Thursday, June 26, 2008

Wall Street Aware of Auction-Rate Danger, Still Sold to Investors

It's becoming clear now that Wall Street dealers knew that the demand for auction-rate securities was disappearing and even as they warned securities issuers that the market was in danger of collapsing, the dealers were still telling investors that these were safe and liquid investments they should buy into.

Many investors are probably suffering like Yanping Cui of Long Beach, California. Cui said her UBS AG broker urged her to invest in auction-rate bonds last December, but in that same month, UBS told one of the issuers of those auction-rate securities, a New Hampshire student-loan agency, that the $330 billion market was in danger of failing. The market did fail two months later and Cui was told she wouldn't get her money back until the market recovered. So much for the promises of safety and liquidity.

Bond documents and interviews show that Citigroup and UBS were among the dealers who sold auction-rate securities as low-risk while they were telling issuers that demand was softening.

Since March, at least 24 proposed class-action lawsuits have been filed against brokerages and a nine-state task force has been formed to examine how the firms marketed the auction-rate securities. Massachusetts, part of the task force, charged UBS with fraud today for its sales of auction-rate securities to the state's investors. Massachusetts alleges UBS told investors the long-term bonds were ``safe, liquid cash alternatives'' when the bank knew the securities weren't.

As the auction-rate market slowed last year, dealers at firms like UBS urged issuers to increase their bond's penalty rates to attract bidders. Issuers like the Missouri Higher Education Loan Authority and the New Hampshire Higher Eduction Loan Corp. raised their rates as a result. However, when bidders disappeared and the banks stopped buying unsold auction-rate bonds in February, the penalty rates issuers had to pay for failed auctions began soaring. Dealers didn't want to be known as the first to have a failed auction so some securities filings didn't disclose the new penalty rates and their implications of turmoil in the market until March, after buyers like Cui purchased auction-rate debt recommended by her broker.

So far, UBS has offered loans to their investors who are stuck in auction-rate securities. Meanwhile, UBS is cutting the estimated value of auction-rate securities held by its customers by 5 percent to reflect the lack of trading.

Many investors have lost their life savings or ability to even pay their next mortgage because their assets are frozen in the now worthless auction-rate paper. Investors are turning to arbitration and their lawyers for help and most are crying conflicts of interest; their financial advisers urged them to buy auction-rate securities and at the same time, those advisers' firms underwrote and managed the auctions.

Jon Corzine, New Jersey's Governor and former head of Goldman Sachs, pointed out that the securities were never truly liquid because they had a maturity on them. Corzine commented that investors' confusion may be how auction-rate securities were sold in the first place.

A settlement with the SEC in May 2006 over auction-rate securities sales practices required dealers to disclose risks to investors. A description of those practices can be found on most dealers' websites. A very close reader might have spotted that.

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