The nation's financial markets collapse has introduced to the public new games the institutions played in pursuit of the almighty buck. One under the radar is auction-rate securities.
"Auction-rate preferred securities is the largest fraud ever perpetuated by Wall Street on investors," said Harry Newton, a private investor who operates the AuctionRatePreferreds.org website. "It dwarfs all frauds in history, including (Bernard) Madoff."
Auction-rate securities, generally backed by student loans, municipal bonds or other debt, have interest rates that are reset periodically through auctions -- sometimes as often as once a week. More than $330 billion of the securities were sold in recent years to investors attracted to their yields, which could be a percentage point or more above a typical money market fund.
Almost every banking institution dabbled in these securities and all were burned when the market collapsed. Investors cried securities fraud because the bankers promised them their returns were safe.
The result has been a flurry of lawsuits and arbitration by investors to recovery some of their losses. At least one judge has thrown out a class action case against the banks. The latest lawsuit charging fraud was filed by the state of California against three Wells Fargo & Co. subsidiaries on Thursday.
Atty. Gen. Jerry Brown alleged they committed securities fraud by telling California investors that $1.5 billion of risky securities sold to them were as safe as cash.
The securities "were sold to customers on the basis that they were like cash and people could get their money back in eight days," Brown said in an interview. "Now, it turns out they were not like cash and people can't get their money back even after many, many months, and they're mad as hell."
Regulators have alleged that many banks and investment firms deceived their clients into believing that auction-rate securities were as safe as a money market account. But when the market for auction-rate securities collapsed in February 2008, many investors couldn't sell the securities, or could sell them only at a loss. According to the Los Angeles Times:
Several financial-service companies that issued auction-rate debt have agreed to repurchase billions of dollars of the devalued securities to settle claims by regulators that they defrauded investors.
Last month, Wachovia Corp., which Wells Fargo acquired last year, agreed to repurchase $1.5 billion of the securities from California investors in a settlement with the state Department of Corporations that also included a division of Citigroup Inc. Brown said that case didn't involve the securities at issue in the lawsuit he filed Thursday...
The state alleges that Wells Fargo sales personnel weren't properly trained in the intricacies of auction-rate securities, and that the risks of the investments weren't explained to clients. Investors included retirees and small businesses, and accounts ranged from $25,000 into the millions of dollars, the suit says...
"We fully understand and deeply regret the effects this prolonged liquidity crisis has had on our clients," Charles W. Daggs, chief executive of Wells Fargo Investments, said in a statement.
"Wells Fargo could not have predicted these extraordinary circumstances, and even with the benefit of hindsight is not responsible for them."
Also on Thursday, Braintree Laboratories, a pharmaceutical company, filed a lawsuit in the U.S. District Court in Massachusetts claiming $33.2 million of auction-rate securities were sold to them by CitiGroup even though the market for them had collapsed.
Citigroup concealed from regulators and customers its continued sales of such toxic instruments by means of false and misleading descriptions, and also destroyed relevant evidence concerning its wrongdoing," Braintree said in the filing.
Even national models of business savvy such as Texas Instruments Inc. has sued Citigroup Inc., Morgan Stanley and Bank of New York Mellon Corp. for selling it $524 million in auction-rate securities that were supposed to be as good as cash but turned out to be impossible to sell.
Reports the Dallas News:
The Dallas-based chipmaker says the three financial companies misled it into purchasing the securities by understating the risks of auction failures that would – and did – leave TI unable to cash out.
"TI has an absolute commitment to conducting business transactions in an ethical manner and holds its suppliers, partners, vendors to that same standard – banks are no exception," TI spokeswoman Kimberly Morgan said.
ARS owners were – and still are – mostly stuck with investments they could not sell at scheduled auctions. Often, investors were forbidden by underwriters from selling their securities at a loss.
A mass of lawsuits were filed after the ARS market broke in February 2008, some as class actions, some as independent suits. More have filed in months since, and there have been several large settlements between underwriters and various government agencies acting on behalf of investors.
To date, existing cases have not moved far enough through the judicial process to establish any rules of thumb about how underwriters, brokers, investors and bond issuers will share the costs of unwinding or reviving the ARS market.
Diane Nygaard, founder of the Nygaard Law Firm in Kansas City, Mo., is a leading expert on auction-rate securities. On her website she writes:
Clients with auction rate securities may wonder if they can prove that they were misled into purchasing the securities. The truth is that some broker-dealers have already been fined by the government for misleading investors, so it is well documented that companies made fraudulent statements when selling auction rate securities. In fact, Wachovia was recently fined $4 million by Texas for misleading investors about the safety of auction rate securities. In other words, many people say they were misled when they bought their auction rate securities and the government is backing them up.
"The other thing that happened last week is that the UBS class action lawsuit was dismissed by a judge," Nygaard says. "Anybody who has not been compensated by UBS for auction rate securities bought at UBS will not get money from the class action. It is now dead. And, given the way the judge wrote that opinion, it means, in my best estimate, that probably the other broker dealers who sold auction rate securities will probably win dismissal of their class actions."
According to Nygaard, the Court held that as long as a firm agreed to compensate most investors, a class action should not proceed. In such cases, investors still holding auction rate securities should file individual lawsuits or arbitrations. Of course, since most brokerage firms require customers to sign arbitration agreements, most cases will have to go to arbitration.
People who were involved in such class action lawsuits can still file an arbitration. However, they are advised to do so as soon as possible because the number of arbitrations filed will likely increase as more class action lawsuits are dismissed. The sooner an arbitration is filed, the sooner the case will be heard.
Okay, let's review.
California Atty. Gen. Brown says the Wells Fargo push to sell auction-rate securities up to and after the market crashed was incompetence. The Wells Fargo CE of investments said they had no way to tell and therefore not responsible. Balderdash! Wells Fargo saw the approaching clouds and worked frantically to safeguard its other investment assets which they did better than any other major bank.
But from an investors perspective, Texas Instrument's Kimberly Morgan said it best: An expectation of high ethical values from all its business associates, including the banks.
George Carlin had it right in one of his famous comedy sketches. The business community is out to screw the public any chance it has.
Just to rub dirt in our faces, one wonders how much federal bailout money these large banks used to pay off their auction-rate investors.
1 comment:
I think your comments on ARS's as stated in your blog are a bit facile. While one could take serious issue with my comment here that the downside of ARS's was not fully contemplated by those selling them (certainly including WFB), I maintain that this is overall an accurate portrayal. If there was naivete or a blind eye at work, it cut across all sectors, including those in the financial sector such as myself. We have more than a few customers who purchased ARS's for their higher yielding return than comparable forms of short-term, near cash-equivalent, liquid assets such as simple money market funds. Most all ARS's re-price every seven days and until the recent downturn, did so like clockwork. When we analyzed our customers sources of liquid assets, we always counted ARS's as safe and, indeed, very liquid, because that was our experience. We didn't care how our customers came to own them, either through our investment division or another bank's. The demise of this market, about which, by the way, you are completely silent, caught everyone unawares. I don't offer this as an excuse. I'm sure that customers who bought these short-term instruments from WFB got sales pitches about their safety. I don't believe there was any false advertising or fraudulent intent. Rather, I really believe everyone including us just got caught up in the mood of the market that any and everything had a market, at some price. I doubt if anyone contemplated no market at any price, which is essentially what happened here.
I guess what concerns me is the distancing of all financial institutions selling these instruments, including WFB, from any responsibility for the repercussions. On the one hand, buyers of any financial instrument should operate in the context of buyer beware. The ONLY truly safe investment, at least until the end of the world as we know it, are federally FDIC guaranteed deposits now up to $250,000. People forget this, because they delude themselves. On the other hand, it seems almost cynical that banks selling ARS's responded to the current debacle by either denial (initially) or by offering low interest rate loans for up to 90% of the face value of the ARS's. The good news here is that by doing so the banks are suggesting that the market will return for ARS's and that when that happens the borrowers will receive their original proceeds to repay these loans and, one would hope, get some back value for interest lost (doubtful). As a final comment, let's not get all worked up about an instrument that largely was limited to more sophisticated investors. The notion that ARS's were typical retail financial products purchased by ordinary bank customers is nonsense. And by the way, TARP has nothing to do with ARS's.
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