For over 20 years, National Investment Fraud lawyers KlaymanToskes has pursued claims involving many type of securities. Many of these investments involve costs and penalties that are not clearly understood by investors but impact how your financial advisor is compensated, such as alternative investments, business development companies, REITs, and, as of recent date, SPACs. Back in 2008, one particular security type caused havoc on financial markets: Auction Rate Securities (ARS).
Auction Rate Securities are debt securities that are sold through a dutch auction. A dutch auction is public offering auction structure in which the offering price is set after receiving bids and determining the highest price. At that point, at which the total offering can be sold. In a dutch auction, investors place a bid for the amount they are willing to buy in terms of quantity and price. In this type of auction, an ARS is sold at an interest rate that will clear the market at the lowest yield possible. This ensures that all bidders on an ARS receive the same yield on the debt issue. The interest rate is reset periodically. ARS’s can be issued by municipalities, hospitals, student-loan companies and other special entities.
ARS were marketed to retail investors who were seeking a “cash-equivalent” investment that paid a higher yield than money market mutual funds or certificates of deposit, although ARS did not have the same level of liquidity as those other instruments.
In 2008, interest-rate auctions for ARS started to fail when the auctions attracted too few bidders to establish a clearing rate. Theis caused high interest rates on those securities, or worse, the inability of investors to sell their ARS until there was a successful auction. The ARS market collapsed in February 2008 when lead underwriters chose not to step in to support the auctions. For investors, this meant that they were left with illiquid investments with long-term maturities.
FINRA Investigates ARS Sales
As stated in FINRA’s Regulatory Notice 09-12, FINRA’s investigation of brokerage firms found evidence that some firms misrepresented to their customers that ARS were liquid investments that were equivalent to cash and failed to disclose the increasing risks associated with ARS, including the firms’ reduced ability to support the auctions in early 2008. The investigation also found evidence that firms failed to establish and maintain supervisory systems reasonably designed to achieve compliance with the securities laws and FINRA rules with respect to the marketing and sale of ARS.
FINRA was not the only government entity to investigate ARS sales years ago. The Securities and Exchange Commission and certain states also reached similar for ARS-related misconduct with firms.
Auction Rate Securities Settlements Reveal Major Issues
In August 2008, Wachovia agreed to buy back up to $8.8 billion in auction-rate securities and pay a $50 million fine for its conduct in selling ARS. Regulators at the time stated that Wachovia did not accurately represent the risks of the securities to investors, which inaccurately lead them to believe that the bonds were as liquid as cash. However, most clients have been unable to access their auction-rate investments for months before the settlement, when banks stopped submitting bids for the investments.
At the time, KlaymanToskes partner Lawrence L. Klayman, Esq. commented to the Charlotte Observer about Wachovia’s conflict of interest in the ARS sales. “They are on both sides of the trade. They had their doubts about the market, but they continued to sell these to investors to the very end. They were trying to shift the loss.” By November 2008, the firm was representing approximately 10 investors in ARS cases.
Another major issue in the ARS sales was the broker’s failure to understand the risk of the securities. In a 2008 Wall Street Journal article, KlaymanToskes partner Steven Toskes commented that ““Most of the time it’s just the firm [that’s named], with the firm being the deep pockets/ But brokers were named in some cases where the client’s gripe was ‘more personal’ or the broker vastly misrepresented the securities.”
What Other Firms Were Subject to Regulatory Scrutiny for ARS Sales?
Per the SEC’s Investor Alert and Bulletin, the following firms were subject to SEC administrative orders or complaints relating to 2008 ARS crisis:
Connect with Us to Learn More about Auction Rate Securities
For more information about auction rate securities, contact Lawrence L. Klayman, Esq. at (888) 997-9956, and download our Special Investor Report.
About KlaymanToskes
KlaymanToskes is a leading national securities law firm which practices exclusively in the field of securities arbitration on behalf of retail and institutional investors throughout the world in large and complex securities matters. KlaymanToskes has recovered more than $228 million for investors in FINRA arbitrations. KlaymanToskes has office locations in California, Florida, New York, and Puerto Rico.