Morgenson -- Good From The Past on Auction Rate Securities

(c) F. Bruce Abel

Auction Rate Securities -- do you have any? Are you sure? This article by one of my favorites, Gretchen Morgenson, is from 2008 but the problem still obtains, I believe.


By GRETCHEN MORGENSON
Published: November 28, 2008
LIFE is unfair, as the saying goes, but for investors still stuck in auction-rate securities, the inequities keep on coming.
Times Topics: Gretchen Morgenson
Auction-rate securities, you may recall, are preferred shares or debt instruments with rates that reset regularly, usually every week, in auctions overseen by the brokerage firms that originally sold them. They have long-term maturities or, in the case of the preferred shares, no maturity dates at all. The securities are issued by municipalities, student-loan companies, closed-end funds and tax-exempt institutions like hospitals and museums.
Brokers that peddled these securities told buyers that they were cash equivalents, easy to get out of and relatively safe. But the promises of liquidity turned false last February when buyers for the securities disappeared and the auctions began failing. The $300 billion market for auction-rates ground to a halt, entrapping thousands of investors both large and small, sophisticated and novice.
Officials in Massachusetts, New York and other states came to the rescue earlier this year, striking settlements with some of the bigger brokerage firms in the arena.
But while some of the larger firms agreed to redeem the securities, not everyone is covered by those agreements. A group of people, size unknown, has fallen through the cracks in the settlements, and for several quirky reasons. They remain frozen in the securities and understandably upset.
Irene Scharf, a professor of immigration law at the Southern New England School of Law, in North Dartmouth, Mass., is one of them. Back in 2005, she invested $75,000 in several auction-rate securities backed by municipalities. The money was earmarked to pay college tuition bills for her two sons.
Ms. Scharf says she bought the auction-rate securities at the suggestion of her UBS broker. When that broker joined Smith Barney last year, she moved her account with him to the new firm. Unfortunately, that sequence of events disqualifies her from participating in the redemption of her securities as dictated by the various state settlements.
The terms of the Massachusetts settlement with UBS, for example, require it to redeem auction-rate securities of those clients who bought them from the firm between Oct. 1, 2007, and Feb. 13, 2008, and who moved to other firms, as well as those clients who were holding any auction-rate securities at UBS on Feb. 13. The settlement covers $19 billion in securities; UBS neither admitted nor denied wrongdoing.
The agreement struck by Smith Barney states that it will redeem auction-rate securities that were bought by its customers directly from the firm before Feb. 11, 2008. The deal, in which the firm neither admits nor denies wrongdoing, covers $7.3 billion of securities.
That leaves Ms. Scharf, however, out in the cold. Making matters worse, the college bills that her securities were supposed to cover are coming due.
“We lived very frugally for years so I would not have to take out loans when my kids went to college,” Ms. Scharf said. “I was not informed of any risk; my broker kept assuring me nothing was safer. When I asked about redeeming them, he said I’d only need to give him two or three days’ notice to redeem.”
She said she has tried to get help from authorities in her home state of Massachusetts, in Texas and also at the Securities and Exchange Commission. She has received sympathy but little else.
A spokeswoman for UBS confirmed that former clients were not all covered by the settlement agreement it struck with regulators.
“Investors who moved their relationships away from UBS while liquidity for auction-rate securities was still available through the auction process are not eligible for our settlement offering, as they were no longer using a UBS financial adviser for investment advisory or brokerage services at the time that auctions failed,” said Karina Byrne, the spokeswoman. “We believe our settlement covers more auction-rate securities holders because it covers all UBS clients who were holding the securities, regardless of where they purchased them, and our settlement is the only one that covers retail, corporate and institutional holders.”
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This article has been revised to reflect the following correction:
Correction: December 7, 2008 The Fair Game column last Sunday, about investors who have been unable to redeem their stakes in auction-rate securities, misstated the terms of a settlement between UBS and the state of Massachusetts on buying back such securities. The settlement covers securities bought from UBS between Oct. 1, 2007, and Feb. 13, 2008, regardless of whether the securities were moved to other firms, and securities held at UBS on Feb. 13, 2008, whether bought there or not. It is not limited to securities still held by UBS.