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]