Cellular South Inc. has filed a federal lawsuit in Mississippi against JP Morgan Securities for misrepresenting the risk and liquidity of auction rate securities, leaving $4 million in securities that it cannot liquidate. Auction rate securities are fixed-income debt instruments ? typically municipal bonds, preferred shares of closed end mutual funds, or asset-backed securities collateralized by student loans or mortgages ? for which the interest rate is regularly reset through an auction process. Auction rate securities were once routinely marketed as safe, cash equivalents that were highly liquid, but the broker-dealers who sold them failed to disclose that liquidity was entirely dependent upon the success of the auction process, which was being artificially supported by the undisclosed participation of brokers bidding in auctions where they had an interest. The Cellular South suit alleges that JP Morgan manipulated the market by failing to disclose that it was supporting the auctions, thereby creating the false appearance of stability and liquidity in the auction rate securities market.
Auctions were once held every 7 to 35 days by the brokerage firms that dealt in auction rate securities, but because of the subprime lending crisis and its effect upon the financial markets, These auctions ground to a halt in February 2008 because they were no longer viable investments and broker-dealers who had previously propped up the market by bidding in their own auctions were no longer inclined to invest in them. The result has been that many holders of auction rate securities have been unable to cash out even at a loss, and investors who were led to believe that they were purchasing a liquid cash equivalent have learned that they essentially have no liquidity at all. Others have been forced to take steep losses by selling at a discount in a limited secondary market. Like many, Cellular South alleges in its lawsuit that it was unable to sell without incurring substantial losses.
Since the market collapse, there have been several regulatory settlements with broker-dealers that have allowed many investors to redeem their auction rate securities at par, but many of those investors have made claims for consequential damages caused by the loss of liquidity?for example, lost business opportunities that they were unable to take advantage of. Many more investors have still not achieved liquidity, however, because the broker-dealers who sold them their auction rate securities were not party to the regulatory settlements or because the investors were not eligible under the terms of the settlements, which primarily benefited individual “retail” investors. Many of these investors have continued holding the securities, which have long-term maturities but are locked into paying short-term interest rates?in some cases less than one percent for periods of more than thirty years.
According to the Cellular South lawsuit, JP Morgan placed support bids in virtually every auction in which it was the designated auction leader, dealer, or co-lead dealer. This enabled JP Morgan to not only misrepresent the safety and liquidity of the particular securities purchased by Cellular South, but to underwrite billions of dollars of auction rate securities and to sell them at par value when it fact they were worth much less?allowing JP Morgan to rake in hundreds of millions of dollars in underwriting and auction dealer fees.
Craig T. Jones, an attorney with Page Perry in Atlanta, a firm who represents a number of investors who are still holding illiquid auction rate securities recently observed “Now that the regulatory settlements have been concluded, many investors have learned that they are ineligible for those settlements, either because of the size of their investment or the date when their securities were purchased.” Furthermore, says Jones, “there are several large broker-dealers who were either not targeted by regulators or have not yet been party to the settlements. ” Now that it has been two years since the collapse of the market, investors who are still holding these securities need to be concerned about the statute of limitations. “If you still do not have liquidity at this point,” says Jones, “you may never get it unless you take legal action. Under the laws of some states, the time for doing that is about to expire, and it will eventually run out in other states as well. If you are thinking about consulting a lawyer, you need to do it now before it is too late.”
While the Cellular case was brought in federal court, the vast majority of investors are contractually obligated to bring their claims in arbitration. According to Jones, “many investors find arbitration to be a more relaxed forum that moves faster and costs less money than taking someone to court.” Page Perry is based in Atlanta but handles securities arbitrations?as well as court cases–all over the country.