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Home > Cases > Auction-Rate Securities > Auction-Rate Securities: Where To Go From Here

Auction-Rate Securities: Where To Go From Here

It's been a season of discontent for auction-rate securities, not to mention for thousands of individual investors stuck with the now-illiquid investments that brokers had told them were as good as cash.

Many of these investors are taking their frustration out in court, filing lawsuits against the Wall Street firms that marketed the securities as safe, high-yielding cash-like investments.

For months now, the $330 billion auction-rate market has been plagued with problems. Beginning in February, the bond insurers responsible for backing the auction bonds began to lose their high-grade ratings. In turn, buyers for the securities disappeared, and the brokerage firms and investment banks that once prevented the auctions from failing refused to step in and support them.

As a result, the auction-rate market became “frozen,” leaving retail investors trapped in a short-term, cash-equivalent investment that had become a long-term instrument they still cannot liquidate.

Many of the investors burned in the auction-rate fiasco are like 51-year-old Jerry Cohen. Cohen, as reported in the May 22 issue of Business Week, was on a fixed disability income and needed immediate access to his finances. With $150,000 in hand from the sale of a home, Cohen went to a local branch of Wachovia bank, where he planned to put his money into certificates of deposit (CDs). That is until the bank's brokerage representative advised him to go with auction-rate securities instead. Cohen ultimately ended up owning auction-rate preferred shares issued by closed-end funds of Nuveen Investments.

According to the Business Week article, the Wachovia agent never explained the auction-rate process to Cohen, or the risks associated with the securities. In the end, Cohen joined thousands of other investors who have unwittingly become members of the failed auction-rate securities club.

Like other members of that club, Cohen has filed an arbitration action with the Financial Industry Regulatory Authority (FINRA), the watchdog group responsible for overseeing the nation's investment banks and securities firms, for what he says was Wachovia's failure to provide sufficient information on auction-rate securities.

Stories like these are what prompted securities regulators in 10 states to launch probes and investigations into how Wall Street investment banks and securities firms marketed auction-rate securities to investors. Earlier this year, a task force headed by Bryan Lantagne, director of Massachusetts' securities division, was formed to coordinate various state efforts.

The Securities and Exchange Commission (SEC) also has an ongoing investigation into the auction-rate market, and in fact requested information from Wachovia concerning its underwriting, sale and auctions of auction securities in May.

Meanwhile, individual investors like Cohen are left with the grim process of untangling themselves from the auction-rate mess as they look for answers from the banks that sold them the investments in the first place. Thus far, some brokerage firms are allowing customers to “borrow” loans against their illiquid auction-rate bonds. A few issuers have started to buy back portions of the securities. There's also a secondary market that has now opened for trading, giving investors who are willing to take a loss on the principal of their investment an avenue to get their money.

Still, investor patience is wearing thin and cynicism growing large over the current state of the auction-rate securities market. Already, the majority of Wall Street's investment banks and brokerage firms face class-action lawsuits and charges of securities law violations and inadequate disclosure.

In the coming months, the seriousness of the problems surrounding the auction-rate securities debacle will likely become even more evident, according to analysts, as hundreds of arbitration claims are expected to be filed on behalf of investors who say the promises made by Wall Street failed them miserably and were as empty as their now-illiquid investments.

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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