Regulation And Legislation

Auction rate securities class actions are filed

A spate of class actions involving auction rate securities may be behind an expected rise in securities class actions this year.

The suits, most of which were filed over the past month by New York plaintiff’s law firm SeegerWeiss LLP in the U.S. District Court in Manhattan, are against 10 major brokerage firms.

The suits allege that the firms “misrepresented to their brokerage customers the liquidity of these auction rate securities,” said Stephen Weiss, founding partner of SeegerWeiss.

New York Attorney General Andrew Cuomo has subpoenaed “all the wirehouses” investigating their auction rate securities sales, according to an official with one of the Wall Street brokerages who declined to speak for attribution.

In addition, several state securities regulators have been conducting investigations involving auction rate securities and are coordinating their efforts to help in-vestors who can’t access funds that their brokers placed in the investments, the North American Securities Administrators Association Inc. of Washington said last Thursday,

“These are individual investors who mandated that their investments be placed in securities that were completely safe and completely liquid,” Mr. Weiss said. “And they were told that these securities were indeed safe and liquid, when they were in fact prone to the credit market crisis and highly illiquid.”

A study of 2007 securities class actions that PricewaterhouseCoopers LLP of New York issued this month found that the number of cases filed last year rose about 50% to 163, from 109 in 2006, according to Grace Lamont, a partner with the firm. Most of the cases were filed in the last half of 2007, and “some of that was spurred on by the in-creased activity … related to subprime credit issues,” she said.

“If there’s a great deal of success for these cases, you would expect the settlements to be higher” this year as well as next year, Ms. Lamont said.

Auction-rate securities are preferred stocks, municipal bonds and other debt instruments with interest rates or dividends periodically reset through auctions, usually at least once a month. The bonds are usually issued with 30-year maturity dates, but they can be for perpetuity.

SeegerWeiss’ suits represent “many thousands of people and institutions. We have been contacted by many hundreds of individuals,” mostly during the past month, Mr. Weiss said.

“We have been getting volumes of phone calls on a daily basis,” he said. “People are in great despair.”

NO DOLLAR AMOUNT

The suits have not specified a dollar amount in terms of losses.

The brokerage firms named in the suits, along with their subsidiaries, are Citigroup Inc., E*Trade Financial Corp., Merrill Lynch & Co. Inc. and Morgan Stanley, all of New York; Deutsche Bank AG of Frankfurt, Germany; Raymond James Financial Inc. of St. Petersburg, Fla.; SunTrust Banks Inc. of Atlanta; TD Ameritrade Holding Corp. of Omaha, Neb.; UBS AG of Zurich, Switzerland; and Wachovia Corp. of Charlotte, N.C. A similar suit against JPMorgan Chase & Co. of New York was dismissed, according to information provided by SeegerWeiss.

Representatives for Citigroup, Deutsche Bank, TD Ameritrade and UBS declined to comment, citing company policies against discussing pending litigation. Meanwhile, representatives for E*Trade, Merrill Lynch, Raymond James and SunTrust said that the suits have no legal merit.

Calls to Wachovia seeking comment weren’t returned.

Morgan Stanley denies the allegations, spokeswoman Christine Pollak wrote in an e-mail, adding: “The challenges of the auction-rate markets are industrywide and result from broad credit market conditions.” The firm is “working to address its clients’ liquidity needs on a case-by-case basis through various alternatives, including lending.”

Plaintiff’s attorneys who handle individual arbitration cases are also beginning to receive calls from distressed auction-rate-securities holders.

Attorney Kirk Smith last week filed an arbitration case against Morgan Stanley on behalf of an 86-year-old investor. The investor “was told that this was the same as cash, similar to a money market,” said Mr. Smith, a partner with Shepherd Smith & Edwards LLP of Houston.

The investor had $750,000 invested in auction-rate securities with Morgan Stanley, Mr. Smith said.

“I don’t think the broker knew any better,” said Mr. Smith, referring to the registered rep who sold his client the auction-rate securities. “I think the broker was somewhat duped by his own company.”

Based on conversations Mr. Smith said he had with the representative, “the broker had no idea that his firm was about to pull the plug on the auction-rate market or that they were ever supporting it in the first place,” he said.

Ms. Pollak said that Morgan Stanley hasn’t yet received the arbitration case and couldn’t comment on it.

PRINCIPAL TRADES

The cases could raise issues regarding principal transactions.

“Essentially, they were selling this stuff out of inventory to their own clients,” Mr. Smith said.

“They were getting this off their books just before they knew they were going to stop supporting the market,” he said. “When they stopped supporting the market, they knew the market would then collapse.”

In September, the Securities and Exchange Commission loosened rules allowing investment advisory firms that are dually registered as broker-dealers to make principal transactions more easily.

The rules were loosened to make it easier for brokerage firms to move their former fee-based brokerage accounts to advisory accounts after the U.S. Court of Appeals for the District of Columbia Circuit ruled that the fee-based brokerage accounts didn’t meet requirements that the accounts be registered as advisory accounts. Most large brokerage firms sell securities that they own, and brokers have long said that the restrictions on principal transactions in advisory accounts were onerous.

‘LATEST TREND’

Auction-rate-securities cases are “the latest trend,” said Faten Sabry, vice president of NERA Economic Consulting, a division of National Economic Research Associates Inc. in New York, which has been tracking subprime litigation cases. “This is the latest wave of suits,” she said.

“The allegations are very similar,” Ms. Sabry said. Defendants allegedly told investors that auction-rate securities were “highly liquid, safe investments for short-term investing.”

“The allegation is, the defendant knew but failed to disclose material facts about auction-rate securities,” Ms. Sabry said. “They failed to tell investors they were complex financial instruments.”

The auction-rate-securities market, with an estimated $360 billion in assets, has been illiquid since mid-March, according to plaintiff’s attorneys, when Wall Street firms stopped bidding in the market. That has left tens of thousands of people holding securities they can’t liquidate, according to lawyers.

The Securities and Exchange Commission is looking at ways to try to alleviate the market freeze-up. In testimony given last month to the House Financial Services Committee, Erik Sirri, director of the SEC’s division of trading and markets, said that the commission is looking at allowing municipal bond issuers to provide liquidity to investors who want to sell their auction-rate securities.

In addition, the Municipal Securities Rulemaking Board in Washington is considering rule changes to increase price transparency for such securities.

E-mail Sara Hansard at [email protected].