RBC Auction Rate Securities: Canada's Largest Bank Hit with Class Action Lawsuit

New York, NYThe implosion of the auction rate securities market has caught up with Canada's largest bank, after Royal Bank of Canada (RBC) was hit with a potential class-action lawsuit that has been filed in New York. The allegation is that RBC conveyed to its clients the assurance that auction rate securities were safe, short-term opportunities for investors with a minimum of $25,000 to play with.

The action has yet to be certified, but is intended for anyone who may have purchased the securities from RBC after May 12th 2003 and were still held as at February 13th of this year. The latter has been identified as the date that 87 percent of the securities failed.

Exacerbating the issue is the fact that RBC is a bit player in the US capital markets, according to Moody's Investors Service. "RBC's relative competitive weakness in U.S. capital markets tends to lead to more volatility in earnings, as evidenced by its recent losses in structured credit," said Peter Routledge, Moody's vice-president and senior credit officer, Canadian financial institutions, in a statement.

On Friday Moody's revealed that RBC had taken a $1.3 billion write-down over the past two quarters with regard to its structured credit operations. Exposure to US sub-prime mortgage assets, auction rate securities and US municipal guaranteed investment contracts, were all factors leading up to the billion-dollar write down.

Auction rate securities are in actual fact long-term bonds with maturities of up to 30 years, but with interest rates reset every few weeks at auction, allowing investors to cash out. The practise was so successful and the market robust, investors acclimatized to playing the auction rate securities market could be forgiven for regarding the investments as practically akin to cash, even though the truth was anything but. In the wake of the ultimate and sudden seizure of the market, brokers have been accused of perpetuating that myth while the market was steaming along by withholding prospectus documents, and verbally supporting the myth that an auction rate security was, for all intents and purposes a virtual guarantee that the investment could be recovered at auction within a matter of days.

When the market suddenly and unexpectedly dried up, investors were left with their cash adrift without any access, amounting to a hardship for many.

In court documents summarized in this morning's Globe and Mail, Canada's national daily newspaper, the suit claims "auction rate securities were extremely profitable for RBC and for the RBC financial advisers and brokers who sold the securities.

"In order to perpetuate the auction market and sell as many auction rate securities as possible, RBC represented to investors in its written materials and uniform sales presentations by financial advisers that auction rate securities were the same as cash and were highly liquid, safe investments for short-term investing," the suit claims.

"RBC continued to aggressively market auction rate securities after it had determined that it and other broker dealers were likely to withdraw their support for the periodic auctions and that a 'freeze' of the market for auction rate securities would result."