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Friday, Mar 29, 2024

ARS Investors Fight For Funds Liquidity

By THOM SENZEE Contributing Reporter A San Fernando Valley law firm has created a special task force to advocate for victims of the auction-rate securities crisis, which has made investments that were billed as being “as good as cash,” in terms of liquidity, now virtually illiquid. While not exactly the millionaires’ mortgage meltdown, the $330 billion ARS debacle bears some parallels to that more middle-class financial crisis. The most significant similarity is the assertion that investment brokers obscured the risks of such securities, as did some mortgage brokers with variable-rate home loans. “These are securities that allowed either individuals or businesses to invest at rates of return, on a short-term basis, that would otherwise be typically given in a money market or other vehicle,” says Sanford Michelman, partner at Encino-based Michelman & Robinson, LLP (M & R;). Auction-rate securities are long-term investment opportunities that have paid like short-term bonds. Issuers reset rates every few weeks, so investors could cash out with a profit in as few as seven days,theoretically. Furthermore, conventional auction-rate securities usually had a penalty clause that compelled the issuer to pay investors who couldn’t sell their securities at auction at a price that would make them whole. But a different type of auction-rate security eventually made its way to brokerage houses and investors. So-called “preferred” securities appeared to be no different than conventional ARS investments, yet they had no buy-back guarantee from issuers. “As attorneys representing clients, anytime you hear ‘cash-equivalent,’ your antennae should go up,” Michelman said. “You do your due diligence and you start to peel back the onion, and see they’re not as safe as they say.” That, says Michelman, is what began happening at his firm in 2005 when some of M & R;’s clients began to be involved in transactions in which auction-rate securities were presented as collateral or capital. “By 2006 we were on high alert,” he said. In fact, Michelman said, not only was M & R; tracking the issue as the firm’s lawyers saw more and more transactions based in part on the liquid value of ARS investments, it averted disaster for more than one client by advising them to divest themselves of the instruments as soon as possible. “We were able to advise a host of clients not to invest as well,” he said. Michelman says ARS investors range from wealthy individuals (this type of security was once sold only in increments of $250,000, though recently in denominations of $25,000), as well as medium- and large-sized companies. ARS auctions began to fail earlier this year. Institutions that were once willing to step in and stem losses by buying ARS certificates, such as Bank of America, Merrill Lynch, and Morgan Stanley suddenly declined to do so. Locally, some brokers are not completely surprised by the predicament facing ARS investors, while others are fighting not to become scapegoats for their bosses. “We are representing a handful of brokers,” says Michelman. “The ARS task force is working to make sure people at the top of some brokerage houses who were really responsible for deceptive practices don’t get away with using subordinates as their scapegoats.” But Dennis DeYoung, branch manager for Morgan Peabody in Northridge, says selling auction-rate securities as if they are absolutely liquid is unconscionable. “Any honest broker is going to tell you the only thing as good as cash, is cash,” DeYoung said. “I don’t think those investors have much in the way of options now, other than to ride out the current storm.” DeYoung believes ARS investments will make a comeback when the overall economy improves. “This is a temporary situation,” he says. “As time goes on the pendulum will swing back.” However, the auction-rate securities market could actually “cease to exist.” At least that was the prediction from a prominent Citicorp analyst speaking to the Wall Street Journal. Prashant Bhatia’s prediction has been reverberating in newspapers and magazines around the world. The only option for investors when there is no auction will be to keep their money in ARS’s and accrue whatever interest they can until the bonds mature. That could be decades for some. Worse, says broker DeYoung, there is always a possibility that if things get bad enough, ARS bond funds could be restructured to mature at dates later than originally stated. “I don’t want to panic anyone,” he said. “That’s one of the worst-case scenarios.” But M & R;’s Sanford Michelman says the current situation is already “worst-case” for many of his clients. “The travesty is there are a lot of companies who are getting pummeled because they need the funds [tied up in ARS’s] to operate their businesses,” Michelman said. In fact, Westlake Village-based Move, Inc., an online real estate information clearinghouse firm, had a rough first quarter in ’08 because of ARS auction failures. ARS-heavy investments caused the firm, which operates the consumer website for the nation’s foremost authority on real estate,the National Association of Realtors,to charge off $8.4 million. Overall, Move, Inc. has $129 million invested in auction rate securities. The company declined to comment on the loss for this story. Michelman and Robinson’s ARS task force is peopled by a combination of corporate lawyers, litigation attorneys, as well as regulatory experts. “The reason we put it together that way is so the corporate lawyers can understand the companies’ need for cash, while the rest of the diversified team is there to address all the moving parts of auction-rate securities and the regulations that govern them,” Michelman explained. Moreover, Michelman hopes his firm’s task force on auction-rate securities will have a positive impact on the potentially devastating national crisis. By navigating the legal system, a maze of securities regulations, and negotiating with financial institutions, M & R;’s task force aims to unlock what are effectively locked-up funds. “I think we will have an impact on the evolution of the issue,” he said. “Our goal is not to saber rattle; our goal is to get our clients the liquidity they need to feed their families or operate their businesses.” While Michelman says he does not think any of his firm’s clients are at risk of losing their homes because of the ARS debacle, he says many of the families M & R; represents stand to see a decline in their standard of living. “For some their entire business is at stake,” Michelman said. “There is great stress and juggling to maintain their lifestyle.” But make no mistake, he says, for people with tens of thousands or even millions of dollars in auction-rate securities, the problem does not fall into a category Michelman referred to as “a high-class problem to have.” To those affected, Michelman advises not to take their brokers’ word that nothing can be done. “They should seek legal advice,” he said.

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