Lawyers in the two dozen or so proposed class action suits filed in connection with the failure of the auction rate securities markets may be "unable to prove their clients lost money or collect fees for themselves," writes Bloomberg's Thom Weidlich. We're not so sure the defendant broker-dealers and issuers in these cases should be so confident.
Find out why after the jump.
First, a little background. The ARS lawsuits generally claim that investors should recover opportunity costs incurred by having their funds locked up in the auction rate securities. Recovery of income lost from impairment is a rather straight forward application of ordinary tort law. But some lawyers familiar with the cases believe the arguments for damages might undermine the case for class certification.
"Arguing that investors lost chances to use their money might create an obstacle to winning class-action status," Weidlich writes. "Each missing opportunity might present unique facts, while a class action, which would give investors settlement leverage and keep costs down, requires similar loss situations."
But federal courts have shown a willingness to allow class certification in securities fraud cases even where the individuals harmed vary widely. The courts adopted the theory of "fraud-on-the-market" for securities fraud cases to get around similar procedural obstacles. The question of damages at issue in the ARS cases will likely turn on whether the securities were sold at higher prices than they would have been without the alleged fraud by issuers and dealers.
Evidence of this mispricing is available--at least for those securities that remain frozen and do not pay very high penalty rates--from both the secondary market that has emerged for the securities as well as the debt market. Where there is an available secondary market, the securities with low-penalty rates are typically trading at a discount from par. In short, once the liquidity risk of ARS became known, the price declined. This seems to be strong evidence that the securities were mispriced when sold to investors who were allegedly mislead about the risks involved.
The debt markets also provide evidence of damages for ARS that pay low penalty rates. Some are long-term debt obligations and others are perpetual preferred securities. In either case, plaintiffs lawyers can show damages by comparing the interest rates available for long term debt on the market to those lower-rates paid to holders of ARS.
These arguments won't be available to every investor in the $330 billion market for ARS. (If you're making 14% interest you probably don't have a lawsuit and you've probably already been refinanced out of the market.) But for investors stuck in ARS that pay low penalty rates and trade at a discount in the secondary markets, proving damages on a class wide basis against broker-dealers and issuers should not be that difficult.
Auction Suits Face Burden of Proof Eluding Lawyers [Bloomberg]
Posted by guest , May 28, 2008 2:58PM
The fraud on the market theory has nothing to do with proving similarity of loss among class membes. The fraud on the market theory presumes that an investor (or investors) actually relied on an alleged misrepresentation if the company's shares were traded on an efficient market, even if the investor cannot show that she actually heard/read the alleged misrepresentation. The theory addresses reliance, not harm.
Can't see how fraud on the market helps potential class members here get around the statutory requirement of similarity of harm/loss among class members.
Posted by guest , May 28, 2008 3:10PM
hmmm...isn't this argument like saying if i steal your money, but promise to keep it safe and pay you interest, i have no problems with the law? unbelievable.
Posted by John Carney , May 28, 2008 3:11PM
To spell it out a bit more, the claim is that the secondary market discount and interest rate discount compared to long term bonds is the harm to the class members. No need to show what each investor would have done with the money, just that the pricing was less than it would have been because broker-dealers and issuers concealed the liquidity risk.
Posted by american bandersnatch , May 28, 2008 4:09PM
If the investors thought these were no-risk cash equivalents, where did they think the higher yields came from? The inefficient market fairy?
Posted by guest , May 28, 2008 4:39PM
Most of the muni closed end ARS are paying rates far above muni money markets and pretty close to intermediate-term muni rates. That they are technically "long-term securities" or "perpetual" is totally irrelevant, since everyone knows they will be redeemed in the next 12 months.
Posted by guest , May 28, 2008 4:47PM
Excellent comments and blog. They could certainly group the classes by type of issue as those would be very much the same.
E.g. student loan underlying are mostly at zero rates after a single month's max rating. There is no incentive to redeem these "...in the next 12 months."
Closed end fund issues are being called in as fast as they can and won't have time to sue before their money is returned.
Municipals don't have the issuer friendly max rate clauses the student loan guys do, so they are on a case by case basis incentivized to refi.
...I don't understand why the student loan issuers haven't seized upon the Fed/NEA collateral swap to refi and unload these loans on the govt.
Posted by guest , May 28, 2008 5:01PM
bandersnatch: The yield differential was sold as compensation for forgoing daily liquidity. I grant you that someone looking at a 50bps spread for monthly rather than daily liquidity should probably have thought it a bit much, longer than that and it is less of a stretch.
Posted by guest , May 28, 2008 9:08PM
bandersnatch: "If the investors thought these were no-risk cash equivalents, where did they think the higher yields came from?"
nobody asked for these things. in every one of the tens of cases i know about, the bagholder didn't even know what they were till the broker started touting them.
the 'full service' brokers tell us we pay their endless fees and develop a relationship with a FA so we can have their expert advice. do you think they can also tell us that it's our fault that we didn't research the 'perfectly safe and liquid cash equivalent', recommended to us by out FA and listed as 'Other Cash' on our online statement? sorry, but i'm afraid that's a contradiction that blows their whole retail model. it certainly has for me. bye bye Merrill-RICO, hello Fidelity. if i wasn't getting Merrill's expert advice, i probably still wouldn't know what an ARS was. do you think i'm gonna pay for that?
even so, i would have been suspicious of a big yield premium. as the other guy said, there should be a premium for tying up the $ for up to 28 days. if i should have known what i was getting, which didn't seem all that large to me, really was suspiciously large...i guess that's why i have an expert FA to advise me it's safe, right?
Posted by guest , May 28, 2008 9:09PM
bandersnatch: "If the investors thought these were no-risk cash equivalents, where did they think the higher yields came from?"
nobody asked for these things. in every one of the tens of cases i know about, the bagholder didn't even know what they were till the broker started touting them.
the 'full service' brokers tell us we pay their endless fees and develop a relationship with a FA so we can have their expert advice. do you think they can also tell us that it's our fault that we didn't research the 'perfectly safe and liquid cash equivalent', recommended to us by out FA and listed as 'Other Cash' on our online statement? sorry, but i'm afraid that's a contradiction that blows their whole retail model. it certainly has for me. bye bye Merrill-RICO, hello Fidelity. if i wasn't getting Merrill's expert advice, i probably still wouldn't know what an ARS was. do you think i'm gonna pay for that?
even so, i would have been suspicious of a big yield premium. as the other guy said, there should be a premium for tying up the $ for up to 28 days. if i should have known what i was getting, which didn't seem all that large to me, really was suspiciously large...i guess that's why i have an expert FA to advise me it's safe, right?
Posted by Anal_yst , May 28, 2008 11:18PM
As the above poster points out, the issue here Carney is not so much what you point out (although it is certainly an issue), but were I part of the "class", I'd take the angle that these things were sold as cash (i.e. like money market funds), verbal descriptions during sales pitches were "yea no problem you can redeem every week/month/etc", despite the "fine print" in the disclosures.
Retail brokers are on the whole sales mules, of course with some exceptions, whose actions represent a good-sized legal liability for the firms. All it ever took was the wrong clients, or the critical mass of clients to get burned before this bullshit house of cards comes crashing down. Of course I dabble in hyperbole, and, as we all know after some settlements everything will mostly return to normal, sheep will continue to get slaughtered (i.e. sold shit they don't need/isn't appropriate), and life will go on. Sigh...
Posted by miami , May 29, 2008 10:53AM
90%+ of them were not sold as 'cash.'
If you can prove that they were, then you might have a case.
A broker's verbal description [including factually correct assertion market had been fine for 20+ years] does not supersede the OS, that's why the OS exists. Unless he said 'guarantee.' Caveat Emptor.
Posted by guest , May 29, 2008 12:18PM
Instead of deluding yourselves that financial advisors did nothing wrong you guys should be spending the time updating your resumes, assuming you can get jobs in the financial industry again. Realized loss or not, in many cases these were unsuitable investments.
Posted by guest , May 29, 2008 1:20PM
FYI, Contrary to all the nonsense, FAs at most firms got paid very little (10bp yr max) for recommending ARS. They only did it to get their clients a higher yield than the firms lousy money markets. And the FAs were also lied to about the liquidity. None of us would have bought these things for our clients had we been told the truth.
Posted by guest , May 29, 2008 1:31PM
how much do you douchebags get paid for putting accounts into t-bills?
Posted by guest , May 29, 2008 3:02PM
To American Bandersnatch re the inefficient market fairy : you may not have noticed that there is a huge variety in the yield on cash equivalent investments, and choosing the highest yield is not exactly equivalent to relying on a fairy. For instance, there are alot of e-savings accounts right now yielding more than auction rates would be yielding if the meltdown had never happenned. Are you relying on the inefficient market fairy by getting 4% on an FDIC insured e-savings account ? Maybe you are one of those who believe you'll only ever get your money back if it is earning around 1%
Posted by guest , May 29, 2008 3:03PM
To American Bandersnatch re the inefficient market fairy : you may not have noticed that there is a huge variety in the yield on cash equivalent investments, and choosing the highest yield is not exactly equivalent to relying on a fairy. For instance, there are alot of e-savings accounts right now yielding more than auction rates would be yielding if the meltdown had never happenned. Are you relying on the inefficient market fairy by getting 4% on an FDIC insured e-savings account ? Maybe you are one of those who believe you'll only ever get your money back if it is earning around 1%
Posted by guest , May 29, 2008 3:04PM
To American Bandersnatch re the inefficient market fairy : you may not have noticed that there is a huge variety in the yield on cash equivalent investments, and choosing the highest yield is not exactly equivalent to relying on a fairy. For instance, there are alot of e-savings accounts right now yielding more than auction rates would be yielding if the meltdown had never happenned. Are you relying on the inefficient market fairy by getting 4% on an FDIC insured e-savings account ? Maybe you are one of those who believe you'll only ever get your money back if it is earning around 1%
Posted by guest , May 29, 2008 3:04PM
To American Bandersnatch re the inefficient market fairy : you may not have noticed that there is a huge variety in the yield on cash equivalent investments, and choosing the highest yield is not exactly equivalent to relying on a fairy. For instance, there are alot of e-savings accounts right now yielding more than auction rates would be yielding if the meltdown had never happenned. Are you relying on the inefficient market fairy by getting 4% on an FDIC insured e-savings account ? Maybe you are one of those who believe you'll only ever get your money back if it is earning around 1%
Posted by guest , May 29, 2008 3:19PM
like i said, if i can't go by the FA's verbal description and the listing as 'Other Cash' on my online statement - hello Fidelity!
did i say that they were listed on my online statement as "Other Cash"? if anyone here thinks that's irrelevant, i can tell you that the lawyer on the multistate task force who interviewed me had a different view.
as for the historic safety of the auctions, in this article
http://www.cfo.com/article.cfm/10683650/c_2984368/?f=archives
it says, among other things
"Three years ago, PwC and the others among the Big Four reportedly advised their corporate clients to change the way they accounted for auction-rate securities. Their suggestion was that U.S. corporations no longer treat ARS as similar to a cash equivalent, and the accounting firms asserted that they are more appropriately classified as "investments.""
and then, referring to the credit meltdown
"One potential silver lining emerged from a survey conducted by the Association of Financial Professionals last August.
It found that one-third of the companies that invested in either auction-rate securities or variable-rate demand notes reduced use of the vehicles after the major accounting firms ruled that such investments were not cash equivalents."
looks to me like the marketing of ARS to us retail investors ramped up exactly as the corporations were getting out. it said "Other Cash" on my statement while PwC said it was an 'investment'. time will tell if that's fraud.
Posted by guest , May 29, 2008 3:26PM
I agree with 3.19 - sue the bastards!
Posted by guest , May 29, 2008 3:44PM
To the guest who is an FA: I've been told that the investment bank management produced the research on ARPS, and the brokers just relied on that when pushing these instruments on clients.
Does the broker really have no responsibility to verify what his research department says?
By the way, ARPS were listed on UBS statements as MONEY MARKETS. Not just "other cash." Money markets. That is how they were presented to clients.
Posted by guest , May 29, 2008 6:10PM
Excerpt:
Nuveen and Eaton Vance aim to redeem the preferred shares issued by the tax-free funds by making the new instruments
" eligible for purchase by money market funds, which are NOT permitted now to invest in the preferred shares. "
**** This is a key point, and is evidence that F/As and brokers did not do their homework (due diligence) and misrepresented ARSs and omitted information. F/As have fiduciary responsibilities and they failed.
AS WE LEARN NOW, MONEY MARKET FUNDS WERE NOT ALLOWED TO PURCHASE ARSs SO WHY WERE THEY PURCHASED FOR CLIENTS BY F/As AS MONEY MARKET EQUIVILENTS.
Posted by guest , May 30, 2008 10:21AM
the MA AG forced UBS to return $37 to MA cities and towns because they are required by law to keep their funds in safe instruments, and ARS did not meet the standard. no law holds for individuals, but it seems like an interesting precedent to me.
Posted by Anal_yst , May 30, 2008 10:44AM
Much like the waiver you sign when you sign up for Tommy Moe's 'extreme skiing' clinic @ Jackson Hole, the 'fine print' often doesn't hold up too well in court, especially in light of seemingly insurmountable other evidence that suggests (for example, if they let an obviously novice skier on the trip, or a novice investor buy "cash" that wasn't) fault on behalf of the issuer/seller/FA/etc
Posted by guest , May 30, 2008 11:32AM
oops - i meant UBS-RICO had to return $37 MIL
again, by law, ARS were 'unsuitable' for cities and towns. i would think a lawyer could do something with that.
Posted by guest , May 30, 2008 4:35PM
Anyone have some tips on negotiating with my broker to have ARS exchanged for securities that actually have a market (can be sold)? Or, to negotiate a margin loan using the ARS as security? Thanks.
Posted by guest , May 31, 2008 3:05PM
if someone told me about ARS and i was looking into them as an investment on my own, for example for my online account where i don't have an FA, i would not have bought them without the most careful research. based on what i know is available on the net now, i would have found out that i didn't want these things.
the only reason i was less careful when i got them from Merrill-RICO was that i thought i had a reliable FA. again, if anyone wants to tell me that i should have done just as much research after my FA told me they were perfectly safe and liquid and they showed up on my statement as 'Other Cash', i hope they realize that they are telling me that i'm better off without an FA.