Corporate purchasers of auction-rate securities continue to file lawsuits and arbitration claims against sellers claiming that the securities were misrepresented as liquid, short-term, cash equivalent investments. In one recent case, Texas Instruments, Inc. sued Citigroup Inc., Morgan Stanley and Bank of New York Mellon Corp. for misrepresenting and omitting to disclose the true risks and characteristics of the $524 million of auction-rate securities it purchased. Texas Instruments cannot liquidate its auction-rate securities, because the auction rate securities market collapsed in February 2008 when the banks and other dealers stopped participating.
In a nutshell, Texas Instruments alleged that the banks knew of problems with auction-rate securities, including auction failures, but continued to sell them did not disclose the problems and failures to investors. More specifically, Texas Instruments alleged, among other things, that:
- The banks misrepresented the auction-rate securities as a highly liquid alternative to other short-term investments.
- The banks omitted to disclose a number of important facts, including the fact that the auctions depended on continued bidding and purchasing by the banks.
- The banks covered up problems by, among other things, inducing the issuers to take steps to avoid auction failures that would otherwise occur, such as making their securities more attractive by waiving caps on higher interest rates the issuers would pay in case of auction failures. The waivers misled investors into believing that the auctions were safe and that they could count on getting that higher interest rate if an auction failed, when, in fact, many issuers may not be able to pay those higher rates.
Auction-rate securities are securities that have interest or dividend rates that are reset through a purported Dutch auction process. There are several types of auction rate securities, including Municipal Auction-Rate Securities, Auction-Rate Preferred Stocks, and Student Loan-backed Auction-Rate Securities. Although auction-rate securities were sold by the banks as short-term, liquid (i.e. cash equivalent) investments, these securities have long-term maturity dates, such as 20 or 30 years. While the auctions functioned, the coupons were generally reset on a 7 to 35 day cycle and interest was paid periodically depending on the issue. The type of securities sold to Texas Instruments are Student Loan-backed Auction-Rate Securities or “SLARS”. With the high and increasing percentage of student loan defaults, SLARS are among the riskiest auction-rate securities.
Texas Instruments is not eligible to participate in the settlements the banks reached with regulators last year, in which they agreed to buy back the auction- rate securities. The rationale for excluding companies like Texas Instruments from the settlement was that their officers are financially sophisticated and should have known better. This ignores the fact that one cannot bring his or her sophistication to bear when one is lied to.
J. Boyd Page, a senior partner of Page Perry, observed that, “I know that many investors are reluctant to realize losses and hope that things will get better, but these investors also need to appreciate that things could get a lot worse. Furthermore, investors who have viable legal claims risk losing those claims if they wait too long.”
In summary, investors who still continue to hold auction-rate securities without taking action should appreciate that they are exposed to potentially significant losses in the long run. These investors should carefully weigh the pros and cons of disposing of their auction-rate securities in the secondary market for less than face value, and seeking legal redress for the difference in value. As painful as it is to realize a partial loss, it is wise to consider steps that may prevent a total and permanent loss.
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions. Page Perry’s attorneys are actively involved in representing institutional and corporate investors in auction-rate securities cases. For further information, please contact us.