Request Legal Help Now - Free


Auction-rate Securities: What They Are, and Why You Should Call Your Lawyer

. By
New York, NYAn investment product often touted as completely liquid and as good as cash is proving to be anything but in a slowing economy, leaving many desperate investors high and dry, and without access to their funds. Auction-rate securities, it turns out, are in reality not akin to cash and the fine print, it has been reported, duly points that out. However, some investors are claiming never to have received a prospectus at all, while others assert that brokers told them auction-rate securities were AAA products and as good as cash.

Disgruntled investors are now turning to the courts, in an attempt to get their money back.

Liquid InvestmentTo understand the problem, one has to understand what an auction-rate security is. An auction-rate security is, in reality a bond, often issued by hospitals or municipalities, and often (but not always) with a 30-year maturity date.

The potential for near-instant liquidity is the result of the sale of these bonds at weekly or monthly auctions, together with major players like UBS, Merrill and Goldman Sachs routinely stepping up to the plate to purchase any unsold bonds.

These investments have been around since the 1980s, and have since proven a handy and useful tool for investors to earn higher yields than what would be possible with money market funds, 30-day certificates or traditional savings accounts. Many investors need to have cash available for tax liabilities, tuition or other requirements, but couldn't bear to watch their money languishing, and doing nothing.

Little surprise then, that investors have embraced the auction-rate security as a favored vehicle to increase yield with minimal risk.

The problem, is the divergence between what the auction-rate security really is—a bond that locks in the funds—and the goodwill of major financial institutions flush with cash in a robust market, undertaking the purchase of even unsold bonds and thereby allowing investors access to their cash, along with interest earned, in a relatively contracted period of time, as opposed to the waiting out the maturity for a long-term bond.

Banks bought them up, because they knew they could sell them. However, that doesn't appear to be the case any longer. As the credit crisis mushrooms to unheard-of proportions and the economy slides into a recession, banks are suddenly finding that there are few, if any takers for these securities, and auctions have been failing. The bottom has essentially fallen out of the auction-rate securities market, and banks will not buy what they can't sell.

That leaves investors in a spot. It also leaves investors who were allegedly sold a bill of goods, seething.

That's because unlike a money-market fund or bank savings accounts which guarantee that investors can access their money at any time, auction-rate securities make no such guarantee. Additionally, banks have no obligation to buy the bonds associated with the auction-rate securities—one reason why the yield is slightly higher than that of money-market funds and savings accounts.

Bonds with a fixed maturity date have the best chance of returning the full value of the bond to the investor once the bond matures. The investor would just have to wait it out.

However, it has been reported that many retail investors hold auction-rate preferred shares in so-called closed-end funds that feature no maturity date. Thus, there is no exit point, and analysts believe that as much as $65 billion of an overall $300 billion-plus auction-rate market is tied to these closed-end funds.

While most experts agree that the market will get going again once the credit crisis has passed and the economy emerges from the doldrums, it is also believed that upwards of 30 per cent of the auction-rate market will never trade at par again.

On March 28th the giant Swiss bank UBS announced a markdown of its auction-rate securities, down to as much as 20 per cent—a reflection of the drop in value of the products give that the auction-rate market has, for now, summarily dried up.

Until it gets going again, investors who were under the false impression, or were told outright that their investments were completely liquid, will now see their investment frozen, and diminished in value. Few will ever see the full value, if they see anything at all. A few financial institutions are reimbursing investors the full value of their investments as a token of good faith, and out of a need to protect a reputation—but those players are few and far between. Others have been 'working with' their clientele, cutting them sweet deals on loans and interest rates in view of this sudden inability to access their funds at a time when access is fundamentally vital (it's tax time...).

The issue now, comes down to disclosure. Were retail investors fully briefed on just what they were buying, and the limitations? It has been reported that a majority of retail investors purchased the bonds not from the asset managers, or directly from the schools or related institutions that actually issued them, but rather made the purchase through brokers who may not have been completely transparent with the investor with regard to the product.

Such products are supposed to be accompanied by the requisite prospectus information which spells out the limitations, and the reality that auction-rate securities are only cash-like given the availability of a market which allows for the securities to be flipped quickly, thereby freeing up the investment. However, if the market falters and the security cannot be sold, then the funds are frozen either for the duration of the maturity date, or until the market picks up again.

However, it has been reported that many investors did not receive prospectus information. Others said that the auction-rate securities were promoted to them by their brokers as safe, liquid investments that were cash, or cash equivalents.

Indeed, in the presence of a healthy market they appear to be as good as cash. But appearances are everything, and while historic performance and confidence go far to provide the underpinnings of a robust economy, once those underpinnings start to crumble all bets are off, and confidence is not a legally supported entity. Simply expecting things to always be the way they are because they've always been this way, is a fool's paradise.

Not to suggest that the investors should be described in such fashion. Perhaps it's fair to say that any investor with misgivings about something that sounds too good to be true, and fails to read a prospectus duly provided, should seek blame no further than the image he sees peering back at him from the mirror.

But a broker, with full knowledge of the Achilles' heel of the auction-rate security, only to promote the investment as safe, liquid and "as-good-as-cash" without providing a prospectus as some investors have claimed, is allegedly at fault here. Knowledge is power. For a broker not to fully disclose the true underpinnings of an investment to an investor in dire need of funds and without access to those funds, is a matter for the courts.

And investors have been turning to the courts in droves.


Auction Rate Securities Legal Help

If you have purchased Auction Rate Securities from a brokerage firm or dealer, please contact a lawyer involved in a possible [Auction Rate Securities Lawsuit] to review your case at no cost or obligation.


Please read our comment guidelines before posting.

Note: Your name will be published with your comment.

Your email will only be used if a response is needed.

Are you the defendant or a subject matter expert on this topic with an opposing viewpoint? We'd love to hear your comments here as well, or if you'd like to contact us for an interview please submit your details here.

Click to learn more about

Request Legal Help Now! - Free