By GRETCHEN MORGENSON
FOR many holders of auction-rate securities — investments that Wall Street once peddled as safe, sound and as fully liquid as cash — life in the frozen zone drags on.
Not only are some brokerage firms still refusing to let customers redeem their securities — Oppenheimer and Raymond James are two examples — but also investors’ efforts to be repaid through class-action lawsuits are being stymied. Judges overseeing at least 23 auction-rate class actions have dismissed them in recent months, leaving investors who were hoping for some relief out of luck again. In September, one judge said the plaintiff was not specific enough in his allegations.
Municipalities, student loan companies, closed-end funds and tax-exempt institutions like hospitals and museums all issued auction-rate securities as either preferred shares or debt instruments to companies and individual investors. The interest rates that issuers paid investors were supposed to reset periodically, usually every week, in auctions overseen by the brokerage firms that sold the securities.
Problems in the market emerged in early 2008, when weekly auctions that allow investors to cash in their holdings simply stopped functioning. Wall Street firms sponsoring the auctions could no longer match buyers with sellers, and the machinery supporting the $330 billion auction-rate trade ground to a halt.
State securities regulators have forced some of the larger brokerage firms in the market to redeem their customers’ holdings, but not all investors have been so fortunate.
So what is an investor to do?
On the corporate side, a coalition of executives from 25 companies holding $8 billion in frozen auction-rate securities backed by student loans is arguing that if companies and individual investors could cash in those securities, jobs would be created, investments would be made and money would be spent.
The overall market for auction-rate securities backed by student loans is sizable: about $70 billion.
James Butkiewicz and William Latham, economics professors at the University of Delaware, estimated in research conducted for the coalition that 15,000 jobs and $2.3 billion in spending would be created for every $1 billion redeemed in auction-rate securities backed by student loans.
Michael J. Beyer, chief executive of Foresight Energy, a privately held company in Palm Beach Gardens, Fla., and a member of the coalition, says his company is stuck with $146 million in auction-rate securities. He has struggled to finance three mining projects his company has already begun in Illinois.
Foresight raised capital for the projects in late 2007 and parked the money in auction-rate securities in early 2008, just as the market was starting to shut down. Since then, it has tried to get the securities redeemed by Citigroup, the bank that recommended them. Citigroup refused, but gave Foresight a $100 million line of credit against the securities.
“We have been scrambling to find other alternative sources of cash,” Mr. Beyer said. “But at some point next year, we will end up short.”
Citigroup said in a statement that it had “worked diligently with issuers, investors and regulatory authorities” on the frozen auction-rate securities, adding that “We have made progress on our efforts to help provide liquidity to our clients and remain committed to continuing our work on these initiatives.”
Mr. Beyer says his coalition is trying to educate the Obama administration about the impact that this Wall Street failure has had on Main Street.
“Our goal is to show the administration that this is money that could be creating jobs in a high-unemployment area,” he said.
INDIVIDUAL investors, of course, don’t have the resources or reach of corporate coalitions, and their plight seems even more intractable given the host of recent court rejections.
Still, one promising road remains open to them: filing an arbitration case against the brokerage firm that sold them their securities. For a variety of reasons, such cases have been much more successful than the class-action matters have been. (An arbitration is a closed-door hearing overseen by a small panel of officials appointed by the securities industry itself.)
According to the Financial Industry Regulatory Authority, the large regulator that oversees investor arbitrations, almost 500 auction-rate claims have been filed by investors since the market seized up. A total of 253 are pending; 242 have been closed.
Only 17 claims went all the way through the process. Of those, investors won in four cases; a $400 million award was handed down by a panel in one matter.
But 146 of the 242 closed cases were settled by the parties involved in the dispute. Although the settlement terms aren’t public, lawyers who have handled these cases say that such deals typically involve refunding much, if not all, of investors’ money.
Some settlements also involved “consequential damages” — extra money awarded to cover investors’ costs or opportunities they missed because they didn’t have access to their funds. According to Finra, investors have filed 32 claims seeking additional damages in auction-rate cases that were settled through regulatory enforcement actions. Of those, 14 remain open and 9 were settled. Five cases that went through arbitration produced three victories for the plaintiffs.
It isn’t particularly surprising, legal experts said, that judges have rejected so many class-action suits. The legal hurdles that investors must clear under the Private Securities Litigation Reform Act of 1995 are far greater than those in arbitration, where the less arduous standard of “just and equitable principles of trade” is the guiding benchmark.
For example, investors in a class action must convince the judge that the brokers who sold them the auction-rate securities knew they were problematic — not an easy task. And investors filing a class action cannot begin to conduct discovery until their case has survived a defendant’s motion to dismiss. This makes it hard to plead the specifics of their case early on.
Protracted battles over who will be the lead plaintiff and the lead counsel can also arise in a class action, eating up time and money. And sometimes there are time-consuming disputes over the proper venue for the case.
Arbitrations are likely to move along much more speedily and at lower cost.
Of course, arbitration does have its costs and risks. But for so many investors still stranded with these securities almost two years after the market failed, taking matters into their own hands may be the only approach that holds any promise.