for over $150 a share a year ago.  As a result of shareholder discontent, JP Morgan has recently raised its offer to $10.02 a share-still a far cry from what Bear was trading at just two weeks ago.

The question for many investors is ‘how could this happen?’  How could such a prominent Wall Street firm simply fail?  The answer is partly due to the complexities of the products that Bear (and other investment banks) create to sell to investors.

As babyboomers retire and the amounts of investable monies grow, Wall Street is looking for new ways to generate profits (for both themselves and clients).  As a result, investment firms are constantly creating products that supplement the usual stocks, bonds and mutual funds.  One of those newly created investments, collaterized debt obligations (CDOs), is generating quite an impact on the markets today.   

CDOs are investment products that pool mortages and other debt together and are sold to investors.  Much has been written about how mortgages, often of the subprime variety, were packaged by investment banks and sold.  As the housing market burst, many homeowners were left unable to meet their mortgage payments.  The result has been an increase in defaults and therefore a decline in the value of the investments.

It seems to many that a perfect storm came together and that Bear Stearns was a victim of the unforseeable.  However, the problems in the current market were created by Wall Street.  Bear Stearns, and others like them, are not victims of the credit crunch.  They  are responsible for it.  The real victims are the investors who were sold products that were unsuitable, whose risks were not properly disclosed and who have lost millions as a result.

Although the collapse of Bear Stearns is a historic event, the collapse of many investors’ portfolios is the true tragedy.  The government has stepped in to help the investment banks, who is going to help the real victims?             

Gretchen Morgenson penned an insightful piece in the March 9, 2008 Sunday Business section of the New York Times.  Ms. Morgenson likened auction-rate securities to the Hotel California, where investors have checked-in, but they can never leave.

Auction-rate securities are debt instruments whose interest rates reset at regular intervals, often weekly, and usually have long maturities.  The auctions for these notes are overseen by the very Wall Street firms that originally sold them.   

Historically these notes freely traded at the auctions.  As a result, Wall Street sold these products to investors as an alternative to cash.  However, when the $330 billion market for these products halted in February 2008, investors were left holding these notes with no market available.  This freeze has left investors with no immediate way to liquidate their positions.

To date, the auction-rate securities have not defaulted.  Investors are receiving a fixed interest rate as detailed in the note’s offering documents.  But clearly the failing auctions are creating concerns among investors as to when, if ever, they can access their money.  Many feel that it is only a matter of time before we see the first defaults.

What is clear at this time is that these products were misrepresented by Wall Street.  They were sold as cash alternatives.  Considering investors are not free to liquidate at their pleasure, these investments are not cash alternatives.  As Ms. Morgenson suggests in her article, investors are in for a shock when they see their month-end statements reflecting major declines in the value of their auction-rate securities.     

The front page story in today’s Wall Street Journal illustrates how investors of all types have been stung by the subprime crisis.  The WSJ reports that the Maher brothers, M. Brian and Basil, have lost over $286 million in investments through Lehman Brothers Inc. 

The Maher’s sold their family’s shipping business this past summer for over $1 billion.  Following the sale, the brothers sought investments that were safe and conservative.  However, within weeks they had lost over a quarter million dollars.  

How can this happen? Well the Mahers are not unlike many investors who were allegedly misled regarding the investments they were sold. 

At issue in the Maher case are “auction rate” securities.  These auction rate securities are long term bonds that behave like short term bonds.  Until recently, not much was known off of Wall Street about these products.  However, as Wall Street became more and more creative with the investment products they packaged and sold, these auction rate securities started finding their way into more investors portfolios.

The lure of these bonds was that they acted like money markets while producing slightly higher returns.  In addition, these funds were easy to buy and sell.  This was exactly what many conservative investors wanted.  Unfortunately, these bonds, like many others, did not perform as represented.

One outgrowth of the ongoing mortgage and subprime crisis is that many investors and banks are not willing to add more debt positions to their books.  As a result, the market for these funds has dried up.  This has left investors holding products that are now worth only a fraction of their original value.  

While their losses are staggering, the Mahers are just one example of investors suffering losses due to Wall Street misrepresenting the complex products they have created.  Their case is no more disturbing than the scores of investors who lost far less.  No matter what the losses, Wall Street needs to be held accountable for their misrepresentations.  

Maddox Hargett & Caruso, P.C. is investigating the possibility of taking legal action on behalf of investors that lost money in a collateralized debt obligation (“CDO”) called Norma CDO I Ltd.(“Norma”).

Merrill Lynch created Norma to capitalize on the sub-prime market before that market crashed. Norma’s holdings consisted primarily of CDOs and the resulting structured investment products were sold to both retail and institutional investors. Over $1.5 billion of these securities found their way into the portfolios of investors. 

As a result of the recent housing market collapse and the ongoing mortgage crisis, the value of Norma has been greatly diminished. This decline in value has led to significant losses for investors. 

We are investigating how Merrill Lynch and others marketed Norma, and whether the true risks of Norma were fully disclosed to its investors. Questions have arisen and we are working to determine whether Norma was suitable for the retail and institutional customers that invested in the product.