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Home > Cases > Auction-Rate Securities > Band-Aid Solutions Provide Little Comfort to Holders of Auction-Rate Debt

Band-Aid Solutions Provide Little Comfort to Holders of Auction-Rate Debt

For more than two decades, auction-rate securities were quietly pitched to investors as a safe haven to park their cash and reap benefits of yields higher than those of traditional money-market funds.

Everything seemed to run without a hitch. Municipalities, not-for-profit groups, student lenders and closed-end mutual funds sold the auction debt as a way to raise capital. In turn, individuals and companies bought the securities, which had long-term maturities that acted like a short-term investment by paying interest rates reset through auctions held every seven, 14, 28, or 35 days.

Then, in February, the bottom literally fell out of the auction-rate market.

As reported in a June 12 story by Liz Rappaport in the Wall Street Journal, when the fall out of the subprime mortgage crisis made its way to other areas of the credit markets, the auctions for the auction-rate securities began to fail miserably, unable to attract enough bidders. The Wall Street investment banks - which previously had conducted and financially supported the auctions - abruptly stopped their involvement.

As a result, the auction-rate securities market became “frozen,” leaving thousands of small investors with major-size financial headaches.

Where to Turn

The perpetual freeze of the auction-rate market has meant investors are forced to face a grim - and unknown - financial future. Rappaport cites the case of Cecilia Walsh, a 47-year-old woman who put $375,000 from a divorce settlement into auction-rate securities. She planned to use the money for daily living expenses.

That didn't happen.

When the auction-rate-debt market froze up, Walsh was left out in the cold. Unable to access her money, Walsh's broker, UBS, offered her a margin loan, using her auction securities as collateral. Later, however, UBS began to mark down the value of the securities held in Walsh's account and now wants her to repay a portion of the loan.

Scenarios like this have become commonplace, leaving investors who hold auction-rate securities forced to face the very real prospect that they may never see the full value of their investment again.

There are options, of course, but they are band-aid solutions at best. Investors can take out loans from their broker, but they run the risk that the value of their securities could continue to fall. They can sell their securities on the secondary market if they are willing to accept a steep discount (and, as seen in recent news reports, some brokers are refusing to even release the securities to clients who wish to go this route). Or, investors can simply ride the current situation out, hoping the auction market will eventually return to “normal” trading one day in the future.

Another option - and the one that Walsh elected - is to file an arbitration claim. Walsh apparently is seeking the full value of her original investment, plus more than $1 million in punitive damages, from her broker, UBS.

In the months ahead, expect more investors to follow Walsh's lead. Financial experts are betting that the number of arbitration claims connected to auction-rate securities will mushroom as weary investors become tired of the band-aid solutions proposed by Wall Street. So far, about 80 such claims have been filed, according to the Financial Industry Regulatory Authority, the nongovernmental watchdog of the securities industry.

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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