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Auction Rate Securites

 

Federal Securities Law

August 18, 2008

SE C and New York Attorney General Settle Auction Rate Securities Claims

Source: Bloomberg Law Reports

Four major firms have recently reached settlements with federal and state regulators regarding their sales of auction rate securities (ARS ) prior to the collapse of the ARS market in mid-February 2008. The Securities and Exchange Commission (SE C) Division of Enforcement (Division) and New York State Attorney General Andrew Cuomo announced that they have entered into separate settlements with (1) Citigroup Global Markets, Inc. (Citi) and (2) UBS Securities LLC and UBS Financial Services, Inc. (together, UBS). Citi agreed in principle to provide approximately $7.5 billion in liquidity to individual investors, small businesses and charities who purchased ARS before the market collapse and use its best efforts to provide approximately $12 billion in liquidity to retirement plans and other institutional ARS purchasers. Under the terms of its settlement, UBS agreed in principle to provide approximately $22 billion in liquidity to ARS purchasers, including $8.2 billion for individual investors, small businesses and charities, $3.3 billion for holders of tax-exempt auction preferred shares (APS) and $10.3 billion for institutional ARS investors. The UBS settlement also resolves a lawsuit that Cuomo filed against the company. Both settlement plans are subject to SE C finalization, review and approval.

In a separate but related matter, Cuomo announced ARS settlements with JP Morgan Chase & Co. (JPM) and Morgan Stanley (MS ), under which the firms agreed to provide a combined approximately $7 billion in liquidity to retail customers, charities and small to mid-size businesses that purchased ARS from the firms prior to the market collapse.

Background
Plaintiffs initiated a FINRA arbitration claim against UBS on April 15, 2008, alleging that UBS induced them to invest in securities that were supposedly “cash alternatives” but which were, in fact, auction rate securities. Plaintiffs claim they suffered financial losses as a result of these investments. On April 17, 2008, plaintiffs filed this action, seeking a prejudgment remedy of attachment of $150 million to secure any arbitration award they might receive. UBS moved to dismiss the action, arguing that FINRA rules, and FINRA Rule 12209 in particular, “prohibit judicial proceedings concerning matters pending in arbitration.” UBS also argued that prejudgment attachment was unnecessary because, under FINRA Rule 12904(i), a party is required to pay any arbitration award within thirty days of its issuance.

Citi Settlement
Under the terms of its settlement, Citi will liquidate at par all ARS held by its retail customers, including individual investors, small businesses and charities, by November 5, 2008. Citi will also make whole any losses sustained by customers who purchased ARS before February 12, 2008 and then sold them at a loss, and provide no-cost loans for customers until Citi repurchases their ARS . Citi further agreed to participate in a special arbitration process that the Financial Industry Regulatory Authority will oversee, in which retail ARS purchasers may elect to bring claims for consequential damages beyond the loss of liquidity in their ARS holdings. Citi agreed it would not contest liability for its alleged misrepresentations and omissions at these arbitrations, but it may challenge the existence or amount of consequential damages. With respect to the approximately $12 billion worth of ARS that Citi sold to retirement plans and other institutional investors, Citi agreed to use its best efforts to liquidate all such securities by the end of 2009. According to a press release issued by Cuomo, Citi also agreed to pay a civil penalty of $50 million to the State of New York and an additional $50 million civil penalty to the North American Securities Administrators Association (NASAA). Moreover, Citi committed to reimburse all refinancing fees to any New York State municipal issuer that issued ARS through Citi since August 1, 2007.

UBS Settlement
The terms of the UBS settlement are similar. UBS agreed to liquidate at par all ARS held by its retail customers, including individual investors, small businesses and charities, with less than $1 million in funds on deposit at UBS by October 31, 2008. Also by that date, UBS will proceed with a previously announced plan to repurchase tax-exempt APS held by all UBS customers. UBS further agreed to liquidate at par all ARS from its retail customers with UBS accounts valued at up to $10 million by January 2, 2009. UBS will use its best efforts to liquidate ARS held by its institutional investor customers at par by the end of 2009, but, unlike Citi, committed to offering to liquidate the positions of all such customers by June 30, 2010. The UBS settlement also includes the same make whole, no-cost loan and special arbitration provisions as the Citi settlement. Cuomo announced that UBS agreed to pay a civil penalty of $75 million to the State of New York and an additional $75 million civil penalty to NASAA. Like Citi, UBS further agreed to reimburse all refinancing fees to any New York State municipal issuer that issued ARS through UBS since August 1, 2007.

JPM and MS Settlements
According to a press release issued by Cuomo, JPM and MS separately agreed to buy back, by November 12, 2008 and December 11, 2008, respectively, all illiquid ARS that retail customers, charities and small to mid-size businesses purchased from the firms. The firms will collectively return approximately $7 billion to investors. JPM and MS also agreed to (1) fully reimburse all retail investors that sold their ARS at a discount after the market failed, (2) participate in a special arbitration procedure to resolve retail customers’ claims of consequential damages from their inability to liquidate ARS, (3) “[u]ndertake to expeditiously provide liquidity solutions to all other institutional investors,” and (4) reimburse all refinancing fees to any New York State municipal issuer that issued ARS through JPM and MS since August 1, 2007. JPM and MS “will also pay New York State and [NASAA] civil penalties in the amount of $25 million and $35 million, respectively, which will be distributed pro rata by states’ [ARS ] investment dollar totals.” The press release did not specify how much JPM and MS , individually, will be required to pay.

Wachovia Settlement
On August 15, 2008, the Division, Cuomo and Missouri Secretary of State Robin Carnahan also announced that they reached a preliminary settlement of ARS -related claims with Wachovia Securities, LLC and Wachovia Capital Markets, LLC (together, Wachovia). The terms of the Wachovia settlement are substantially similar to the agreements the federal and statue regulators reached with the other four firms, and call for Wachovia to buy back up to $9 billion in illiquid ARS . The Division and Cuomo indicated that their respective investigations into the ARS market will continue.

 

Source: Bloomberg Law Report, August 18, 2008.

 

 

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