Wednesday, April 30, 2008

FINRA Issues Guidance to Broker-Dealers on ARS Redemption

In response to current market conditions, some issuers are offering partial
redemptions of auction rate securities. This Notice reminds firms that
when allocating partial redemptions of auction rate securities among their
customers, theymust adopt procedures that are reasonably designed to
treat customers fairly and impartially, andmust put their customers’
interests ahead of their own.

To view the complete notice, click here.

Fidelity Ultra-Short, Schwab Yield Plus and SSgA Yield Plus Losses

Ultrashort bond funds don’t take on much interest-rate or credit risk and their returns are a bit better than traditional money market funds so they have historically been considered an investment superior to money market funds. That’s why it is so surprising that since the credit crisis began last year the bond funds’ performance started sliding and a few funds in the group have blown up.

It turns out that the root of this debacle is that many ultrashort funds have securities tied to the performance of the housing market and the funds plunged as the housing market plummeted.

To make matters worse, many investors who owned these securities had to sell them, which further brought down the prices and reduced the funds’ chances of a quick recovery. Increasing redemptions have caused funds like Fidelity Ultra-Short, SSgA Yield Plus and Schwab YieldPlus to drop 13% to 27% in value and SSgA has decided to liquidate Yield Plus. In order to fulfill redemptions, fund managers have to keep cash handy and to do that, they have to sell securities to have enough cash for outflows. But the markets for ABS and MBS bonds froze last summer with sellers far exceeding buyers, forcing prices even lower and losses higher.

So why did these supposedly safe and high quality funds own such risky investments?

Ratings agencies like S&P, Moodys and Fitch had tested out various bonds using logical default risk assumptions and the results showed these securities offered decent yields. For example, the most secure groups of loans in subprime ABS offered yields that were only 0.05% higher than the three-month LIBOR, which was 5.3% to 5.4% during the first half of 2007. That was considered relatively safe but it wasn’t. Recently, that yield spread expanded 3.5% to 5.5% above LIBOR and prices have dropped in proportion.

This downturn highlights the weakness of ultrashort funds. Their goal is to exceed money market returns without being much more risky. Unlike money market funds which are restricted to certain investments, ultrashort funds can target relatively safe short-term bonds with good total-return potential that are off-limits to money markets. But when these targets aren’t available, ultrashorts can’t beat money markets. Also, to keep up the reputation of their money markets, many companies (such as Legg Mason, Northern Trust and SEI) would infuse their funds with capital if their money markets are at risk. Ultrashort funds have no such life savers.

Auction-rate bonds leave many investors hanging

Matt Krantz - USA Today

Q. My broker told me it was safe to put almost my entire life savings into bonds sold by the Missouri Higher Education Loan Authority. But the interest rate has fallen from nearly 6% to about 2% and I'm told I can't sell. What should I do?

A: Sounds like you've been sucked into the credit-crunch vortex.
What you, and many other investors are stuck with, are what's called auction-rate securities.
Auction-rate securities are bonds sold by municipalities and mutual funds that, on paper, were ingenious. These were long-term bonds that gave these borrowers access to money for 20 or more years. Buyers also got higher yields than they'd get on money market investments.

But, what's different, is that auction rate securities don't have a stated interest rate. Instead, the bonds are supposed to be offered in a periodic auction, ususally every 7, 28, 35 or 49 days, and investors would bid on them. The interest rate would be reset depending on the auction results. The more bidders, the lower the interest rate.

In theory, it's a good idea. Borrowers can access money for long periods at what are basically short-term interest rates. And investors who need their money back after a short term, in theory, can sell their securities to other investors. The theory, unfortunately, blinded many brokers who suggested these investments to clients and said they were as good as money in the bank.

In February, investors got a rude awakening. It turns out many of these auction-rate securities only had high credit ratings because they were guaranteed by large bond insurance companies. When the insurance companies ran into trouble, due to their exposure to sub-prime loans, investors realized the safety net for many auction-rate securities was gone. Suddenly, new investors weren't willing to bid in the auctions — leaving existing investors like you holding the bag. If there are no buyers for the bonds bidding in the auctions, you can't sell yours.

So the question is: What should you do now?

Step 1: Don't panic. You're not alone. Regulators are aware of the problem and are looking into it. State regulators from Florida, Georgia, Illinois, Massachusetts, Missouri, New Hampshire, New Jersey, Texas and Washington are all investigating this matter as part of a initiative from the North American Securities Administrators Association. You can read more about the investigation by clicking on the link below.

FROM OUR ARCHIVE: Read about the auction rate investigation.

The Securities and Exchange Commission is also aware of the problem. ""While we cannot disclose specific matters, as a general matter, we are looking at representations made to investors when they purchased auction rate securities, in coordination with FINRA," John Heine, spokesman for the SEC, said in an e-mailed response.

The SEC has, as long as two years ago, slapped brokerages on the wrist over the way the auctions were conducted. This action shows that the SEC is aware of this market and the abuses in the past.

PREVIOUS SEC ACTION: From 2006.

Step 2: Run up the chain of command at the brokerage. If you don't get any help from your broker, call your broker's boss and if necessary, keep working up the chain, says Sally Hurme, an attorney for the AARP. The question at hand is whether your broker sold you an investment that was "unsuitable," which is a word you should use because it will get attention at the brokerage. That is, did he or she know you needed a stream of income and he told you this was a risk-free investment that would provide it. Regulators have been paying keen attention to suitability of broker recommendations, Hurme says.

Gather as much information as you can about your investment. Ask the brokerage firm what it will do for you. Also, ask for any documents about the security you bought. Ask for the prospectus on the security. That will contain details about the bond that you own.
Also, on your brokerage statement, you should see the CUSIP number for the bond you bought.

The CUSIP number is like a ticker symbol, or identifier of the bond. Run that CUSIP number through Finra.org, which is one of the leading regulators of the securities industry. Here's how:
1. Go to finra.org/marketdata
2. Enter your bond's CUSIP number on the "Search" box in the upper right-hand corner of the page. Change the pull-down box to bond and click the Go button. The CUSIP on the bond you're asking about is 606072HM1. Click on the name of the bond. Here's where you can look up some details on the bond.

Regarding your specific bond, using the FINRA site and a Bloomberg terminal, I can tell you that the bond appears to come up for auction once a month. The next auction is scheduled for May 1. Tell your broker to try to sell your bonds. Who knows, you might get lucky.

Step 3: If you can't sell your bond and the broker gives you no satisfaction, contact the regulators. You'll want to canvass all the regulators and let them know you're one of the victims, Hurme says. That includes FINRA, which oversees the brokers.

COMPLAINT CENTER: For the Financial Industry Regulatory Authority.

Next, make your situation known to all the states involved. That includes the state you live in, the state the broker is located in and the state the bond issuer is in. A great place to do this is with the NASAA, at www.nasaa.org.

Click on the "Contact your regulator" link on the left-hand side of the page. Click on each state that's affected, and you will get contact information. When you call or contact the state regulators, make sure you have the bond CUSIP number and information about your broker.

Finally, let the SEC know. There is a section to file complaints here.

Step 4: Weigh your options. You essentially have four immediate options as you wait to see what the regulators do: Hold on to your security, try to sell it, borrow or sell other asset to help you through.

Each course has its own risks. Holding on, in some cases, might work. There are some auction rate securities that failed in February that are now functioning. The auction rate bonds sold by the Metropolitan Museum of Art, New York, for instance, failed, but are trading again.
You may not be as lucky. The type of loan you own, student loans, is one of the worst performing areas of auction-rate securities. Investors are fearful of credit risk and are unwilling to bid so far. Plus, it looks as if when an auction in your bond fails, the rate goes lower, not higher. That means there's not exactly going to be a line forming of people willing to bid for the auction at the low rates.

It's possible the issuer of the bond will try to restructure its auction rate bonds by selling new bonds to replace yours. But that's unclear in the tight credit market. Again, student loans continue to be one of the worst spots in the auction rate market. The student loan organizations don't have many options available to them.

Will Shaffner, spokesman at the Missouri Higher Education Loan Authority, told me April 25 the student loan market remains difficult. "The auction rate note market to students loans is still not functioning," he says. MOHELA is working to find a solution, since the problem is costing them, too, with high interest rates on some other bonds that have failed, he says, and causing difficultly in raising more money. MOHELA is seeking Congress' help in finding a solution to get the market for student loans functioning again, he says. Here's the latest information about the bonds available on the website (pdf).

That leaves the option of selling the bond. But again, this isn't going to help you since your bond is student loan backed. Your brokerage may allow you to borrow money, but you'll likely pay interest on that or, they will want you to sign a document saying you won't sue them in the future. You may be able to sell other assets and wait this out, but then, you're eating into your nest egg further and may have capital gains that create a taxable event for you.

Get more details on these options here.

Step 5: Consider legal representation. Even if the regulators do tackle these cases and win, it could take years before you see a penny. If you've pursued all the steps above and don't get anywhere, you may consider a lawyer, Hurme says. The lawyer may be better able to use language with the broker to get more satisfactory results. There's also a chance you can take the brokerage to arbitration and try to get a settlement that way.

There are also attorneys who are pursuing the possibility of pooling many investors who bought these investments into a super suit. Girard Gibbs is one of the law firms that has filed a complaint against leading investment banks and brokerages including Citigroup, UBS, Wachovia, Merrill Lynch, Wells Fargo, Morgan Stanley, J.P. Morgan Chase and TD Ameritrade over this issue.

Daniel Girard, partner at Girard Gibbs, says investors will not be precluded from pursuing claims in arbitration against brokers even if they join the preliminary formation of the class action. "People don't need to make a choice now," he says. You can get more information about the action here.

As you can see, there aren't many great options at this point. Your best hope is that somehow the credit crunch eases and either the auction-rate security starts trading again or the issuer may refinance the debt.

“Low Risk” Citigroup Hedge Funds?

Falcon and ASTA/MAT, two hedge funds that Citigroup launched last year and marketed to investors as safe fixed-income funds with losses not to exceed 5%, have been decimated by the credit crunch. Citigroup’s Smith Barney brokers had sold Falcon and ASTA/MAT as investment funds ideal for conservative retirees. That pitch attracted hundreds of millions of dollars from clients.

So far, the value of Falcon has plunged 75% and ASTA/MAT’s worth has dropped more than 90%. But even as the funds deteriorated, Reaz Islam, the manager of the funds, still assured brokers and clients that the funds were expected to make a rebound.

After weeks of internal debate over whether to help their best customers recover some of their losses or do nothing because the risks were outlined to investors, Citigroup finally decided to cover some of the losses. $250 million will be spent to help investors get out of Falcon without absorbing their full losses, but if investors agree, they forfeit all legal claims to the funds. Some ASTA/MAT investors will get a similar offer. One investor who put $500,000 into one of the hedge funds isn’t considering these offers and has already filed a federal lawsuit against Citigroup earlier this month.

A few top brokers have quit Citigroup in frustration and one broker, Paul R. Koch, pointed out at Citigroup’s annual shareholder meeting last week that the bank seems to be compensating clients “just enough so they don't sue us.”

In defense, Citigroup claims that they offered Falcon and ASTA/MAT only to clients with large, diversified portfolios and they outlined the funds’ risks in their disclosure and marketing materials. And the funds are suffering from unprecedented market dislocations.

ASTA/MAT invested mainly in municipal bonds while Falcon invested in municipal bonds, mortgage-backed securities, bank loans and other debt instruments. Each fund was made up of different funds that were launched periodically. Boosted by heavy leverage, returns were strong until the credit crunch began last summer.

Last year, Citigroup encouraged brokers at their private bank and at Smith Barney to push Falcon and ASTA/MAT with their best customers because Citi wanted to stabilize Falcon with a cash infusion after market tremors caused Falcon to decline more than 10%. By September, $71 million was raised for Falcon while ASTA/MAT raised about $800 million. Both funds were heavily comprised of retail investors. In the future, Citigroup will scale back its marketing of hedge funds to retail customers.

Tuesday, April 29, 2008

ASTA and MAT: Citigroup Hedge Funds Implode

Falcon and ASTA/MAT, two hedge funds that Citigroup launched last year and marketed to investors as safe fixed-income funds with losses not to exceed 5%, have been decimated by the credit crunch. Citigroup’s Smith Barney brokers had sold Falcon and ASTA/MAT as investment funds ideal for conservative retirees. That pitch attracted hundreds of millions of dollars from clients.

So far, the value of Falcon has plunged 75% and ASTA/MAT’s worth has dropped more than 90%. But even as the funds deteriorated, Reaz Islam, the manager of the funds, still assured brokers and clients that the funds were expected to make a rebound.

After weeks of internal debate over whether to help their best customers recover some of their losses or do nothing because the risks were outlined to investors, Citigroup finally decided to cover some of the losses. $250 million will be spent to help investors get out of Falcon without absorbing their full losses, but if investors agree, they forfeit all legal claims to the funds. Some ASTA/MAT investors will get a similar offer. One investor who put $500,000 into one of the hedge funds isn’t considering these offers and has already filed a federal lawsuit against Citigroup earlier this month.

A few top brokers have quit Citigroup in frustration and one broker, Paul R. Koch, pointed out at Citigroup’s annual shareholder meeting last week that the bank seems to be compensating clients “just enough so they don't sue us.”

ASTA/MAT invested mainly in municipal bonds while Falcon invested in municipal bonds, mortgage-backed securities, bank loans and other debt instruments. Each fund was made up of different funds that were launched periodically. Boosted by heavy leverage, returns were strong until the credit crunch began last summer.

Last year, Citigroup encouraged brokers at their private bank and at Smith Barney to push Falcon and ASTA/MAT with their best customers because Citi wanted to stabilize Falcon with a cash infusion after market tremors caused Falcon to decline more than 10%. By September, $71 million was raised for Falcon while ASTA/MAT raised about $800 million. Both funds were heavily comprised of retail investors. In the future, Citigroup will scale back its marketing of hedge funds to retail customers.

Recovery of Schwab Yield Plus Losses: Securities Arbitration vs. Class Action

Before retaining an attorney, aggrieved investors should consider carefully whether their rights are better pursued through a class action lawsuit or securities arbitration before the Financial Industry Regulatory Authority (FINRA). This is particularly true for Schwab Yield Plus (SWYPX and SWYSX) money market investors.

Important Facts to Consider Prior to Joining A Schwab Yield Plus Class Action

· The pending Schwab Yield Plus class action Class Period is March 17, 2005 to March 17, 2008. Investors who made purchases prior to March 17, 2005 are not represented and will have no right to recovery in the Class Action.

· In the case of Schwab Yield Plus losses, many investors sought safe, liquid, cash investments but were sold a product that was, in reality, much different. Such investors will have viable claims based on the investment's unsuitability. Because a suitability claim is dependent on an individuals circumstances, this claim cannot be prosecuted on a class wide basis.

· Investors with significant losses are unlikely ever to be made whole in a Class Action. Class action representation may be attractive where individual losses are small so that any one investor may not have an economic interest in pursuing the case. However, investors who have lost more than $20,000 should strongly consider pursuing their rights on an individual basis.

· Class actions are filed by attorneys seeking to represent all investors who have suffered a common wrong or purchased the same investment. Classes in securities cases are typically represented by the investor with the largest claim at stake. This often means that state pension funds or institutional investors will choose the attorneys and will be the ones who work on the strategy of the case. The interests of the class representative may not always be aligned with your interests, a specific example of this potential conflict is the inability to pursue suitability claims.

· Class actions sometimes create hurdles to recovery for individual investors including depositions and motion practice which are generally not permitted in securities disputes decided before FINRA. FINRA arbitration usually takes 12 months, recovery through a Schwab Yield Plus class action may take several years.

The Advantage of Individual Schwab Yield Plus Arbitration

Arbitration before FINRA is done on an individual basis with the investor having input in the selection of counsel and participating in the litigation of the case. Individual investors receive specific counsel relative to their claims.

Securities arbitration is a superior forum to seek damages that exceed out of pocket losses, as well as interest, attorneys fees and punitive damages in an appropriate case.

Morgan Stanley Warns Bank Woes Just Starting

Morgan Stanley is advising its clients to “sell the rally” in financial stocks and is forecasting lower big bank earnings as the credit crunch continues with no end in sight.

Morgan analysts reduced its estimates for 2008 large bank earnings by 26% ($17 billion) and reduced 2009 forecasts by 15% ($13 billion). Higher loan losses and expenses are expected and profits could fall further if the Federal Reserve stops lowering interest rates. Analysts are expecting this crunch to be worse than the one in 1990.

According to Morgan Stanley’s top “long” picks, the Bank of New York, JP Morgan Chase, and PNC Financial Group have less credit sensitivity or better capital structures. In contrast, investors should be careful to “underweight banks like Wells Fargo, Wachovia, Fifth Third Bancorp, KeyCorp and Citigroup since those banks have a greater exposure to mortgages and risky assets.

Monday, April 28, 2008

Arbitrations and Lawsuits against Morgan Keegan Piling Up

Memphis-based Morgan Keegan is accused of selling a variety of risky subprime mortgage-backed RMK funds to clients without disclosing the risk to them and most of the value of those funds has since been wiped out. Investor lawsuits are piling up fast.

With an average of two lawsuits being filed against them every month for the last five months (except January), Morgan Keegan directors are trying to get out. Pending shareholder approval, directors of seven RMK funds signed an agreement that would remove themselves and the funds’ director from managing the funds and transfer them to a New York-based asset management company. The effect that management change would have on the now nine pending federal lawsuits is unclear.

Lawrence Jones, an analyst at Morningstar Inc., commented that “some of the litigation that has been brought up regarding these funds may have just been a real thorn in RMK's side” and that’s why Morgan Keegan handed off local funds to Hyperion Brookfield Asset Management. Jones thinks Morgan Keegan “may have just wanted to put this part of their business to rest and just mop up the litigation and then move on.”

Those who invested in the RMK funds come from a variety of backgrounds. Some are sophisticated and successful business professionals and entrepreneurs; some are hard-working middle-class families or retired widows or widowers dependant on a fixed income. They all lost an exorbitant amount in what they thought were stable investments and it’s a huge problem for Morgan Keegan’s asset management division.

Investor Arbitration over Auction-Rate Securities

As the crisis in the auction-rate securities market continues, individual investors are getting more frustrated and angry over the fact that Wall Street broke their promise of safety and liquidity to them when brokers sold them these securities. Investor backlash is brewing as investors learn their assets are frozen or sharply devalued.

Harriet Johnson Brackey, from the Florida Sun-Sentinel, reports hearing many complaints with auction-rate securities. Brackey cites the case of a Delray Beach woman who thought she was depositing $370,000 with UBS AG in a money market-like fund which turned out to be an auction-rate securities fund. A short time later, the value of her account was written down by UBS and she lost $97,000 without even touching the principal. Since the collapse of the $330 billion auction-rate market, some companies like UBS have written down the value of the accounts to what UBS thinks the securities could be sold for today.

The Delray Beach woman isn’t taking this lying down. She’s filing an arbitration claim against UBS. Besides arbitration, some investors are also finding buyers but they are selling their securities at a 25 percent discount. State regulators are getting into the action too. Nine states have formed a task force to investigate the collapse of the auction-rate securities market and how those securities were sold to investors by brokerage firms.

Brackey points out that it is not only the broken promise of liquidity that has infuriated investors. High-yield bond funds that were heavily invested in securities backed by risky subprime mortgages are also hurting investors.

John Klecha complained to Brackey that his brokers at Morgan Keegan, a unit of Regions Financial Corp. sold him the RMK Multi-Sector High Income bond fund which was invested in risky mortgage-backed securities that wasn’t disclosed to investors. In 2007, that fund dropped 61 percent and it has dropped 29 percent so far this year. Like other trapped investors, Klecha is filing an arbitration claim against Morgan Keegan.

Saturday, April 26, 2008

Moody's Notes Further Deterioration in SIV Market

Reflecting further deterioration in the Structured Investment Vehicles (SIVs) market, Moody’s Investors Service announced that it could cut the ratings on the most junior debt issued by six SIVs.

SIVs are off-balance sheet vehicles set up mostly by banks that issue a combination of senior debt and capital notes. The proceeds are invested in long-term securities that are mainly asset-backed securities and bank debt.

Moody’s ratings cut affects debt issued by HSBC’s Asscher Finance, WestLB’s Harrier and Kestrel, Bank of Montreal’s Links Finance, Banque AIG's Nightingale Finance and Societe Generale's Premier Asset Collateralized Entity. Holders of this type of debt are not likely to benefit from restructuring proposals.

SIVs have been one of the biggest victims of the credit crunch. All of the notes under review are already rated in the “junk” category, between Ba2 and Caa3. The trouble for SIVs began when their funding dried up and the value of their assets fell, forcing sponsoring banks to rescue them by launching restructurings, and causing many to declare death for the SIV business.

Holders of SIV capital notes agreed to bear the initial losses on the portfolio of assets which mitigated losses for senior debt holders but Moody’s said those holders have been further hurt by market turmoil.

Morgan Stanley's Limited Auction-Rate Preferred (ARP) Redemtion

Ten Morgan Stanley closed-end municipal-bond funds have approved using alternate sources of leverage that would allow the funds to redeem some of their auction-rate preferred shares so some investors can get their frozen assets back. A timetable has not been set for the redemptions.

Tender Option Bonds will refinance up to 30% of each fund’s ARPS leverage. The bonds are derivatives created by placing high quality municipal bonds into a trust arrangement and each fund receives cash and a residual interest security. Then the trust issues securities which are purchased by third parties and pay interest rates that usually reset every week based on a short-term index rate.

However, bond usage depends on the availability of high-quality municipal bonds at certain yield levels to be transferred to the trust structure and demand for the securities issued by the trust. Higher short-term interest rates would increase payable interest on the trust securities but the generated income would be lower meaning a reduced income for shareholders and a possible decline in the overall yield and market value of each fund’s common shares.

The 10 funds approving the alternative leverage are Morgan Stanley Insured Municipal Trust, Insured Municipal Bond Trust, Insured Municipal Income Trust, California Insured Municipal Income Trust, Quality Municipal Income Trust, Quality Municipal Investment Trust, Morgan Stanley Quality Municipal Securities, California Quality Municipal Securities, New York Quality Municipal Securities and Municipal Premium Income Trust.

Friday, April 25, 2008

U.S. Bonds Shunned in the Market

According to the Federal Reserve, U.S. asset-backed bonds saw its biggest weekly contraction in two months and stands at its lowest level since mid-December.

Following a decline of $2.9 billion last week, the market for outstanding short-term bonds backed by mortgages, car loans and credit cards fell further to $10.8 billion this week. In total, asset-backed commercial paper (ABCP) is worth $767.1 billion, down from a peak of $1.2 billion in July. For its fourth consecutive week, the broader bond market also shrank and now stands at a value of $1,785 billion.

Investors have fled the ABCP market since the credit crunch and that in turn has hurt bank-sponsored entities that relied on short-term funding. The value of mortgages and other assets used in the market has only worsened.

Thursday, April 24, 2008

What Wall Street Knew About the Auction Rate Failure

While many individual investors and their financial advisers are surprised by the collapse of the auction-rate securities market in February this year, Wall Street firms actually saw trouble ahead and began looking for ways to prevent auction failures for one type of securities several months before the market collapsed.

Late last year, UBS, Citigroup and Bank of America requested student-loan authorities to issue waivers that would make the auction-rate securities easier to sell. Meanwhile, these firms were struggling to keep the auctions from failing as the credit crunch scared off experienced investors such as corporate treasurers from buying at the auctions.

These behind-the-scene moves raise questions about whether Wall Street firms told their clients about risks emerging in the auction-rate securities market. Many individual investors who bought securities during that time had no idea there were problems in the auction-rate market and were still being told that they were safe cash alternatives. The firms’ failure to alert investors could mean the firms were afraid of a panic-driven domino effect that would cause the market to collapse faster.

UBS, Citigroup and Bank of America all declined to comment on how investment bankers advised student-loan issuers late last year and how they communicated with financial advisors and investors.

Credit Vehicle Defaults Continue to Rise

Defaults of structured credit vehicles based mainly on subprime mortgages continue to rise and now total $170 billion, up from $54 billion at the beginning of this year. Consequently, the $450 billion market for asset-backed collateralized debt obligations (CDO) has been crippled by these rising defaults.

Banks and bond insurers with these deals are suffering and investors are seeking legal action. Ambac, the second largest bond insurer, reported $3.1 billion of mortgage-related charges this week.

Mortgage-backed CDOs attracted lots of investors in recent years because its structure created different slices of risk (aka tranches) that referenced an underlying pool of assets. Senior tranches carry higher credit ratings due to potential losses from the pool of assets borne by the smaller subordinated tranches. However, in the past year, many highly rated CDO tranches have been downgraded sharply and this triggered an Event of Default (EOD) for many structures. When a CDO experiences an EOD, many investors of the deal are pushed to the side and super-senior investors assume control of the CDO.

After seizing control, these super-senior holders will try to get their money back ahead of other investors, including those that held the AAA-rated slice of risk, by accelerating payments to themselves from the assets or liquidating the portfolio. Some other holders are now contesting these actions in court.

Data shows that Merrill Lynch had underwritten 26 CDOs in default and UBS and Citigroup each have 24 deals they have underwritten in EOD. Underwriters often keep significant amounts of the most senior notes of the CDOs on their books. Currently, Citigroup leads the pack with $30 billion, followed by Merrill Lynch’s $29 billion and UBS with $26 billion. Among the managers of CDOs in default, Strategos Capital Management leads with $14.2 billion.

Letter to SEC on Auction Rate Preferred Securities

April 23, 2008

The Honorable Christopher Cox
Chairman
U.S. Securities and Exchange Commission
100 F Street, NEWashington, DC 20549

Dear Chairman Cox:

The loss of liquidity in the market for auction rate preferred securities has hurt a number of my constituents and, we are certain, at least some constituents of every member of Congress. The fact that the root cause of this situation appears to be turmoil in the broader credit markets, and not a single market participant, does not excuse us from urgently seeking a solution. But at least one potential solution—a redemption of the preferred shares by the issuing funds—apparently meets resistance among the fund companies as a threat to interest of the fund’s common shareholders. What is the Commission’s view of this apparent conflict? Under the Investment Company Act, how do the rights and standing of investors in the preferred shares of closed-end mutual funds compare with those of common shareholders?

We would also like to know what action the Commission is taking to determine whether brokers who sold auction rate preferred securities did so using deceptive or misleading practices. We have received several reports of brokers routinely touting these securities as though they were as liquid as cash. This is obviously not the case and brokers that used inappropriate sales tactics should be held accountable.

As you are aware, the mutual fund industry is seeking exemptive relief from the asset-coverage tests that SEC fund companies believe will allow them to redeem at least some of the currently illiquid securities. We understand the Commission may be able to grant this request on a temporary basis.

We strongly urge you to consider this request and any other relief that the Commission may be able to provide in as expedient a manner as possible as they are presented.

BARNEY FRANK

PAUL E. KANJORSKI

Tuesday, April 22, 2008

Auction-Rate Market Shrinks 18%

As Citigroup predicted last week, the $330 billion auction-rate securities market is ceasing to exist. About 18% ($58.9 billion) of the securities outstanding in January have already been redeemed or will be converted by municipalities and closed-end mutual-funds. In addition, the SEC, FINRA, and at least 10 states are investigating brokerage firms to see if they misrepresented the securities to investors and criminal charges may be filed by the states.

Municipalities nationwide sold their bonds during the past two months to refinance auction debt as investors took advantage of tax-exempt yields that rose to a half-percentage point above taxable Treasuries. Yields on 10-year top-rated tax-exempt debt ended last week just 0.03 percentage point higher than the rate on the Treasury note and about 0.6 percentage point less than Treasuries over the past seven years. This reflects fading concern that auction-rate refinancing would overwhelm demand.

Rates on auction debt have fallen as borrowers such as Puerto Rico bid for their own securities as a temporary tactic to normalize rates before refinancing the bonds. By the end of next month, $48.3 billion of municipal auction debt is expected be to be converted by borrowers.

New York-based BlackRock said its closed-end funds plan to buy back $1.87 billion out of the $9.8 billion preferred auction-rate securities they issued and it wants to issue about $1 billion of floating-rate securities (aka tender-option bonds) to provide cash to some investors stuck in its tax-exempt preferred shares. Additionally, BlackRock and nine other fund managers plan to redeem at least $10.6 billion in taxable and tax-exempt preferred auction shares. And along with fund advisers such as Nuveen Investments, BlackRock is exploring options to add a “put” feature that would allow investors, including money-market funds, to sell the securities back to borrowers when rates reset.

According to strategists at Lehman Brothers, municipal bonds produced returns of 4.64 percent since the end of February, better than all other fixed-income asset classes. Lehman predicts that returns will increase as municipalities revert to sub-Treasury yields.

Monday, April 21, 2008

Citigroup’s Falcon, ASTA and MAT Hedge Funds

The decline of Citigroup’s fixed income hedge funds has led to investor claims and an investigation of Citigroup, Inc. (NYSE: C) according to a four-law firm legal team with nationally recognized securities law experience.

“We are investigating the decline of fixed income portfolios that Citibank sold. The Falcon, ASTA and MAT funds employed leverage to purchase municipal bonds,” said attorney Ryan K. Bakhtiari, of Aidikoff, Uhl & Bakhtiari. “Falcon appears to have lost more than 30% of it’s value while ASTA and MAT appear to have suffered losses in the range of 60% to 80%.”

A class action lawsuit was filed against Citigroup in the United States District Court for the Southern District of Florida for purchasers of the Falcon fund, A. Robert Zeff v. Citigroup Alternative Investments, LLC et al., Case No. 2008cv80346.

If you are an investor that lost more than $100,000, you should consider all legal options.

Sunday, April 20, 2008

Citigroup May Lose Investors and Brokers

Already mired in a series of write-downs, Citigroup must now deal with the mess from blowups in a series of hedge funds. High-net-worth clients with losses approaching $2 billion are threatening to move their money to competing banks, which is prompting some of Citigroup’s top brokers to consider jumping ship as well.

In a desperate bid to do keep their investors and talent, Citigroup recently injected $661 million into six ailing hedge funds and devised a restructuring plan that would allow investors to potentially recoup some of their money. The company is also holding weekly conference calls with its sales force to show they aren’t underestimating the impact of the failed funds. However, it’s not clear if this will work in Citigroup’s favor because clients and brokers alike have claimed that the funds were marketed as low-risk to them and the restructuring plan may be too little too late for the wealthiest investors who already lost most of their initial investment.

The six troubled hedge funds, sold under the brand names ASTA and MAT, used a large amount of leverage to buy municipal bonds. At its peak, the funds controlled $15 billion wroth of muni bonds when they only had $1.9 billion in investors’ money. The funds borrowed about $8 for every $1 raised. When the municipal bond market suffered a meltdown in February, the funds sank. Even after Citigroup’s cash infusion this year, the funds are down 60% to 80% because the funds owned some of the hardest hit muni bonds. These losses came just as the $1 billion Falcon Strategies, another group of highly leveraged funds run by Citigroup, took a steep plunge due to a series of bad bets on the mortgage market.

So far, at least one broker with a number of clients in the hedge funds has switched over to Morgan Stanley. Some brokers are referring frustrated clients to lawyers. Meanwhile, the bank is trying to stay out of litigation by requiring investors to agree that they won’t sue as part of the restructuring plan.

Citigroup isn’t the only bank facing the trouble with investors and brokers. Bear Stearns, UBS, Merrill Lynch, and Lehman Brothers are all dealing with settling with clients, lawsuits, and losing brokers. However, the threat of clients and brokers leaving is more troubling for Citigroup which has been one of the few bright stars in the brokerage business.

Auction-Rate Securities Have Lost Value

Citigroup, the leading underwriter of auction-rate bonds since 2000, announced in its quarterly earnings report that it has taken a loss of $1.5 billion on its inventory of these securities. According to Michael Quint of Bloomberg.com, the writedown amounted to 20% of the $8.1 billion in auction-rate securities held by Citigroup at the end of 2007.

Most of the loss was in student-loan backed auction-rate securities whose value dropped $971 million. The value of municipal auction-rate debt fell $355 million while tax-exempt and other assets fell $132 million. Citigroup’s holdings of auction-rate securities were valued at $6.1 billion as of March 30, 2001.

Most other investment banks are still valuing auction-rate securities at face value. UBS, however, has started writing down the value of auction-rate securities held in its customer accounts. Reports are that UBS customers are taking haircuts ranging from 3 to 30% on their auction-rate securities.

Saturday, April 19, 2008

States Investigate Auction-Rate Securities

Securities regulators in Massachusetts, Florida, Georgia, Illinois, Missouri, New Hampshire, New Jersey, North Dakota, Texas and Washington are investigating auction-rate securities and coordinating their efforts to help investors get back some of their frozen assets from these supposedly safe and liquid investments.

The North American Securities Administrators Association, which represents state securities regulators, is following the lead of the SEC and Financial Industry Regulatory Authority, both of which recently started looking into how brokers marketed the products to investors.

State securities regulators began their investigation in late February. Although they’re being handled separately in each state, probes are being coordinated through a task force headed by Bryan Lantagne, head of the Massachusetts Securities Division. The regulators are focusing on broker conduct and paying special attention to what was potentially misrepresented and omitted at the time of sale.

Friday, April 18, 2008

Hedge Fund Advisor Pleads Guilty

R. Alexander Acosta, United States Attorney for the Southern District of Florida, Jonathan I. Solomon, Special Agent in Charge, Federal Bureau of Investigation (FBI), Miami Division, and Don B. Saxon, Commissioner, Florida Department of Financial Regulation, announced that defendant, Jung Bae Kim, a/k/a John B. Kim, 39, formerly of Jupiter, Florida, pled guilty earlier today to one count of wire fraud in connection with the running of a hedge fund formerly run by the KL Group LLC in Florida and California. Kim faces a maximum period of twenty (20) years in jail, a fine of $250,000, and possible restitution to the victims of the massive fraud. Sentencing has been scheduled for July 17, 2008 at 2:30 p.m. in West Palm Beach before U.S. District Court Judge Kenneth Ryskamp.

In December 2006, Jung Kim, his brother Yung Bae Kim, and Won Lee were indicted by a West Palm Beach grand jury on charges that they orchestrated a massive investment fraud in running various hedge funds under the umbrella of the KL Group, LLC, initially in California and later in Palm Beach County. Yung Bae Kim pled guilty previously and is awaiting sentencing.

Also indicted were three hedge fund advisor companies that were owned and controlled by the individual defendants: KL Group, LLC, KL Florida, LLC and KL Triangulum Management, LLC. The corporate defendants were charged in the investment fraud conspiracy and subsequently pled guilty and have cooperated with the government. In sum, approximately $195 million was taken in from investors between 2000 and 2005.

During today's guilty plea, Jung Kim acknowledged lying to investors to induce them to invest and re-invest in the Hedge Funds. For example, the defendants misrepresented the success of particular funds, stating that the funds were profitable, when in fact none were. These misrepresentations regarding the success of the funds were made orally, on-line at a KL website, and through false account statements sent to investors by mail and email. Kim also admitted that counterfeit clearing firm statements were used to perpetrate the scheme to entice victims to invest or re-invest their money. More specifically, Kim admitted that in February, 2005, fictitious stock trading sheets were created that purported to show a one-day profit of $22 million in a stock known as RIMM, the company that manufacturers the "Blackberry" device.

The RIMM trade, however, never took place, and the fictitious stock trading sheets were used to fool investors concerning the profitability of trades being conducted by the KL Hedge Funds.

Mr. Acosta commended the investigative efforts of the Federal Bureau of Investigation and the State of Florida's Office of Financial Regulation. The case is being prosecuted by Assistant United States Attorneys Stephen Carlton and Edward Nucci.

Wednesday, April 16, 2008

Falcon Plus Strategies and CSO Partners

Citigroup, the largest U.S. bank, is barring investors of CSO Partners, a fund specializing in corporate debt, from withdrawing their money. CSO Partners dropped 10.9 percent last year and investors were trying to redeem more than 30 percent of the fund’s roughly $500 million of assets before Citigroup stopped them. Citigroup has injected $100 million into the fund to help stabilize it.

John Pickett, the CSO’s manager, left following a disagreement with Citigroup and complaints from investors after he tried to back out from committing more than half the fund’s assets to buy leveraged loans tied to a German media company. CSO eventually agreed to buy $746 million of the loans at face value even though they were trading at 86 to 93 percent of face value.

Meanwhile, Falcon Plus Strategies, a new leveraged fund launched last September, lost 52 percent in its first three months. It wrongly betted on mortgage-backed and preferred securities and made trades based on the relative values of municipal bonds and U.S. Treasuries. Some collateralized debt obligations in the fund trade at 25 percent of their original worth.

Both CSO and Falcon belong to Citigroup’s alternative investments unit. That unit was briefly headed by Vikram S. Pandit before he became Citigroup’s chief executive last December. Old Lane Partners, a hedge fund that Pandit founded and sold to Citigroup last year, also has dismal returns.

Citigroup Sued Over Falcon Hedge Fund

The first lawsuit was filed against Citigroup for allegedly lying to investors about the risks in one of its hedge funds and is seeking class-action status.

Filed in federal court in Florida, the suit accuses Citi Alternative Investments of marketing its Falcon hedge fund strategies as low risk and low volatility to defraud investors through the funds’ “exorbitant fees.”

Falcon Strategies Two B fund lost more than 40% of its value and the potential class-action blames Citi for moving the fund’s assets into a riskier strategy without letting investors know. The class-action covers any investors who put money into the fund between September 30, 2005 and January 8, 2008 when Standard & Poor’s changed the fund’s volatility rating from its second-lowest risk rating to its second-highest. Citi bailed out the Falcon strategies with a $500 million line of credit this past February.

Tuesday, April 15, 2008

Investors May Get Nothing on Student Loan Bonds

Investors in the student loan-backed sector of the ailing auction-rate securities market haven’t been able to sell their securities, and now, it looks like some may not even collect the penalty rates that were supposed to be paid to them as compensation.

Out of the entire $330 billion auction-rate market, about $86 billion of student loan-backed auction-rate securities were outstanding at the beginning of 2008. The hitch with student loans is that they are trusts and trusts cannot pay out more than its generating.

After Wall Street firms fled the auction-rate market and the market collapsed earlier this year, student loan bonds were among the worst hit since the trusts had to pay out high penalty interest rates for the failed auctions. Those penalty rates rose beyond what the trust earned on the loans and beyond a pre-set maximum penalty rate usually tied to a spread over certain money market rates. Those maximum rates are usually based on rolling averages of 12-month “lookback” periods. In the event that the trusts paid out more than they earned, the trust could reset the penalty rate to zero percent; thus paying investors nothing while they hope for a chance to sell their securities.

There is one upside to this. Because the maximum rate is a rolling average, each subsequent month could chop off some of that high rate and get closer to equalization.

Iowa Student Loan Liquidity Corp. and the Utah State Board of Regents are among issuers who are currently paying zero on some of their taxable student loan revenue auction-rate bonds.

Missouri Probing Auction-Rate Sales

In response to investors’ complaints about not being able to sell their auction-rate securities, the state of Missouri is investigating brokerage firms in how they sold these securities to investors.

Auction-rate securities have been sold as safe and liquid alternatives to cash with rates better than traditional money-market accounts. The $330 billion auction-rate collapsed after Wall Street firms, suffering from their own write-downs and losses, stopped rescuing the failed auctions. That left investors with securities no one wanted to buy and debt issuers with high penalty interest rates for failed auctions.

Missouri is advising their investors to review promises made to them by brokerage firms and asking firms for documents on how they marketed the securities.

Missouri is not alone. Massachusetts, FINRA, and the SEC have all taken up action to investigate investor complaints and the sales practice of brokerage firms.

Citigroup Says Auction-Rate Market Will “Cease to Exist”

Citigroup, the top underwriter of auction-rate securities in 2006 with $8.4 billion in sales, says the ailing $330 billion auction-rate securities market will “cease to exist.”

To raise funds, local governments, hospitals, and closed-end mutual funds issued securities maturing in as long as 40 years at interest rates that reset every week to a month through auction bidding. Investors began abandoning the auction-rate market around February this year amid concerns that companies insuring the bonds wouldn’t meet their obligations in case of default. As investment banks and firms suffered write-downs and credit losses, they stopped using their capital to save failed auctions which led to the total collapse of the auction-rate market. Consequently, investors weren’t able to sell their securities and some issuers had to pay hefty penalty interest rates as high as 20 percent.

Citigroup realizes that brokers’ earnings will only be trimmed by 1 to 2 percent by the death of the auction-rate market but investor anger will only rise if there is no solution to liquidate their frozen assets. Investors would also be reluctant to trust brokers and managements firms again.

Some banks are offering help by letting customers borrow against their illiquid auction-rate bonds. UBS AG, which cut the value of the auction-rate securities in its account by about 5 percent, said it would allow customers to borrow the full value of their auction debt from them starting in May. U.S. municipal borrowers have taken this route to refinance their way out of higher costs, and combined with closed-end funds bailing investors out, the auction-rate market has shrunk by $51 billion.

Redemptions will also bail some investors out. Nuveen Investments and seven other fund managers will redeem $7.8 billion in taxable preferred shares that have rates set through periodic dealer-run auctions. About 70 percent of closed-end funds borrow money in an effort to boost returns, most by selling preferred shares on the auction-rate market.

According to Citigroup, the collapse of the auction-rate market will raise the cost of leverage for closed-end funds. It will also benefit firms with large money-market funds such as Federated Investors, BlackRock and Charles Schwab.

Lenders Getting Out of Student Loan Business

The credit crunch and cash-strapped Wall Street is driving lenders out of the federally backed student loan business in droves just as loan applications are piling up from students heading to college this fall semester.

Student loan-backed securities make up about $80 billion of the $330 billion auction-rate securities market. The collapse of that market this year has had rippling effects in the student loan market.

There have been calls for the government to act and protect access to education and Congress is concerned.

According to the Education Department and education experts, so far, no student has been unable to get a loan because with over 2,000 lenders participating in the Federal Family Education Loan Program, there have been lenders ready to step in when certain lenders stopped making loans.

Not satisfied, lawmakers pressed for a contingency plan and they got it. Education Secretary Margaret Spellings says she is providing a safety net in the event the government’s help is needed. Kennedy's bill would allow the Education Department to use government funds to finance student loans.

A Case for Unhappy Brokers to Switch Firms

Unhappy financial advisors looking to change brokerage firms may find another reason to switch with the turmoil currently plaguing the auction-rate securities market. The collapse of the $330 billion auction-rate market has brought many investor lawsuits against brokerage firms, alleging deceptive marketing of auction-rate securities as safe alternatives to cash. Brokers may be able to convince their clients, who are upset over their frozen assets, to leave with them and that their firm is all to blame for selling them supposedly safe products. However, angry investors may be hard-pressed to trust their brokers again and changing firms doesn’t mean investors will have access to their money.

Other factors motivating brokers are the large transition packages firms are offering top moneymakers. To lure top brokers from the competition, firms have offered 150% of the fees and commissions the broker generated over the past 12 months in upfront cash and there’s more if he or she meets certain asset and production goals over time.

Brokers are also rattled by the falling share prices of company stock they are holding, Bear Stearns’ near collapse a month ago, and the massive write-downs financial service firms have taken because of U.S. sub-prime mortgage exposure. Loyalty is running short and brokers are looking for better deals at other firms even though brokerage firms across Wall Street are facing similar issues.

Bayou Group Hedge Fund Founder Sentenced

The founder of defunct hedge fund Bayou Group was given a 20-year prison term today for bilking investors out of more than $400 million, Bloomberg reports. Samuel Israel must also pay $300 million in restitution for masterminding a “ponzi scheme” in which investment returns were paid with new investors’ money. His sentence is the longest for a white-collar crime since Enron litigation.

"You were, in every meaning of the sense, a career criminal … you ruined lives," US District Judge Colleen McMahon told Israel at sentencing.

Monday, April 14, 2008

Alabama Legislature Debate Jefferson County Takeover

Senate and House committees will debate over four bills this week in the Alabama Legislature that could result in the state controlling the Jefferson County Commission. Meanwhile, the County Commission will vote today to extend the deadline on a $53 million sewer bond debt payment, that is due to Wall Street banks tomorrow, to May 15 in order to reach an agreement with banks, including JPMorgan Chase, that serve as trustees for bondholders.

This extension could help Jefferson County settle with the banks and avoid bankruptcy but the extension may be stretched again since the county said they didn’t have the cash and missed the sewer bond debt payment on April 1.

The four bills under consideration include SB Bills 591 and HB 838 which would create an eight-member Alabama Public Management Authority, which would include Gov. Bob Riley, Lt. Gov. Jim Folsom and other top state officials or their appointees. And SB Bills 583 and HB 837 would require a county, city, town or municipal authority such as a utility to first get the permission of an eight-member state authority before it could readjust public debts after declaring bankruptcy. Thus, the APMA would takeover the county’s powers and duties if the county defaults on debt and would maintain control until the utility or county made 12 consecutive debt payments on time and implemented any APMA recommendations.

Some in the committee support the bills and blame the commissioners who oversaw the county but some also think the people closest to the problem would best understand and handle the problem.

Friday, April 11, 2008

Charles Schwab YieldPlus Fund Turns Toxic

Charles Schwab’s YieldPlus fund was once marketed as a safe alternative to cash and was Schwab’s most popular bond fund. But Schwab stuffed mortgage-backed securities into YieldPlus’ portfolio to pump up performance and it turned toxic. YieldPlus has lost 24% of its value this year, while the average ultra-short bond fund is down just 1.9%.

Created in 1999, YieldPlus often beat bond indexes and peers and offered better yields than options such as money-market funds. Schwab brokers often advised clients with short-term certificates of deposit to switch into YieldPlus, saying the fund aimed to provide steady monthly income with limited interest rate and credit risk. But one of YieldPlus’ tactics was to focus on mortgage-backed securities, which ended up making up half of its assets. Some of those securities were supported by sub-prime loans, which started going bad last summer.

YieldPlus took an unexpected blow in November last year when Interactive Data Corp. marked down the price of some of the portfolio's debt. Schwab's problems increased when investors pulled their money out and fired their brokers. Some frustrated brokers have started giving clients the email address for Kimon Daifotis, YieldPlus’ leading manager since its inception, to send him complaints directly. As of last week, the fund's asset base had dropped to $1.5 billion from a high of $13.5 billion last year.

YieldPlus's problems are feeding on themselves. To meet redemptions, YieldPlus has had to unload bonds, potentially at fire-sale prices, tied to a variety of troubled companies, including New Century Financial, Washington Mutual, Countrywide Financial, and Bear Stearns.

Schwab blames its problems on the credit crunch and says they affect only a small part of the company, which is performing well overall. And in a backhanded no-confidence vote, none of the other Schwab funds will hold YieldPlus in their portfolio starting in April.

Investors are suing Schwab for misleading them about the YieldPlus fund but Schwab is denying the allegations. Lawsuits and the fund’s failure is a setback to Schwab’s effort to diversify beyond collecting volatile trading fees. Schwab started out providing discounted stock trading and then sold others’ mutual funds before moving into offering its own funds and advisors to build a steadier revenue stream. Service fees totaled 23% of the firm’s net revenue last year but

YieldPlus’ failure has meant lost fees YieldPlus isn’t alone in its trouble though. Similar but less popular funds like Fidelity Ultra-Short Bond Fund and SSgA Yield Plus from State Street Global Advisors have also been hurt in recent months. The funds are down 7.3% and 18% respectively this year.

FINRA Creates New Reporting Category Relating to Auction Rate Customer Complaints

FINRA has added three new product categories for use by member firms in reporting customer complaints relating to auction rate securities. NASD Rule 3070(c) and incorporated NYSE Rule 351(d) require all members and member organizations to report, on a quarterly basis, statistical information regarding customer complaints. This information is required to be filed by the fifteenth calendar day of the month following the end of the quarter.

Member firms are required to submit quarterly statistical reports under NASD Rule 3070(c) and incorporated NYSE Rule 351(d) using the new product categories beginning with second quarter reports that are due to FINRA by July 15, 2008. FINRA member firms may voluntarily use the three new product categories when reporting customer complaints for the first quarter of 2008.

Wednesday, April 9, 2008

Secondary Market for Auction-Rate Securities at Discount Prices

Some relief is appearing for investors with illiquid auction-rate securities. Investors can now sell their auction-rate securities in the developing secondary market for an average of 75 to 95 cents to the dollar. That average range of bids which is 5% to 25% below par.

These lower bids provide clues to the losses facing cash-starved investors and dealers with auction-rate securities. The Restricted Securities Trading Network began trading auction-rate securities in early March after the $330 billion auction-rate market collapsed in the face of a global credit crunch and investors’ cash became stuck in these illiquid securities. Currently over 150 different securities are listed for sale and activity is expected to increase when investors realize that they may never recover the full face value of their securities in the future anyway.

For example, UBS AG has already begun lowering its clients’ auction-rate securities value by about 5 percent and some limited cases were lowered 15 percent. This was a jolt of reality to investors and some may conclude that they could achieve more liquidity if they sold their securities at a discount in the secondary market.

Bids for auction rate bonds sold by U.S. municipalities have the smallest discounts; student loan bids could get as cheap as 75 cents on the dollar; and closed-end fund preferred securities could get bids of around 80 to 90 cents on the dollar. Student loan bids are the highest because they pay below market penalty rates when auctions fail to sell.

While most auctions continue to fail, few transactions in secondary markets are taking place as investors are hoping current crisis won’t last and that issuers will buy back these securities. However, the secondary market will stay even though municipalities and closed-end fund like Nuveen, Eaton Vance, and BlackRock have begun redeeming their auction rate securities. The reason being is that the current credit environment won’t be able to help refinance this $330 billion market. Also, some states and cities have high penalty rates at failed auctions but other issuers actually have below market penalty rates and have no incentive to redeem their auction-rate securities.

SEC Chairman Condemns Overhaul Bid by Bush

David Ruder, Arthur Levitt and William Donaldson, former leaders of the SEC, say the Bush administration’s proposed overhaul of financial regulation threatens to weaken the SEC, and it is a mistake for the Treasury Department to push the SEC into adopting the regulatory approach of the much smaller Commodity Futures Trading Commission (CFTC).

Ruder, said it’s not useful for the SEC to have “a prudential-based attitude in which regulators solve problems by discussing them informally with market participants and ask them to change;” instead, the SEC needs “to have an enforcement approach.” Levitt supports an SEC and CFTC merger but says the terms proposed by Treasury are “wrongheaded'” because they would give the CFTC “primacy.”

Current SEC Chairman Christopher Cox hasn’t endorsed a merger between the two agencies, but he promises a system of oversight that best protects investors, promotes fair markets and facilitates capital formation.

The Treasury’s proposal comes as lawmakers question whether the SEC has been lax in fighting fraud. Currently, the Federal Reserve shares oversight of investment banks, and the SEC is transferring some duties for monitoring accounting rules and securities sales to overseas regulators.

Government watchdogs have been asked by Senators Christopher Dodd and Jack Reed to look into why SEC sanctions against companies and individuals dropped 51 percent, to $1.6 billion, in the most recent fiscal year. According to the SEC’s own reports, it also opened 15 percent fewer investigations over the same period. Dodd and Reed said this drop “raises questions about whether changes have taken place in enforcement philosophy or scope of activity.”

Cox’s response to Dodd is that the SEC has been vigorous in enforcing securities law and the agency brought in 655 cases in the fiscal year that ended in September, the second-most in its history. But the number of probes that resulted in enforcement actions within two years dropped to 54 percent last year, compared to 64 percent in 2006.

The SEC was primarily responsible for regulating Wall Street investment banks until the Feds stepped in last month to orchestrate the Bear Stearns and JP Morgan marriage to save Bear Stearns from bankruptcy and prevent widespread market panic. The Feds is now lending money to securities firms for the first time since the Great Depression and having examiners onsite at these firms to help the SEC inspect capital and liquidity.

Treasury Secretary Henry Paulson wants to increase the Fed's power by giving it a role in writing rules for securities firms and making it responsible for monitoring risks that Wall Street poses to the U.S. economy. Paulson also suggests the SEC should rely more on the $11.7 trillion mutual-fund industry to police itself. Most of Paulson’s recommendations would require changes in legislation in order to take effect though.

Donaldson, who stepped down as SEC chairman in June 2005, didn’t agree with Paulson’s recommendations. “Before you start rearranging the organization of the financial-regulatory agencies,” Donaldson said, “you must examine how all of this happened” and determine what powers are needed or weren’t used.

The SEC is also evolving on its own. In 2007, the agency dropped a rule that required overseas companies match their financial statements with U.S. accounting rules. The SEC is now considering allowing American companies to use international accounting rules to adjust to cross-border investing. With these moves, the SEC risks losing control of how companies report profit and revenue under rules drafted by the Financial Accounting Standards Board. Cox assures that the SEC is doing everything to make sure financial reporting from different countries is comparable and reliable but Levitt charges that from a transparency standpoint, these changes hurt American investors.

In addition, the SEC is thinking of easing rules to allow foreign stock exchanges and brokerages to sell securities directly to U.S. investors. Transactions would be carried out under the watch of overseas regulators who have rules that are similar to the U.S. Doubtful that overseas regulators share the same commitment in protecting U.S. investors, Senator Reed plans to hold hearings on this proposal.

Business Owner Arrested in $132 Million Scheme to Defraud Clients

Edward H. Okun, 57, of Miami was arrested and charged with mail fraud, bulk cash smuggling and making false statements. The indictment stems from Okun's scheme to defraud and obtain millions of dollars in client funds held by The 1031 Tax Group, LLP, (1031TG) a qualified intermediary company owned by Okun.

The indictment states that, from August 2005 to April 2007, Okun used 1031TG and its subsidiaries, all owned by Okun, under false pretenses to defraud clients out of millions of dollars. Internal Revenue Code allows investment property owners to postpone paying capital gains tax on properties sold if the proceeds are used to purchase new property in a specific time period. To facilitate this swap, investment property owners deposit their sales proceeds with qualified intermediaries and sign exchange agreements which include various promises by the qualified intermediaries to clients regarding the safekeeping and use of exchange funds.

The charges the indictment is making against 1031TB / Edward Okun include:

Okun embezzled approximately $132 million in client funds that were obtained by promising clients that their money would be used only to effect 1031 exchange. Okun used the funds to support his lavish lifestyle, pay expenses for his various companies, invest in commercial real estate and purchase more qualified intermediary companies to obtain additional client funds.

Okun instructed employees to withdraw $15,000 in cash from Investment Properties of America’s (IPofA) bank account, a company owned by Okun, and smuggle the cash to his personal yacht in the Bahamas to avoid federal currency reporting requirements.

Okun made material false statements under oath before the U.S. District Court for the Eastern District of Virginia relating to conversations he had with the chief legal officer of IPofA.

The indictment is seeking forfeiture of all funds and assets owned by Okun that were taken from or connected to the $132 million he embezzled from 1031TG and all funds and assets traceable to the $15,000 in cash he instructed to be smuggled to the Bahamas.

If convicted of all charges, Okun will face fines and a max of 30 years in behind bars.

Tuesday, April 8, 2008

Citibank Props Up ASTA and MAT Municipal Hedge Funds

Citibank rolled out ASTA Finance, LLC and MAT Finance, LLC in 2002 to trade muni bonds. ASTA made leveraged investments in fixed-rate munis and tried to hedge the interest-rate risk of those positions. MAT focused on arbitrage, sniffing out anomalies between tax-free munis and similar taxable bonds.

The two funds had roughly $2 billion in capital and through leverage, or borrowed money, had about $15 billion in assets.

The normally placid muni bond market has been thrown into turmoil in recent weeks as the mortgage crisis has spread into a full blown credit crunch. At the end of February, some muni arbitrage hedge funds were forced to sell assets to meet margin calls, leading to huge losses that month.

"Citi has made a $1 billion equity commitment to the master funds related to the ASTA/MAT funds of which $600 million has been funded," the Citigroup spokesman.

Suntrust Bank Sued over Sale of Auction Rate Securities

A group of investors filed a class action suit on April 1, 2008 alleging that SunTrust Banks Inc. sold them auction-rate securities as highly liquid cash-management vehicles and alternatives to money-market mutual funds. The meltdown of the auction-rate securities market has left investors hot under the collar, with many charging their brokerage firms of deceptive marketing practices.

SunTrust Banks is the latest financial firm to face litigation over the auction-rate securities debacle. Following the recent collapse of the auction market, similar suits have been filed against Citigroup, Merrill Lynch, Morgan Stanley, and UBS. Auction-rate securities are either municipal or corporate debt securities or preferred stocks that pay interest at rates set at periodic auctions. The securities generally have long-term maturities or no maturity dates.

The SunTrust suit is just the tip of the iceberg. Investors who filed the suit against SunTrust claim the collapse of the auction rate securities market has left them unable to access their capital and with the auction-rate securities market in a perpetual state of deep freeze, more investors who were steered by their brokers to auction securities as safe, liquid investments and who have now lost their entire life savings could likely step forward with class action suits of their own.

Auction-Rate Securities Investigated

The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) are looking into how brokers sold auction-rate securities after receiving an avalanche of complaints from investors who said they were misled into buying the now illiquid securities.

FINRA is asking financial companies for a breakdown of total auction-rate-securities holdings by customer type, how auction-rate securities are categorized on customer statements, how firms marketed the products and the number of customer complaints related to auction-rate securities the firms have received since Oct. 1.

Recently, FINRA began a broad probe into industry practices (aka sweep investigation) in regards to auction-rate securities. However, this move doesn't necessarily mean enforcement action will take place. The SEC is also working with FINRA to look into how brokers represented the auction-rate securities when investors purchased them.

Massachusetts regulators are also getting into the investigation action. Last month they subpoenaed UBS AG, Merrill Lynch, and Bank of America for documents and testimony on how they sold auction-rate securities to retail investors.

Auction-rate securities are bonds issued by municipalities, student-loan agencies and closed-end funds that have interest rates reset at auction every week to a month. The recent credit crunch led to the collapse of this $330 billion auction-rate market, leaving investors with assets tied up in securities no one wants to buy. Brokers had marketed auction-rate securities as liquid, super-safe investments with interest rates slightly better than traditional money-market funds. Investors are now questioning why they weren’t warned about the possibility of failed auctions.

Monday, April 7, 2008

Regions Own Employees File Class-Action Suit

Since December 2007, seven separate lawsuits have been filed in Tennessee against Regions Financial Corp., its subsidiaries, and various company directors, all of which involve claims of negligence, misrepresentation and securities fraud. The terrible performance of several mutual funds managed by Regions’ subsidiary Morgan Keegan & Co. Inc. has caused investors to collectively lose millions of dollars and see their nest eggs and savings dry up. Now, Regions’ own employees have filed a class-action lawsuit against Regions.

Filed in Memphis, Tennessee, the class-action names Terry Hamby, a former Regions employee, as a plaintiff and other plaintiffs will be determined as the suit unfolds. According to the complaint filed, potential plaintiffs include participants and beneficiaries of the company plan between November 4, 2006 and “the date that Regions discloses the full impact of its financial problems.”

The defendants named in the suit include Morgan Asset Management Inc., Regions Bank, Regions Financial Corp. and various members of Regions' board of directors. Part of the reason for filing the suit in Memphis is because Morgan Asset Management is based in Memphis and is a fiduciary of the bank’s pension plan.

The same mutual fund holdings that hurt individual investors also affected thousands of Regions’ employee pension plans. The suit claims pension plans were inappropriately loaded with company stock at a time when Regions’ share price was sliding because of a variety of housing-related problems. The company also has spent millions to stop the hemorrhage in its RMK funds.

Meanwhile, Regions reported in a recent regulatory filing with the SEC that they could not yet determine the potential effects of the various RMK-related lawsuits in West Tennessee. That gave more reason for Regions’ employees to file suit; if Regions was unable to assess risks in its funds, then their employees could hardly be expected to evaluate the propriety of Regions stock in their portfolios.

Law firms nationwide are taking up similar investigations into a related pension situation at Morgan Keegan. One attorney said a figure as high as $10 million has been mentioned as the amount of employee money invested in the RMK funds that lost more than half their value in 2007.

Sunday, April 6, 2008

Self-Regulation Recommended for Investment Advisors

U.S. Treasury Secretary Henry Paulson just released a 212-page blueprint to overhaul the nation's financial regulatory system and Paulson recommends that investment advisers “be subject to a self-regulatory regime similar to that of broker-dealers.”

Paulson notes that the distinctions between stockbrokers and investment advisers have blurred as fee structures have changed. Brokers are now primarily governed by the self-regulatory FINRA, while investment advisers are overseen by the SEC and state regulators.

So, Paulson recommends self-regulation of investment advisers which would “enhance investor protection and be more cost-effective than direct SEC regulation.” The blueprint also calls for a Conduct of Business Regulatory Agency to set national standards for business conduct laws which would apply to all types of financial-services firms and “pre-empting state business conduct laws directly relating to the provision of financial services.” Also, states should either be given a role in such an agency's rule-making process or be put in charge of monitoring compliance and enforcement.

Such a model appears as though it would relegate state regulators to a secondary role in policing the markets and states aren’t happy about it. "States have been in the forefront of detecting the adverse impact of rogue investment schemes on the individual investor," said William Galvin, Massachusetts Secretary of the Commonwealth. Some are concerned that loss of regulatory competition would mean the Feds are less motivated to take action in cases they’re reluctant to regulate. Mary Schapiro, chief executive of the FINRA, also worry investors would be left confused and exposed.

Arbitration claims filed by investors with FINRA rose slightly in February compared to last year and it is expected to continue to rise in 2008. This rise is normal since down markets tend to bring increasing numbers of arbitration claims. It typically 6 to 18 months for arbitration claims to climb and this January marked six months from the onset of the subprime-mortgage market implosion.

Wall Street is barely emerging from the onslaught of arbitration claims that emerged after the technology-stock bust and the accompanying research-analyst scandal and now it looks like another wave is coming. In 2000, about 5,500 arbitration claims were filed at the National Association of Securities Dealers, a predecessor to FINRA; that number jumped to almost 7,000 in 2001, and peaked at close to 9,000 in 2003. Since then, the numbers have dropped significantly, reaching a low of just over 3,200 in 2007 but the year-to-date numbers through February show already show a 4% rise in claims, from 535 to 558 in the same period last year.

Friday, April 4, 2008

Student Lenders Failed by Auction-Rate Market

Student lenders nationwide relied on the auction-rate securities market to raise money so they could make or buy student loans. Auction-rate securities backed by student loans made up about a quarter of the $330 billion auction-rate market, but since the market’s collapse early this year, debt sales by U.S. public student-loan agencies have grounded to a halt. For the first time in 40 years, no municipal bonds backed by student loans were sold in the first quarter.

Lacking the ability to finance, public lenders in Michigan, Missouri, New Hampshire, Texas, Pennsylvania and Iowa have suspended or limited their loan originations. The two biggest borrowers, Brazos Higher Education Authority of Waco, Texas, and the Pennsylvania Higher Education Assistance Agency, stopped making new loans in the last two months although the Illinois loan agency will continue the business. Missouri's student loan agency said in February that it would stop making private loans, or those not guaranteed by the federal government, and consolidation loans, which combine different student debts. Cit Group Inc., based in New York, and NorthStar Education Finance Inc., a nonprofit organization in Minnesota, said this week that they will stop making new loans to U.S. students after lending costs soared.

On April 2, 114 of the 115 tranches of student-loan bonds that came up for auction failed. That same day, there were 353 failed auctions out of a total of 563 municipal auction bonds. Almost all auction-rate securities issued by closed-end mutual funds also failed.

When auctions fail, investors are unable to get their money and the rate resets to a high level or one based upon a previously agreed upon formula and often secured to money-market benchmarks such as the London interbank offered rate. The latter is typical of student-loan debt, giving investors less of an incentive to buy, because benchmarks have declined.

According to UBS, lender profitability has suffered after the U.S. government last year slashed subsidies on guaranteed student loans made through the Federal Family Education Loan Program that back most student-loan auction bonds.

Thursday, April 3, 2008

No Relief in Sight for “Low Net Worth” Investors

Since the 1980s, the major firms and banks have been convincing their clients to invest in the supposedly safe and liquid auction-rate securities market, and at the same time, committing their own money to make sure the auction-rate market operated smoothly. Due to concerns over credit exposure early this year, these firms disappeared at the auctions, leaving thousands of investors holding securities they cannot sell. When asked who held such securities, the firms quibble and answer that it was wealthy individuals.

Joe Mysak at Bloomberg News suspect the real reason the securities firms gave this answer was to marginalize an entire group of investors they now find expendable. This group, individuals with less than $10 million net worth, isn’t wealthy enough for Wall Street securities firms to care about them. There are firms that don’t even want you to walk in the door with less than $25 million or $50 million. These companies, such as Merrill Lynch, UBS AG, Bank of America and Citigroup, are the same ones that claim to specialize in retail or individual, investors.

States and investors are responding to this outrageousness with government probes and class-action lawsuits and arbitration claims.

Last week, Massachusetts subpoenaed UBS, Merrill Lynch and Bank of America for information on how they sold auction-rate securities and informed their clients of the risks. Mysak suspects what prompted Massachusetts to action weren’t complaints from wealthy investors who are catered to by big firms.

The truth is most investors don’t bring enough money to a brokerage firm for them to justify the expense of an account manager. That also seems to be the reason why these firms can afford to ignore and alienate the thousands of investors who hold these auction-rate securities.

Investors Stuck in Auction-Rate Limbo as Brokers Toss Values Around

Many brokerage firms have put their customers in short-term investments known as auction-rate securities that promised to be a safe and liquid alternative to cash. However, that promise of liquidity dried up weeks ago and now investors are stuck with securities they can’t sell and some are even being marked down in value.

The good news in all of this is that the banks and mutual-fund companies are working on valuing auction-rate holdings and finding alternative debt to help investors solve the liquidity problem. The bad news is that it’s unclear how such securities should be marked down.

UBS and Goldman Sachs Group Inc. are the firms that have announced that, using internal price models, they will mark down the value of these securities on client statements. The firms have not disclosed an actual amount but markdowns should vary between 3% and 5%. Other banks, like Merrill Lynch, Citigroup and Morgan Stanley, aren't making that move yet but Merrill clients have been told that there is no market for their securities. Some brokerage firms, including UBS and Merrill, are offering clients loans backed by their holdings to meet immediate cash needs.

It is a challenge to value assets at a realistic price during this credit crunch especially since there is no secondary market in which to sell these securities. Many suffering investors are individual investors – the bread and butter of Wall Street firms – and a lot of them have already started filing class-action suits and arbitration claims against the brokerage firms.

Closed-end funds have a $65 billion share in his $330 billion market. When the market seized up, regulators and primary sellers of close-end funds like Eaton Vance Corp., BlackRock Inc., Legg Mason Inc. and Nuveen Investments began discussing ways to refinance these securities and get owners of the securities out at full value.

One solution is, for a fee, the banks could financially back these securities to make the investments more liquid and secure. But the problems are banks are reluctant to make these guarantees in this current market and tax implications with the IRS could ensue.

This week, Nuveen said it would refinance almost $715 million in auction-rate securities issued in relation to four taxable funds and hopes to complete refinancing of all taxable funds in four to six months. This move would repay some investors in those securities at full value. Eaton Vance also began $1.6 billion in redemptions this week, and hopes to deal with the remaining two-thirds of its outstanding auction-rate securities in the coming months.

Tuesday, April 1, 2008

UBS to Announce More Write-Downs

Having already recorded $18 billion in write-downs tied to sub-prime mortgage securities, UBS AG is expected to announce, as early as today, further write-downs and their plans for raising more capital to cushion their increasing losses related to their sub-prime investments.

UBS could raise capital after shareholders in February approved a plan to raise 13 billion Swiss francs ($13.09 billion) from investors in Asia and the Middle East. Swiss pension fund Profund has proposed that UBS put a separate 10 billion Swiss franc capital increase to a shareholder vote. Profund has said it believes UBS needs the capital to sustain the write-downs.

According to analysts, before its annual shareholders meeting on April 23rd, UBS is likely to tell investors that it has sustained $15 billion more in write-downs. Lehman Brothers Inc. has forecast that those write-downs will include at least $13.8 billion in markdowns tied to sub-prime securities and securities backed by Alt-A loans. Last month, Morgan Stanley estimated that the write-downs could total as much as $25 billion.

In addition, analysts expect UBS will take hits tied to leveraged loans and commercial real estate. This increase in bad debts means UBS might separate the bank’s bad assets from its other operating businesses through the creation of a so-called bad bank.

UBS’s problems stem from their ambitious push the last two years to compete in the business of underwriting and trading complex securities underpinned by risky loans to U.S. homeowners.

More write-downs could lead to doubts over whether UBS has been sufficiently aggressive in marking down the value of its mortgage securities, which include holdings tied to debt pools known as collateralized-debt obligations.

Of course, UBS is not alone. More write-downs across the banking system are expected. Last month, Standard & Poor estimated that financial firms have recorded $150 billion in mortgage-related losses and that the total could reach $285 billion.

Wall St Addressing the Broken Auction-Rate Market

Some help is finally arriving in the broken $330 billion auction-rate market that stuck investors with securities that no one wanted to buy since the beginning of this year.

Yesterday, the Financial Industry Regulatory Authority (FINRA) responded to investors’ frustration with their illiquid assets in the auction-rate securities market by releasing guidelines for investors to deal the problem. To meet cash-flow needs, the guidelines suggested investors could sell the investments to other parties in secondary markets or borrow against the value of their holdings from their brokerage firms. However, FINRA pointed out risks like tax consequences in taking out margin loans and warned that brokerage firms may sell an investor's auction-rate securities to meet a margin call without letting them know first.

Meanwhile, UBS AG announced last Friday it will mark down the values of auction-rate securities on investors’ brokerage statements, causing levels for the securities in one burgeoning trading platform for auction-rate securities to fall slightly yesterday.

Issuers of these securities are also scrambling to adjust. With the SEC’s blessing, some municipalities whose debt reset to high penalty rates after their auctions failed have refinanced or placed bids in their own auctions.

Closed-end funds also issued auction-rate securities to fund their investments with borrowed money. Since their borrowing rates have gone up, they are also looking to refinance. For example, ING Clarion Real Estate Securities plans to retire some auction-rate debt by purchasing some of its own adjustable-rate preferred securities starting today. Other fund providers like Eaton Vance and Nuveen Investments have also announced plans to refinance closed-end funds in the past few weeks.

Subprime Meltdown Spells Trouble for Carrington Capital Hedge Fund

In the wake of the subprime meltdown, a few good investors can be hard to find. Carrington Capital Management, LLC, a $1 billion hedge fund, is betting against the obvious, however, and offering investors an 18 percent payout on preferred shares in an effort to raise as much as $200 million to replace bank debt.

Interestingly, Carrington - which specializes in mortgages - maintains that its relationship with traditional lenders such as Citigroup and JP Morgan Chase is â good. One might call that a statement in contradictions. Exactly how good can Carrington’s relationship with banks be when it must pay investors 18 percent interest to borrow money?

Only time will tell if more hedge funds are forced to follow the same route as Carrington Capital, as banks that have kept hedge funds in business all this time by lending them money pull back their support. For now, many hedge funds are doing whatever they can to simply weather the dark storm called the subprime fallout.

ARS Broker Dealers Come Under Heavy Fire

Following hundreds of failed auctions, the market has now found itself frozen, leaving investors wondering if and when they will ever see their money again. The repercussions of the subprime meltdown have ultimately fueled a firestorm of damage on the $330 billion auction-rate securities market.

And while investors are left holding an empty bag, brokerage firms continue to get paid by the issuers of the bonds for holding auctions that fail. For example, as of mid-February, New York State reportedly paid 10 investment banks more than $600,000 to handle bids of auction bonds, even though the auctions failed and the state has paid higher penalty interest rates. The investment banks, which include Citigroup and Goldman Sachs, receive $10 million each year to oversee the auctions.

Auction-rate securities are long-term bonds that act like short-term debt, with floating interest rates that reset through a bidding process held every seven, 28 or 35 days. In the past several months, the market has witnessed a slew of failed auctions on a daily basis. During the last week of March 2008, auction-rate bond failures rose to 71 percent, with 2,023 out of 2,865 auctions failing.

Investment firms that handle the auctions, such as Merrill Lynch and UBS, used to step in and support the auctions if there were not enough bidders. No more. As a result, issuers of the bonds are forced to pay exorbitant penalties in higher interest rates, while investors are locked into investments they can’t cash out of.

Some borrowers, including the Dallas Ft. Worth Airport and Ascension Health in Missouri, are refinancing their bond debt as a way to avoid paying high penalty interest rates. The Dallas Ft. Worth Airport converted $337 million of auction debt into fixed-rate bonds at interest rates as high as 6.25 percent, which is still considerably lower than the penalty rates on some auction-rate securities.

As for investors, many who are stuck holding auction-rate securities believe they were misled by their brokers, and contend they positioned the investments as cash alternatives. On March 27, 2008 Massachusetts Secretary of State William Galvin announced that his office would take several investment firms to task on this very issue in an investigation into the practices used to sell auction-rate securities at UBS, Merrill Lynch and Bank of America.

Whether Galvin’s investigation provides an acceptable resolution is still up for debate. At the very least, it will hopefully signal the end of the free ride that so many brokerage firms in the auction-rate securities market have enjoyed.