Auction Rate Securities and a Year and a Half of "Solutions": What If You Had More Than $10 Million Invested?
A significant amount of action has been taken to help investors who found themselves unable to sell their Auction Rate Securities holdings.
September 11, 2009
In the wake of the February 2008 collapse of the multi-billion dollar Auction Rate Securities ("ARS") market, a significant amount of action has been taken to help investors who found themselves unable to sell their ARS holdings. State and federal regulators moved against the large banks that issued ARS, resulting in numerous settlements. Many of the ARS issuing banks have offered to buy back ARS from their investors, and class actions have been filed on behalf of individuals who found themselves unable to sell their ARS. However, not all investors have been included in such solutions - namely corporations that used ARS as part of cash management within their Treasury function, and institutional investors. Most of the regulators' settlements were aimed at investors with less than $10 million invested in ARS. Corporations and institutional investors with more than $10 million invested in ARS have no remedy on the horizon other than to hold the investments to maturity for as long as 30 years. As a result, many are turning to private litigation as the best means for extricating themselves from the ARS madness.
This brief article seeks to follow-up on our December 29, 2008 article ("Auction Rate Securities: Survey of Potential Remedies") that analyzed initial reactions to the freezing of ARS investments. In particular, it seeks to focus on the specific realities faced by corporations and institutional investors who are now stuck with long-term investments though they had sought highly liquid, short-term, safe, and cash-equivalent assets as a cash management tool. Not only have such investors found themselves with assets lacking all of the characteristics they specifically sought out, but, more importantly, they have found themselves with few solutions. Because only a few investors have successfully negotiated some limited form of buyback in the future, some investors have addressed the absence of solutions by bringing individual suit against those banks who issued and underwrote their ARS purchases. Furthermore, many are making the decision to bring individual suit now, because they realize their needs will not be met by current solutions, and because the statute of limitations deadlines loom near.
Suits filed to date by corporations and institutional investors have been across all industries and business models. However, what remains consistent is the need for liquidity that no longer exists. As noted in the earlier article, corporate and institutional investors have different needs than other investors. Most corporations sought out ARS as a means to meet their basic liquidity needs associated with internal financial and business growth goals, as well as to obtain slightly higher returns on their investments. For example, in a recently filed suit in the Northern District of California, The Anschutz Corporation ("TAC") explained this reality when it noted that it invested in ARS because "[i]t has significant working capital needs and therefore maintains significant resources in short-term, liquid investments that can be called upon as needed." Complaint at 4, The Anschutz Corp. v. Merrill Lynch & Co. et al., No. 09-03780 (N.D. Cal. August 17, 2009); see also Complaint at 4, American Eagle Outfitters, Inc. v. Citigroup Global Markets Inc., No. 09-cv-00138 (W.D. Pa. Feb. 4, 2009) (stating that its "business requires the Company to keep substantial funds readily available in the form of cash or highly-liquid assets with which to satisfy a variety of business contingencies.") When the ARS market collapsed, then institutional investors did not have access to the capital they needed.
Corporate and institutional investor suits seeking to remedy the losses associated with substantially impaired and unsellable ARS have all taken similar form. The suits allege claims of fraud under various securities laws - including violations of Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), and Rule 10b-5 promulgated thereunder, violations of Section 20(a) of the Exchange Act, and violations of various state securities laws. See, e.g., Complaint, Teva Pharmaceutical Industries Ltd. et al. v. Merrill Lynch & Co. et al., No. 1:09-cv-06936 (S.D.N.Y. Aug. 5, 2009). Additionally, such suits have sought damages based on common law fraud and negligent misrepresentation. See, e.g., Complaint at 54-59, Anschutz, No. 09-03780. Furthermore, and also with little variation, corporate and institutional investor suits allege that the large banks not only knew the securities were not as liquid as marketed, but also actively sought to deceive investors by allegedly artificially propping up the ARS market and manipulating the auction process. Id. at 7-9. Finally, corporate investors in such suits allege that they relied on material omissions and false information provided by the banks, and that if they had known what the banks in fact knew, they would have never invested in ARS. Id. at 45.
Defendants in corporate and institutional investor suits have included, but are not limited to, Citigroup, Merrill Lynch, and Deutsche Bank. Additionally, one suit also alleges that the ratings agencies, Moody's Investors Service Inc., and Standard & Poor's, "enabled this fraud by consistently giving these auction rate securities the highest or second highest rating available, thereby representing to investors such as TAC that the auction rate securities were highly safe and liquid instruments, and that the collateral underlying these instruments was of sufficient quality to virtually ensure principal and interest payments." Complaint at 3, Anschutz, No. 09-03780.
Corporate and institutional investors who have already filed suit have begun the process of working through a multitude of problem areas associated with ARS litigation. For example, in Hutchinson Technology Inc. v. Citigroup Inc. et al., No. 08-cv-6039 (D. Minn. Dec. 18, 2008), Plaintiffs voluntarily dismissed their action in light of a determination regarding an arbitration clause in an account agreement. Notice of Voluntary Dismissal Without Prejudice, Hutchinson Technology, No. 08-cv-6039. More recently, a suit brought by Aimis Art Corporation was dismissed for a failure to state damages where the Plaintiff had received a repayment of the money invested in the relevant ARS fund, and the court determined that the lead plaintiff lacked standing because it had redeemed its ARS purchases at par value. Aimis Art Corp. v. Northern Trust Secs., Inc. et al., No. 08-cv-8051 (S.D.N.Y. Jan. 5. 2009). However, other suits are moving forward, despite challenges, and, where appropriate, individual suits can still serve as the best means for investors who cannot afford to wait for the ARS market to return or until the ARS mature. These entities are seeking to address their substantial and more immediate losses and needs.
Even more than a year and a half after the failure of the ARS market, and after numerous settlements, investigations, and endless media attention, not all holders of ARS have been offered compensation for their losses. Corporate and institutional investors with holdings too large to avail themselves of settlement programs for ARS victims are turning to individual suits, rather than class actions, to seek redress. The individual suit may present the best potential option for the appropriate corporate and institutional investors
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