Former SEC Head -- Wall Street Executives Were Clueless About Subprime Losses

The top executives of Citigroup, Merrill Lynch and Bear Stearns had no idea what their firms stood to lose from the subprime crisis, as a result of poor business practices and a lack of transparent financial data.

At least, that’s the take of former Securities and Exchange Commission chairman Harvey Pitt.“As the crisis was starting, the CEOs would get up and say, ‘I lost $4 billion.’ Later they would say, ‘The figure is $7 billion,’ and months after that they’d say, ‘It’s $11 billion,’’’ Mr. Pitt said at a U.S. Chamber of Commerce conference in Washington. “There’s only one concrete conclusion you can draw: They did not know what they were talking about.”

UBS - Subprime Losses to Continue

For UBS, the European bank hardest hit by the collapse of the subprime housing market in the United States, fell the most in more than two months in Swiss trading on Monday after it said it may face more losses from mortgage securities. UBS declined 5.8 percent to 28.20 francs in Zurich, and has dropped 43 percent this year, cutting its market value to 61.4 billion francs ($59.9 billion).

Companies Still Struggling to Make Peace with Auction-Rate Securities

The credit crisis may be starting to see bottom but many companies in the U.S. are still struggling to pick up after the auction-rate securities' mess that began in February.

More than 400 companies, including major players like Google, Bed Bath & Beyond and Starbucks, had at least $30 billion worth of auction-rate securities in their portfolios. They thought these were cash-like investments and now they're scrambling to get cash out of the frozen auction-rate market.

The chief financial officers of these companies are also learning another hard lesson; these securities are an accounting problem for businesses not used to pricing complicated securities. While half of those 400 companies have written down the value of their auction-rate holdings on an average of 13.2%, the other half still hasn't even though market prices have fallen significantly.

Some companies may not have acted yet because they may hold securities that have high quality government-guaranteed student loans as collateral. Or, those companies do not need access to their cash immediately.Still, the frozen auction-rate market hampers a company's financial flexibility and when they do need the cash, they'll have to sell the securities at a substantial discount. So far, about 25% of the $330 billion auction-rate market has been bought back by municipalities or refinanced with a different type of debt. The rest probably aren't worth their paper value and will have to sell at a discount ranging from 2% for municipal debt to 30% for student-loan-backed bonds.

Here are some examples of companies who have sold their auction-rate securities at a discount:

· Extra Space Storage Inc. in Salt Lake City sold its securities at the end of February at a 10.6% discount to their face value
· ImClone Systems Inc., a biotech pharmaceutical company, had a $69 million impairment charge in the first quarter resulting from the 43% it marked down on its auction-rate securities
· Bed Bath & Beyond took a temporary 2.2% markdown on $327 million of the securities
· Google had a 4.2% markdown on $260 million of the securities
· Jet Blue Airways had a 3.4% impairment charge on $324 million of the auction-rate debt
· Starbucks took no impairment on $70.5 million of such debt

Auction Rate Securities Update: Wachovia Receives Subpoenas

Wachovia Securities received subpoenas and inquiries from the Securities and Exchange Commission and state regulators requesting information on auction-rate securities, according to a filing by Wachovia Corp. (NYSE: WB) with the SEC.

Regulators have requested data concerning the underwriting, sale and subsequent auctions of municipal auction-rate securities and auction-rate preferred securities, the filing states.

Charlotte, N.C.-based Wachovia says it will cooperate fully in the probe.

According to the filing, Wachovia and Wachovia Securities have been named in a civil suit seeking class-action status for customers who bought and continue to hold auction-rate securities based on alleged misrepresentations about their quality, risk and other characteristics.

Credit Crisis Risk Management At Merrill Lynch

Suffering from the continuing credit crisis, Merrill Lynch has named Doug Mallach, the head of U.S. fixed income sales, to manage a group that will figure out how to get rid of troubled or under-performing assets.

Under Mallach, the group will help Merrill Lynch figure out whether to sell, restructure or hold onto assets such as collateralized debt obligations that have been affected by the sub-prime mortgage crisis. Merrill had more than $6.6 billion of net exposure to asset-backed CDOs as of March this year. The group will also focus on fixed income assets and the currencies and commodities business.

Having already written down more than $30 billion of assets since last year, Merrill Lynch is looking for ways to trim its trillion dollars of assets and raise some capital. Merrill is also shrinking its mortgage and structured finance business by selling off assets that trade infrequently and reducing certain kinds of trading activity.

Merrill's move isn't unusual. Regulators and investors worldwide are pressuring banks to shed assets and raise capital to reduce leverage or debt levels relative to assets.

Citigroup's Falcon, ASTA and MAT Fund Manager Leaves

Reaz Islam, the manager of Citigroup's Falcon and ASTA/MAT funds, which suffered major meltdowns in recent months, is leaving Citigroup, his home for the last 18 years.

Islam has been the focus of investor and Citigroup brokers' anger after the Falcon and ASTA/MAT funds went into a rapid and steep decline. The two fixed-income funds were marketed mainly to individual investors who thought the funds were low risk and managed conservatively.

However, the credit crunch has decimated both funds. Falcon lost more than 75% of its value and ASTA/MAT funds lost 77%. Last month, Citigroup took out $250 million to help their investors recoup some of their losses. But that wasn't enough to stop two lawsuits from being filed over the collapse of the funds and a group of Citi brokers from quitting in frustration.

Marc Friedfertig, an investor in Falcon, said he spoke to Islam several times about the fund and Islam had told him not to redeem his shares. Friedfertig suspects the funds weren't as safe as they were marketed to be.

Ex Hedge Fund Manager Convicted of Fraud

Kirk Wright, a former Atlanta hedge-fund manager and owner of International Management Associates (IMA), was convicted of operating an investment scheme that swindled millions of dollars from clients, many of whom are high-profile former pro football players, family members, and Atlanta's top African-American doctors and entrepreneurs.

Wright has been found guilty of mail fraud, securities fraud and money laundering related to IMA's collapse. He faces a max of 710 years in prison, a $16 million fine and restitution for clients' losses when sentencing takes places in August.

According to prosecutors, Wright and IMA, with offices in major cities nationwide, took more than $150 million from clients from 1997 to 2006 and diverted millions for personal expenses, including cash for himself and family members, jewelry, a $500,000 wedding, house renovations and luxury cars. Prosecutors said beginning in 2001, Wright lied to his clients about the substantial gains in their investments. Opposed to the gains he reported every month, Wright actually lost every dollar his clients gave him.

After IMA collapsed in early 2006. Wright spent several months in hiding and was finally arrested in May 2006. By then, Wright was already fined $20 million by the SEC in a civil suit.

UBS Raising $15.5 Billion In New Capital

Swiss-based UBS AG announced today that it would raise $15.5 billion by issuing 760,295,181 new shares at a 31 percent discount from its current share price. This is UBS' second major cash injection in recent months.

Suffering from heavy exposure to the U.S. mortgage crisis, UBS will now sell new shares at $20.09 each to existing shareholders. Compare that to the closing price of $29.75 on Wednesday. In this move, shareholders will receive one subscription right per share held, with 20 of the rights entitling the holder to buy seven new tradeable shares. Subscription rights will be traded from May 27th to June 9th in Zurich and on the NYSE.

According to Peter Thorne from Helvea, there should be a sizable turnover in the new shares because UBS' traditional investors bought the stock as a risk-free investment, and UBS has not become a bank recovery stock.

To reduce negative exposure to housing securities, UBS also finalized the sale of $15 billion in sub-prime and Alt-A mortgage assets to U.S.-based BlackRock Inc. yesterday. The securities had a nominal value of $22 billion.

Auction-Rate Securities Investors File For Securities Arbitration

Before February of this year, investors looking for a safe and liquid place to invest their money with better rates than traditional money-market accounts often placed them in auction-rate securities. Ever since the auction-rate market froze earlier this year, investors who need access to their cash have been faced with the agonizing dilemma of having to either wait to see if the market will recover or look for ways to get some of their money back. Some may have to take out a loan to meet cash needs.

Those who don’t need immediate access to their cash can benefit from waiting for the market to turnaround because of the higher yields. As of May 14th, 103 auctions in the SIFMA Auction-Rate 7-Day Index had an average yield of 3.61 percent. In comparison, the average 7-day annualized yield in the U.S. taxable money market was just 1.95 percent.

Another benefit for patient investors may be that the banks and brokers who underwrote the securities will rescue them by redeeming the securities. So far, Calamos Asset Management, Claymore Securities and Nuveen Investments have secured financing to redeem some customers. Bond issuers like the Southern California Public Power Authority are refinancing their debt to redeem their customers.

However, investors who need their cash fast to pay bills like tuition or mortgage face a rude reality. They will either have to take out a brokerage loan and pay the interest on that loan or allow their broker to buy the securities for a discounted price.

Many investors who wanted safe and liquid investments are saying that the risks of auction-rate securities were never made clear by their brokers. Faced with doubts of the market’s ability to recover and the frustration of having to sell their securities at a discount, some investors are filing arbitration claims against the brokerage firms as their last chance to find a way out of this mess.

Calamos Auction Rate Securities Refinancing

Calamos Investments announced today that two of its closed-end funds, the Calamos Convertible Opportunities and Income Fund (NYSE: CHI) and the Calamos Convertible and High Income Fund (NYSE: CHY), intend to refinance, in aggregate, $630 million of their outstanding auction rate preferred securities (ARPs). "We are pleased to be able to refinance a significant portion of each fund's ARPs," stated John P. Calamos, Sr., the chairman, chief executive officer and co-chief investment officer of Calamos Asset Management. "We nevertheless recognize that our work is not done, and we remain committed to obtaining solutions for those ARPs that will remain outstanding after these refinancings and to do so in a manner consistent with the best interests of all of our closed-end fund shareholders."

The funds have secured an alternative form of borrowing that will enable, based on current market conditions, CHI to redeem approximately 72.9% or $280 million and CHY to redeem 81.4% or $350 million of their outstanding ARPs at par. These refinancings, together with previously announced refinancings of the Calamos Global Total Return Fund (NYSE: CGO), Calamos Strategic Total Return Fund (NYSE: CSQ) and Calamos Global Dynamic Income Fund (NYSE: CHW), represent $1.869 billion or approximately 81.2% of the total ARPs outstanding in the five Calamos closed-end funds.

Auction Rate Securities Earn Wall Street Billions in Fees

Auction-rate securities, which increased to $330 billion over 24 years, are marked by a history of secrecy and dealer manipulation of borrowers and investors, according to U.S. Securities and Exchange Commission documents.

"Proponents of auction bonds downplayed the risks for issuers and buyers, first by not talking about earlier problems, and then managing auctions to keep rates at levels that pleased everybody, at least for a while,'' said Joseph Fichera, chief executive officer of New York-based Saber Partners, which advises governments in their negotiations with banks.

Billions in Fees

Rates on the bonds are determined by bidding typically every 7, 28 or 35 days. If buyers are scarce, the auction fails and some bondholders who wanted to sell are left holding the securities. The issuer gets stuck with a penalty rate.

For investment banks, the bonds generated more than $1 billion in fees at the initial sale. They also received annual payments for handling the auctions of a quarter percentage point, or about $825 million a year based on the $330 billion outstanding before the collapse.

Bankers earned additional, undisclosed profit from arranging swaps intended to convert the variable interest rate on an auction bond to a fixed one. Culinary Institute, for example, expected the combination of auction-rate bonds and swaps to result in fixed borrowing costs of 3.36 percent to 3.68 percent on its three sales, less than O'Mara says it would have paid for ordinary fixed-rate bonds.

Auction Rate Student Loan Note Interest Rates Dive

More than $9 billion of auction- rate bonds sold by student-loan agencies in U.S. states from Pennsylvania to Utah have trapped investors in debt that's not paying interest.

Rates on Pennsylvania Higher Education Assistance Agency bonds backed by student loans were set at 0 percent April 4 after auctions to determine interest costs attracted too few bidders. The same occurred on more than 10 percent of the $86 billion of student-loan debt, as failures triggered provisions in bond documents that limit the interest agencies must pay, according to data compiled by Bloomberg.

The collapse of the auction-rate market drove interest costs paid by states, hospitals and student-lending agencies as high as 20 percent, and froze investors in securities they couldn't sell. Now, holders of student-loan debt are stuck with bonds paying less than the 0.66 percent rate on the one-month Treasury bill.

Merrill Lynch’s Gamble on High Risk, Low Yield Loans

Last year, Merrill Lynch wrapped up a securitization that invested, at a very low yield rate, in financing mortgage “piggyback” loans made to risky borrowers who put no money down. The securities were bought by buyers like the Bond Fund of America, one of the largest mutual funds around. One year later, it is obvious Merrill Lynch made a very bad and risky gamble.

These loans are called “piggyback” loans because typically, a buyer will take two loans: one for 80 percent of the purchase price and another smaller loan to pay the remaining 20 percent. It turns out that these smaller loans are also highly vulnerable to homeowners who default on their mortgages. Foreclosure is usually not worth the effort, since all the money would go to the first, bigger mortgage holder. However, that doesn’t mean homeowners are completely off the hook for that smaller loan; their liability would resurface if they ever tried to sell the home.

Worse, less than 30 percent of those loans were made to borrowers with complete documentation of their income and assets and many probably lied about their income. With shaky credit, most had borrowed the full appraised value of the home and it’s highly possible that some homes were overpriced even before home prices began falling.

The lender of most of these loans, Ownit Mortgage Solutions, has since gone bankrupt because so many of those loans turned bad almost immediately. Moody’s predicts that, by the end of all this, the high number of bad mortgages will mean that 60 percent of the money lent will not be paid back. Merrill Lynch disclosed this bankruptcy in its prospectus for the securitization but failed to mention that it was Ownit’s largest creditor and the loans were quickly defaulting.

So far, the defaults are the worse in California, Florida and Nevada. Home prices declined significantly in these states, and California and Florida loans were likely to have been made without full documentation.

How could sophisticated investors not see the all the glaring red flags in these investments?

The even bigger irony is that Merrill Lynch isn’t alone in thinking these high risk but low yield securities were a good idea. A year ago, Moody’s gave these securities an “Aaa” rating, the highest possible. Now, Moody rates them as Baa3, one level above junk. And Moody’s lists three other similar securitizations underwritten by Goldman Sachs with losses comparable to Merrill’s.

State Street Sub-prime Damage Payouts Looking at $1 Billion

Facing numerous lawsuits claiming hefty losses over sub-prime mortgage investments, State Street Corp., the largest money manager for institutions, may have to get ready to pay more than the $625 million it set aside for such lawsuits.

Loss estimates have not been released but State Street reported in regulatory filings that asset values adversely affected by the sub-prime mortgage collapse fell from $13.9 billion in June 2007 to $6.1 billion at the end of 2007. State Street says redemptions were the main reason for such a drastic drop. This loss will reflect heavily on investor damages and risk analysts have put damage numbers around $1 billion, which is about 80 percent of State Street’s net income in 2007.

On behalf of 200-plus retirement plans, Prudential Financial Inc. is suing State Street for inappropriately investing their money in risky securities. Besides investor lawsuits, some analysts have even suggested that fund managers may have a fiduciary obligation to sue if the plans were misled into buying something they were not authorized to buy.

The corporate retirement and welfare funds of Unisystems, Nashua Corp and Merrimack Mutual Fire Insurance Co. are seeking class-action status against State Street in the U.S. District Court in Manhattan. They’re claiming State Street breached its fiduciary duty by investing pensioners' money in high-risk securities instead of the conservative funds as promised.

A class-action suit will definitely raise the financial stakes for State Street because class-actions are composed of hundreds or thousands of people and the damage amount will be like a rolling snowball and it would only get bigger.

However, to get class-action status, the funds will need to prove their cases have common facts such as whether they received the same advice. Without class-action status, the pension plans may still sue separately because the size of the claims will justify the cost of litigation.

State Street will also get lawsuits from the public sector.

Currently, State Street is being sued in Houston, Texas over pension-fund loses by the city’s police officers’ pension system, Memorial Hermann Healthcare System in Houston and the Welborn Baptist Foundation in Evansville, Indiana. These suits don’t even include claims being filed under the federal Employee Retirement Income Security Act.

Analysts don’t think State Street will be alone in its troubles though. State Street will certainly get more lawsuits but other companies like Regions Financial Corp.’s Morgan Keegan unit are also under scrutiny.

The $9 Billion Bear Stearns Clean-up

J.P. Morgan and Bear Stearns’ marriage won’t be cheap. It will cost the banking giant $9 billion to clean up the losses and bad assets on Bear Stearns’ balance sheet and pay for layoff costs and litigation arising from its cut-price takeover. That’s $3 billion more than J.P. Morgan originally estimated and they expect the final total could end up being up to $1 billion higher or lower.

Since the takeover, J.P. Morgan has also lifted its offer price for Bear from $2 to $10 per share; thus valuing Bear at $1.5 billion and easing some investor and employee anger over the previous cutthroat prices. Still, J.P. Morgan is optimistic about the long-term benefits of the takeover and argues that the fraction of Bear’s value that they’re paying is necessary to offset Bear’s losses stemming from mortgage-related securities and other bad assets.

Despite the higher takeover cost and further Bear losses, J.P. Morgan still expects Bear to boost their second-quarter earnings by $1 billion and its total equity by $2 billion – below previous estimates of a $5 billion equity contribution. From 2009, Bear should contribute more than $1 billion a year to J.P. Morgan’s profit.

Separately, J.P. Morgan has also disclosed that it is facing potential civil charges from the SEC as part of a probe into the bidding for municipal bonds.

UBS Banker Indicted

Some of the secrets of Switzerland’s biggest bank were put on display on Tuesday as federal authorities indicted a former UBS banker on charges of helping a wealthy American real estate developer evade taxes.

The indictment is part of a widening federal investigation into whether UBS, one of the world’s largest money managers for the wealthy, helped certain clients evade taxes, and it suggests that American authorities are stepping up scrutiny of offshore tax transactions. The inquiry focuses on UBS’s private bank based in Zurich, which does much of its business through Liechtenstein.

MBIA and AMBAC AAA Credit Rating in Jeopardy

Bloomberg reported today that Moody's Investors Service said deepening losses at MBIA Inc. and Ambac Financial Group Inc. may imperil their AAA credit ratings less than three months after affirming the top grade.

The two largest bond insurers recorded a total $6.7 billion of first-quarter charges for losses on home-equity loans and collateralized debt obligations, "elevating existing concerns about capitalization levels relative to the Aaa benchmark,'' Moody's said yesterday in a report.

Foreclosure Filings Surge

More U.S. homeowners fell behind on mortgage payments last month, driving the number of homes facing foreclosure up 65 percent versus the same month last year and contributing to a steady decline.

Nationwide, 243,353 homes received at least one foreclosure-related filing in April, up 65 percent from 147,708 in the same month last year and up 4 percent since March, RealtyTrac Inc. said.

Nevada, Arizona, California and Florida were among the hardest hit states, with metropolitan areas in California and Florida accounting for nine of the top 10 areas with the highest rate of foreclosure, the company said.

Irvine, Calif.-based RealtyTrac monitors default notices, auction sale notices and bank repossessions.

One in every 519 U.S. households received a foreclosure filing in April. Foreclosure filings increased from a year earlier in all but eight states.

The combination of weak housing sales, falling home values, tighter mortgage lending criteria and a slowing U.S. economy has left financially strapped homeowners with fewer options to avoid foreclosure. Many can't find buyers or owe more than their home is worth and can't get refinanced into an affordable loan.

Efforts by government and the mortgage industry to stem the tide of foreclosures aren't keeping up with the rising number of troubled homeowners.

The April data show nearly half of the properties received an initial notice of default, suggesting many homes were new entrants to the foreclosure process.

$500 Billion Mortgage Credit Losses Forecasted

Goldman Sachs economists are forecasting $500 billion residential mortgage credit losses, a slowdown in the economy, and no monetary policy tightening in this year or 2009.

According to Goldman, many financial markets have made significant recoveries since the Bear Stearns and J.P. Morgan Chase marriage in March, but overall mortgage credit losses will still turn out to be larger than expectations. That is due to three reasons: the growing excess supply in the housing market, rapid falling home prices and much higher U.S. loan-to-value rations than previous downturns.

Goldman cautions there will be painful adjustments in the housing and credit markets and probably in the broader economy. Even if the shock is moderate, it can have large rippling effects if it reduces the equity capital of highly leveraged financial institutions that mark their balance sheets to market.

However, leveraged losses may have positive implications for the U.S. economic outlook. Less selling pressure or outright purchases of beaten-down assets will eventually raise asset prices and push down leverage. The resulting balance sheet relaxation will bring further asset purchases.

Still, Goldman warns that the downward slide of mortgage credit defaults has further to go and may soon shift away from the already ailing sub-prime mortgages to other residential mortgage debt, including prime mortgages.

That is why an economic slowdown is predicted and the Goldman doesn’t believe the Feds will tighten monetary policy any time soon.

Kelsoe of Morgan Keegan Asset Set to Get Dumped

James Kelsoe, once the top-ranked bond manager of seven funds worth $611 million at Morgan Asset Management, is about to get dumped when shareholders meet to vote on his fate on July 11th.

The seven funds managed by Kelsoe lost an average 67 percent in the past year which prompted a slew of investor lawsuits against Kelsoe and Morgan. Regions Morgan Keegan Select High Income, the largest fund in the group, plunged to $104 million from a peak of $1.23 billion in 2006. At his peak, Kelsoe outperformed his peers three years in a row by betting heavily on bonds with below-investment-grade ratings. He chose increased risk of default for yields higher than those on investment-grade debt. In an interview in July 2007, he said he developed an "intoxication'' for securities backed by risky sub-prime mortgages. Kelsoe was hit hard with redemptions when the market seized up last year.

In a bid for some damage control, Morgan announced in April that it would hand over Kelsoe's four closed-end funds (RMK Advantage Income Fund Inc., RMK High Income Fund Inc., RMK Multi-Sector High Income Fund Inc. and RMK Strategic Income Fund Inc.) and three open-end funds (Regions Morgan Keegan Select Short Term Bond, RegionsMorgan Keegan Select Intermediate Bond) to New York-based Hyperion Brookfield Asset Management Inc., pending the shareholder vote in July. Hyperion isn't expected to lose anything in taking over the funds because if they're not recoverable, it's not their fault. And if they're able to work their way out of the mess, they become the hero. Investors shouldn't expect a miracle from Hyperion though.

Kelsoe joined Morgan in 1991 and established the Select High Income fund in 1999. He increased returns on this high-yield fund by stuffing them with mortgage-backed bonds, collateralized debt obligations and aircraft-leasing obligations. From 2004 to 2006, the High Select Income fund averaged a 12 percent return, compared with 7.6 percent for all other high-yield funds tracked by Morningstar.

But the fund was unraveled by record defaults on sub-prime mortgages and investors fleeing from risky investments. The Select High Income fund fell 60 percent in 2007 and fell another 31 percent this year while the average high-yield fund rose 1.5 percent in 2007 and is up 0.4 percent this year. According to Morningstar, Kelsoe is to blame for taking on so much risk and poor communication with shareholders and assets plunged.

A dozen lawsuits against Morgan and Morgan executives including Kelsoe have piled up since last December. The lawsuits are accusing them of mismanagement and misrepresentation and they're seeking class-action status.

Thin Yields Weigh Heavy on Investors

Amid fears of a recession last year, investors turned to ultra-conservative investments like money-market funds, certificates of deposits (CDs) and savings deposits but they are now facing razor-thin yields after several waves of interest-rate cuts.

Since October, assets increased in the most conservative investments, but during that time, the Federal Reserve had taken action to stimulate the economy by cutting the benchmark interest rate at which banks lend money to each other to 2 percent from 5.25 percent in September. That means investors would find safety but yield little in terms of returns.

To give readers an idea, according to Bankrate.com, six-month CDs are yielding an estimated average of 1.8 percent and iMoney.net shows taxable retail money-market funds are averaging an estimated 2 percent.

Currently, it is challenging for investors to find safe investments with better yields. It's especially hard since a lot of those investments such as auction-rate securities and ultra-short mutual funds turned out to be a lot riskier than expected. The auction-rate market collapsed in February this year after investors fled from those securities. Meanwhile, the value of ultra-short funds holding big chunks of sub-prime asset-backed securities has plummeted. For example, Schwab Yield Plus is down 28 percent over the past year.

Investors may be tempted by high-yield (aka "junk") bonds, which compensate investors for their extra risk with much higher interest rates (the average yield is 7.9 percent). But investors should beware. Companies with unstable credit issue junk bonds and defaults tend to rise during recessions.

Schwab Yield Plus and Fidelity Ultra-Short - Putting Cash in the Wrong "Safe" Place

Investors who've placed their money in ultra-short-duration bond funds for the past year are feeling the pain now. For some funds, the damages are far worse: SSgA Yield Plus (SSYPX) is down nearly 30 percent, Schwab YieldPlus (SWYPX) lost more than 28 percent of its value and Fidelity Ultra-Short Bond (FUSFX) has taken a 12.8 percent dive.

How did these supposedly "safe" funds turn out to be such losers?

Blame it on the sub-prime credit crisis. Ultra-short funds typically hold a big chunk of sub-prime asset-backed securities so when the housing market tanked, the value of the funds went with them. That prompted investors to sell their funds in mass, bringing prices down even further. Managers have no choice but to meet redemption requests and face the losses. They won't be able to ride it out and hope for the fund to mature in a few months and make it whole again.

Before the credit crisis, rating agencies routinely gave appropriate ratings to these securities and many managers considered them safe enough to fit into a risk-averse fund like an ultra-short and gain some extra returns.

Investors who realize the problem they have on their hands now could face two possible scenarios. If the fund can avoid selling securities, the investor can hope that with time the fund can stay out of foreclosure or default and come out whole again. Or, there is a good chance that other shareholders will bail out and leave the hopeful ones to face the mess.

Of course, another scenario is that a fund company could bail out too. State Street Global Advisors has already announced plans to liquidate SSgA Yield Plus.

Morgan Keegan Fixed Income Losses Mount -- Asset Manager Dumped

James Kelsoe, once the top-ranked bond manager of seven funds worth $611 million at Morgan Asset Management, is about to get dumped when shareholders meet to vote on his fate on July 11th.

The seven funds managed by Kelsoe lost an average 67 percent in the past year which prompted a slew of investor lawsuits against Kelsoe and Morgan. Regions Morgan Keegan Select High Income, the largest fund in the group, plunged to $104 million from a peak of $1.23 billion in 2006. At his peak, Kelsoe outperformed his peers three years in a row by betting heavily on bonds with below-investment-grade ratings. He chose increased risk of default for yields higher than those on investment-grade debt. In an interview in July 2007, he said he developed an "intoxication'' for securities backed by risky sub-prime mortgages. Kelsoe was hit hard with redemptions when the market seized up last year.

In a bid for some damage control, Morgan announced in April that it would hand over Kelsoe's four closed-end funds (RMK Advantage Income Fund Inc., RMK High Income Fund Inc., RMK Multi-Sector High Income Fund Inc. and RMK Strategic Income Fund Inc.) and three open-end funds (Regions Morgan Keegan Select Short Term Bond, Regions
Morgan Keegan Select Intermediate Bond) to New York-based Hyperion Brookfield Asset Management Inc., pending the shareholder vote in July. Hyperion isn't expected to lose anything in taking over the funds because if they're not recoverable, it's not their fault. And if they're able to work their way out of the mess, they become the hero. Investors shouldn't expect a miracle from Hyperion though.

Kelsoe joined Morgan in 1991 and established the Select High Income fund in 1999. He increased returns on this high-yield fund by stuffing them with mortgage-backed bonds, collateralized debt obligations and aircraft-leasing obligations. From 2004 to 2006, the High Select Income fund averaged a 12 percent return, compared with 7.6 percent for all other high-yield funds tracked by Morningstar.

But the fund was unraveled by record defaults on sub-prime mortgages and investors fleeing from risky investments. The Select High Income fund fell 60 percent in 2007 and fell another 31 percent this year while the average high-yield fund rose 1.5 percent in 2007 and is up 0.4 percent this year. According to Morningstar, Kelsoe is to blame for taking on so much risk and poor communication with shareholders and assets plunged.

A dozen lawsuits against Morgan and Morgan executives including Kelsoe have piled up since last December. The lawsuits are accusing them of mismanagement and misrepresentation and they're seeking class-action status.

Auction Rate Losses For Missouri Student Loan Notes

The Missouri Higher Education Loan Authority (MOHELA) plans to buy back up to $30 million of its $3.5 billion worth of outstanding auction-rate bonds.

The move would make the state's student loan authority the first issuer of auction-rate securities to publicly announce its intention to repurchase its securities in the secondary market, according to New York-based Restricted Stock Partners. That firm manages the Restricted Securities Trading Network, an online trading platform for buying and selling illiquid assets, through which MOHELA will repurchase its bonds.

MOHELA's buyback would provide liquidity for some investors who have been unable to sell their bonds in recent months. Student-loan bond securities historically have been easy to buy and sell. But as the credit markets seized up in the wake of sub-prime mortgage loan defaults, the market for bonds backed by student loans also froze. That has caused auctions of student loan bonds to fail since mid-February, and investors have been unable to sell them and get their money out.

Investors who sell back to MOHELA will take a loss, however. The student loan authority stated it would only repurchase its bonds at a discounted price, though it did not specify the size of the discount it would seek, according to a disclosure filed May 7 with the Nationally Recognized Municipal Securities Information Repositories.

MOHELA, headquartered in Chesterfield, has about $5 billion in total bonds outstanding of which approximately $3.5 billion were sold as auction-rate securities.

Auction-Rate Securities Subpoenas Issued

Wachovia has announced that its securities unit has received subpoenas from the SEC and various state regulators regarding its auction-rate securities practices.

Recently, state securities regulators have also began focusing on the auction-rate problem and are coordinating their efforts to help investors “who can’t access funds that their brokers placed in these complex investment products” according to an article by Kevin Kingsbury in The Wall Street Journal. North Dakota Securities Commissioner Karen Tyler, the president of the North American Securities Administrators Association, said “If violations are uncovered, then state securities regulators will seek appropriate remedies, including a much stronger commitment from Wall Street to provide their retail clients with an acceptable solution.”

State investigations are being handled by each state individually but are being coordinated through a task force headed by Bryan Lantagne, the head of the Massachusetts Securities Division. The other states involved include Florida, Georgia, Illinois, Missouri, New Hampshire, New Jersey, Texas, and Washington.

According to Tyler, “Our focus is to determine what conduct took place at the point of sale – what was potentially misrepresented and omitted – and our goal is securing for investors access to their cash as requested. If the product was represented to be a cash equivalent going in, it must be treated as a cash equivalent coming out.”

No one knows whether these efforts by the SEC and the states will force broker-dealers to inject needed liquidity into the auction-rate markets or otherwise correct the rampant abuses that were associated with the sales of these securities.

UBS to Pay $35 Million Back to Massachusetts Cities

UBS AG just agreed to pay back about $35 million to Massachusetts cities and other government entities that bought the now frozen auction-rate securities.

After auction-rate securities soured in February, Massachusetts regulators began investigating UBS for evidence of the bank misleading municipalities on whether auction-rate securities were permissible investments for municipalities under state law.

Under this payback agreement, UBS will purchase at par value the principal of the securities from the Massachusetts municipalities. And UBS now says that, under state law, the municipalities were not supposed to buy auction-rate securities. However, UBS is not in discussions with other states for a similar agreement and this agreement does not apply to individual investors.

UBS Settles Auction Rate Dispute with Massachusetts Municipalities

UBS AG will return more than $35 million invested in prohibited auction rate securities to more than a dozen Massachusetts municipalities, the state's top lawyer said on Wednesday.

Martha Coakley, the Massachusetts attorney general, said UBS Financial Services and UBS Securities LLC will return the money after the company had misled towns and cities into improperly putting funds into auction rate securities that many state officials thought were as safe as cash.

More than a dozen Massachusetts towns and cities found a portion of their assets frozen in the auction rate securities after the roughly $330 billion market seized up this year for the long-term bonds whose rates are reset periodically.

Investors flooded dealers with paper backed by bond insurers, whom they feared would lose their "triple-A" credit ratings. As a result, many municipal bond issuers were forced for several weeks to pay unusually high interest rates.

Auction Rate Update: John Hancock to Redeem Certain ARPS

John Hancock Funds, the mutual fund arm of Boston's John Hancock Financial Services Inc., said it plans to restructure $1.6 billion of leverage used in closed-end funds hurt by the disruption in the auction-rate securities market.

John Hancock said a commercial bank will refinance five of the funds.

"At this time, we believe this is an effective and timely solution to the unprecedented illiquidity that has developed in the auction security market," John Hancock Financial CEO John DesPrez said in a statement. "The board and management continue to work diligently on finding a solution for our other two leveraged closed-end funds."

The financing will be used to redeem and replace 100 percent of the outstanding auction rate preferred securities (ARPS) of the five taxable equity funds, and to change the form of leverage from ARPS to debt. The five John Hancock closed-end funds affected by the announcement are: Tax-Advantaged Dividend Income (HTD), Preferred Income (HPI), Preferred Income II (HPF), Preferred Income III (HPS), and Patriot Premium Dividend II (PDT).

John Hancock Funds is evaluating alternatives to complete the refinancing of the remaining two leveraged closed-end funds: Investors Trust (JHI) and Income Securities Trust (JHS). These two closed-end bond funds have approximately $175 million of ARPS outstanding.

SEC Approves Rule Change to Amend the Definition of Public Arbitrator

Effective June 9, 2008, FINRA will add an annual revenue limitation to the definition of public arbitrator, set forth in the Code of Arbitration Procedure for Customer Disputes and the Code of Arbitration Procedure for Industry Disputes.

The amendment, which was approved by the Securities and Exchange Commission, will ensure that individuals with ties to the securities industry may not serve as public arbitrators in FINRA arbitrations.

To view the full notice, click here.

Citibank To Sell Assets

Citibank said on Friday it aims to shed $400 billion of assets -- nearly 20 percent of its total -- over the next two to three years to become more efficient and profitable.

Citi's newly installed chief executive, Vikram Pandit, has faced demands from investors that he slash costs, shed poorly performing businesses and even split up the bank.

Some investors view Citi, built over two decades by Sanford "Sandy" Weill, as too big to govern, a charge that Pandit's predecessor, Charles Prince, routinely rejected.

Citi, hit hard by the subprime mortgage meltdown and ensuing turmoil, said it has about $500 billion of "legacy assets," and it expects to pare those to less than $100 billion within two to three years.

SEC Fund Shortage Affected Oversight

The SEC’s fund shortage may have affected its oversight and may be partly the reason for the agency’s inability to prevent Bear Stearns’ collapse.

From 2005 to 2007, SEC spending declined 1.3 percent to $875.5 million and lost 386 full-time employees (10 percent of their force). Meanwhile, Wall Street firms were getting more complex with at least a 10 percent increase in headcount and climbing revenue largely derived from structured credit including bonds backed by mortgages.

Today, two months after the Feds rescued Bear Stearns, the SEC’s supervision of securities firms and the adequacy of its resources for monitoring them are being scrutinized in two hearings in the U.S. Senate. Erik Sirri, head of the SEC division of trading and markets, said in hearings today that the SEC wants to increase capital and liquidity requirements for investment banks and that the agency chairman plans to increase agency staff members who monitor risk at securities firms to 40 from 25.

In defense of their oversight on Bear Stearns, Christopher Cox, the current SEC Chairman, said last month that the agency tries to ensure firms have enough funds to meet expected obligations for at least a year during periods of market stress. However, the situation with Bear Stearns was “unprecedented” because they couldn’t even secure loans when it offered “high-quality collateral.” Still, Cox said the SEC’s oversight of Bear Stearns succeeded in accomplishing its intended purpose, which is ensuring that the firm’s brokerage clients didn’t lose any money.

Some in the Senate are suggesting an increase in the SEC’s budget to add more staff and boost risk assessment and securities law enforcement. The SEC supports that idea but in the past, it has left money unspent. The $906 million Congress granted the SEC in 2008 includes $63.3 million unspent from earlier years. Lynn Turner, former SEC chief accountant, compares that to the fire department laying off firemen as houses burn down.

John Nester, SEC spokesman, explains that more than 90 percent of the money carried over to the 2008 budget from earlier years cannot be used for staff salaries because it’s intended for contract work such as technology upgrades.

After the inadequacy in preventing the Enron and WorldCom debacles, Congress almost doubled the SEC budget to employ more accountants, enforcement lawyers and examiners. At its peak in 2005, the SEC had 3,851 full-time employees, including 1,232 in its enforcement division, which investigates fraud. After budget cuts in recent years, the agency’s full-time staff level dropped to 3,465 and staffing in the enforcement unit dropped to 1,111.

Morgan Keegan Bond Fund Losses Lead to Asset Manager Termination

Months before its Morgan Keegan mutual funds were beleaguered by an investigation by the SEC, a slew of arbitration claims and large losses, Regions Financial Corp. already saw that the funds were going to be a major financial and public relations disaster and decided it had to go.

Prompted by bad nationwide press on the risky nature of the funds, a regulatory filing last week revealed that, in late 2007, directors of Morgan Keegan already began negotiating with Hyperion Brookfield Asset Management over how to transfer management of the funds and what would occur after a handoff.

An agreement was reached between the two parties in April. Morgan Keegan management would step down and hand over management of the funds to Hyperion. However, it turns out that outcome was expected months ago before all the bad press and lawsuits.

Lawyers involved in the lawsuits are still trying to assess the significance this management change has on their cases.Since June of last year, six of the seven Morgan Keegan funds have lost more than 75 percent of their value. According to a Morningstar analyst, it's rare for an asset management firm to give up assets this way because even with large losses, the fund is still making an expense ratio on it. So, the lawsuits might have played a big part in prompting Regions to get the funds off their hands quickly.

The Student Loan Borrowing Bubble

The Wall Street Journal asks whether the U.S. created an "education bubble" fueled by easy money and overborrowing by families desperate to pay rising tuition costs?

Expect a hastily sputtered "no way" from economists, university officials and student-lending specialists. They attach a high monetary value to academic degrees, no matter how fast tuition rises. As proof, they cite the big and growing income gap between college graduates and people with just a high-school degree.

The student-loan market has been riddled with signs of trouble lately. Default rates are rising. Big-name lenders are pulling out or scaling back. And investors who used to snap up bonds backed by bundles of student loans have snapped their checkbooks shut.

Borrowing to pay for higher education may be a lot like mortgage-financed home ownership: a great idea that can be badly tarnished when financial markets lose all remnant of discipline.

Merrill Lynch's Illiquid Assets

Merrill Lynch said almost 8% of its total assets at the end of the first quarter were illiquid or hard to value, reinforcing concerns that its recent string of losses and need for capital haven't abated.

Merrill, which posted a $1.97 billion loss in the latest quarter and a loss of $8.6 billion last year, said its Level 3 assets surged nearly 70% to $82.4 billion as of March 31 from three months earlier. Level 3 assets are those for which there are no market prices because they trade so infrequently, and include many of the subprime assets that have battered financial firms.

Merrill Lynch Faces Government Auction Rate Securities Request

Merrill Lynch has received requests from governmental agencies for information regarding auction-rate securities, including the recent failure of auctions, and is cooperating with the requests, the company said on Tuesday.

The $330 billion market for the securities -- long-term bonds whose rates are reset periodically -- froze this winter. Investors flooded dealers with paper backed by bond issuers whom they feared would lose their 'triple-A' credit ratings.

Schwab Yield Plus Woes

Jim Phillips, a retiree living in Illinois, said he turned down two compensatory offers from Charles Schwab because they covered less than a third of his YieldPlus fund losses. Phillips says he repeatedly called and visited a broker at a Schwab branch last September to ask him whether he should hold on to YieldPlus or sell it. The branch broker finally told Phillips in early March this year that he needed to see Schwab's client advocacy group about his losses.

On March 26th, seven days after Phillips sold his YieldPlus shares on his own, the branch broker at last suggested he sell the fund. On April 14th, Schwab's client advocate gave an initial compensatory offer to Phillips, which he refused. Eight days later, Phillips received a second offer of 32% of his losses and was told to take it or leave it.

Phillips decided to leave the offer because he gave the Schwab broker every opportunity to recommend that he sell YieldPlus. Instead, Phillips is filing an arbitration claim against Schwab after he combed through all of Schwab's sales materials and prospectuses without finding mention of the primary cause of the fund's collapse. His losses were a significant portion of his nest egg and he regrets trusting Charles Schwab.

Auction Rate Securities - A Redemption Update

Investors and taxpayers are both hurting from the freeze in the $330 billion auction-rate securities market, now into its third month. Investors can't get their assets out and taxpayers are paying the price for municipalities that issued the auction-rate bonds and now are being asked to pay up to redeem and restructure the debt. As Gretchen Morgenson from the New York Times points out, Wall Street is the only winner coming out of all this while investors are crying for rescue.

Brokerage firms operated the auction-rate market on behalf of municipalities, nonprofits, and closed-end mutual funds and were paid 0.25 percent of the security’s total issue for each year of its life. However, with the frozen market, firms are still earning these service fees when 70 percent of the weekly securities auctions are failing.

Additionally, firms are earning banking fees when municipalities redeem the securities and they take in yet another round of revenue when they help issuers untangle from derivative contracts that are often intertwined with the securities. These derivatives were supposed to reduce costs for the issuers by hedging their interest rate risks. But with the continuing decline in interest rates, these derivatives can be expensive.So, what options are there for investors?

Investors get interest on their money but that interest is not nearly enough to compensate for being stuck in their holdings. $78 billion in auction-rate securities will be redeemed by issuers but almost three-fourths of that involves municipal notes, which has exorbitant penalty rates for failed auctions. Investors in the remaining securities are receiving no offers to redeem their securities. That's party due to low penalty rates on those securities so there is little incentive to redeem.

The Restricted Securities Trading Network, a secondary market, can be an option for desperate investors who are willing to sell their securities at a discounted rate ranging from 2 percent to as high as 25 percent. So far, the action in that market is limited but this trading is an opportunity for municipal issuers to buy back the securities at a savings while letting investors get some liquidity.

After the buyback, securities issuers might also be able to renegotiate contracts to eliminate payments for unsold securities and failed auctions. Then issuers could get additional savings by refinancing the rest of its securities at current market rates.

However, this is where a conflict of interest can arise between Wall Street firms and their issuer clients versus investor clients. If a brokerage firm is advising an auction-rate issuer to redeem securities at a discount, then the firm's investors who bought those securities would record a loss. Selling at a discounted price could also force the firm to mark down similar securities, also resulting in a loss for investors.

Wall Street cannot ignore this conflict and it should stop billing issuers for failed auctions and start encouraging issuers to redeem securities at fair market price. On the other hand, governments should not rely on Wall Street to have a conscience; it should be aggressive in representing its citizens to make sure Wall Street takes action. Issuers can also help pave the road to redemption by opening their auctions to more potential buyers by making the auction results transparent so bidders can see which auctions are safer.

Auction Rate Security Pricing Change At Fidelity to Affect 1,100 Securities

Fidelity Investments has been notified by its third-party pricing vendor, Interactive Data, that effective Monday, May 5, 2008, they will discontinue evaluating approximately 1,100 Student Loan Auction Rate Securities (ARS) and 26 Asset Backed ARS.

Below is an excerpt from Interactive Data announcement dated May 1, 2008:

As part of our on-going review of the ARS markets, Interactive Data has learned of recent failed auctions for Student Loan Auction Rate Securities that may result in the resetting of the coupons to zero. These conditions are causing changes within the market, making it increasingly difficult to access information that will enable us to determine on a consistent basis which ARS have reset to a zero coupon or which may be reset to zero or other "failed" rates in upcoming auctions. At the same time, we are continuing to observe some par level trades for Student Loan ARS that have had failed auctions. However, as a result of the increasing uncertainties in the coupon levels and the varying deal structures that impact the failed coupon rates, we will no longer be evaluating Student Loans ARS effective Monday, May 5, 2008.

We anticipate recommencing coverage of any discontinued evaluations when the market resumes its normal auction practices or if the issuers commence tender offers to purchase any and all of the outstanding ARS. We continue to monitor the remaining ARS evaluations for ratings changes, available trade information, issuer support, market color, and other pertinent information.

Client Impact

Advisors who have clients that hold these securities will continue to receive the fail rate set by the prospectus for their security; however, until market conditions sufficiently improve, Interactive Data will not be able to provide a price for these securities. Though customers will continue to receive the fail rate, the security price will be displayed on statements as Unavailable, reflecting the fact that pricing data is not currently available. The net worth of the customer accounts will be reduced by the amount of the unpriced positions.

Wall Street and Lenders Face Subprime Probe

Federal prosecutors from the Eastern District of New York have formed a task force of 15 investigators from federal, state, and local agencies that will investigate Wall Street firms and mortgage lenders involved in the subprime-mortgage crisis and look for potential crimes such as mortgage fraud by brokers, securities fraud, insider trading and accounting fraud. These are some of the questions prosecutors will focus on.

Did officials at mortgage lenders make misrepresentations in securities filings about a company's financial position, the quality of its mortgage loans and rising number of loan defaults? And were they engaged in questionable accounting to hide losses?

Did lenders alter borrower information, such as credit histories, before making loans and selling those loans to banks or Wall Street firms, which packaged them into securities and sold them to investors.

In what possible ways did lenders that originated loans defraud Wall Street banks that funded these lenders. For example, prosecutors are looking at whether some lenders, in violation of agreements they had with Wall Street firms, failed to pay back the firms after the lenders sold loans they originated directly to investors such as Fannie Mae and Freddie Mac, and then lied to the Wall Street firms about the status of the loans.

Did brokers at Wall Street firms lied to investors by telling them that their investments in collateralized-debt obligations were backed by, for example, corporate debt rather than risky assets such as subprime-mortgage loans.

In addition to this task force, other investigations are already under way. Prosecutors are trying to determine if UBS AG improperly valued its mortgage-securities holdings and if American Home Mortgage Investment, the tenth largest mortgage lender in the U.S., committed accounting fraud and false statements before it collapsed last year. Bear Stearns is also being scrutinized for the circumstances surrounding the failure of two of its hedge funds last summer due to losses tied to mortgage-backed securities.

Schwab Yield Plus Settlement Offers: Pennies on the Dollar

Charles Schwab is offering settlements to investors in its supposedly conservative Schwab YieldPlus Fund, which is down 26 percent this year. This settlement is pennies on the dollar for the losses suffered by some investors, who are now seeking a class action against Schwab.

YieldPlus, an ultra-short bond fund that offered high yields, attracted many investors and had more than $13 billion in assets at its peak last year. But the fund was stuffed with mortgage-related securities, and when the subprime-mortgage crisis hit last summer, the fund began its meltdown. Investors have been scrambling to get out and the fund's assets are now down to $1.5 billion.

Typically, fund companies repaid investors with losses in money-market funds. However, YieldPlus was not a money-market fund; instead, it sold itself as a conservative investment to clients looking for a slightly higher yield while preserving their capital.

Schwab's payouts are reported to be about one to twelve cents (or more in some cases) for each dollar lost. Investors who take these settlement offers will not be able to join in on any litigation against YieldPlus which could mean a quick exit for Schwab on a really big case against them.
Several suits against YieldPlus are seeking class-action status in New York, Massachusetts, and California. Disputes with brokerage firms usually require arbitration but the plaintiffs' attorneys say this doesn't apply to their case because Schwab did not adequately disclose the risks of the fund.

An Auction Rate Rebuttal to USA Today's Matt Krantz

Dear Mr. Krantz:

Yesterday, I read with concern your article titled “Auction-rate bonds leave many investors hanging”. The article and advice that you provide is a disservice to the investing public for the following reasons:

Step one - The recognition of the issue by NASAA and state regulators is overplayed in your article. Investors are in fact alone. State regulators, federal regulators and SROs are not vested with the authority to restart the auction process. They are empowered to investigate and discipline misconduct, not create structural change. Moreover, state or federal regulators or SROs do not represent individual investors and act as advocates seeking the return of their losses. If you had an opportunity to speak to the various regulators prior to putting pen to paper, they would likely have confirmed their intentions to you as they have done in private to attorneys and law firms that regularly practice in this area.

On April 15, 2008 some of the most troubling news in this area surfaced when Citibank declared that going forward auction rate markets would cease to exist. Your article doesn’t acknowledge this important development nor it’s impact on pricing and liquidly for investors. The lack of a market place moving forward is a substantial impairment of liquidity. Investors should be very concerned about this problem moving forward, the words “don’t panic” are not reassuring to most investors who understand all of the potential ramifications of this situation.

Step two – The advice to “run up the chain of command” is almost always the wrong move for investors. The effect of using the term unsuitable by Ms. Hurme is also overstated. While an advocate for seniors, AARP plays no significant role in the dispute resolution process for investors before FINRA. The only significant investor advocacy organization is the Public Investors Arbitration Bar Association, PIABA. Moreover, Ms. Hume’s statement that “Regulators have been paying keen attention to suitability of broker recommendations” also demonstrates a lack of understanding of the dispute resolution process.

Looking up a CUSIP on the FINRA website is virtually useless. The only source of information for ARS securities is Bloomberg, even there you don’t get the full story. FINRA, for example, tells nothing of S&P, Moody or Fitch’s credit outlook on particular ARS securities and whether they may be facing a rating downgrade. This is material information that affects pricing and liquidity.

I also note that you didn’t discuss the fact that secondary markets for ARS securities exist. One such example is Restricted Securities Trading Network. There are others. ARPS for example, have been trading for the last couple of weeks at approximately $.85. Most ARP investors do have other liquidity options.

Step three- Ms. Hume’s advice to contact FINRA, state regulators or the SEC will not lead to any immediate response or assistance. Moreover, complaining about the broker is a mistake given the fact that the Auction Rate problem is a massive institutional type problem that is in most cases not a broker specific sales practice problem. Remember brokers were lied to about the product, how does staining their CRD help the individual investor recover their losses or create liquidity?

Step four- Your article points out the correct options, but not for the individualized issues. What I mean by this is that there are three distinct categories of ARS – Notes, Student Loans and Preferreds. Within the Preferred category there are two types taxable and non-taxable. The problem with your advice is that it doesn’t necessarily apply to the categories of investments you describe. For example, single credit worth issuer notes like the Metropolitan Museum of Art may likely be redeemed at some point in time, holding makes sense but not because they are “trading again”. Holding makes sense because single issuer note rate resets are high and will likely cause issuers like the Met to buy back the ARS at par to avoid paying excessive interest to investors.

You’re correct about student loans, however, your article fails to mention the fact that student loan ARS might be saleable through a secondary market. I have seen evidence of secondary market bids between $.60 and $.80 for particular Student Loan notes.

Step five- Regulators do not take cases to advocate the investor’s position. Even if they prevail the ultimate outcome will be fines that go back to a state treasury. Your article gives investors the hope that somehow government will do something for them – it wasn’t designed to.

You mention a firm that has filed a class action, this is the wrong route for ARS investors and ignores the individualized determinations that will likely someday defeat class certification. Doing nothing now is simply bad advice. The only advice is to consult a qualified securities arbitration attorney and determine your individual options based on the specific securities you hold.

By the way -- hoping that the credit crunch will ease is not an exit strategy for investors.

If you would like to discuss these ARS issues further, I invite you to contact me.

Ryan K. Bakhtiari
Aidikoff, Uhl & Bakhtiari