Investment Management

Misleading Marketing of Auction Rate Securities

Misleading Marketing of Auction Rate Securities

The marketing of auction rate securities and auction rate preferred shares as cash equivalents has now been widely shown to have been false and misleading. These instruments are, in fact, long term obligations that should never have been sold as short-term paper, much less a money market instrument. Despite the presentment of patently valid claims, defrauded customers were first placated with inaccurate predictions that the Dutch auctions would restart in a matter of weeks. Plainly, this did not occur, and now is not even being suggested as a possibility. We are advising that this was never a realistic prediction in view of the lack of fundamental value in the majority of these instruments, which simply do not have a high enough failed auction rate to compensate for their actual long-term character. Now, investors are being told that, within months or at most a year, all auction rate preferred shares will be redeemed by the closed-end funds that issued them. Meanwhile, a secondary market for auction rate securities is beginning to develop as holders who can wait no longer are mitigating their damages.


The victims of false marketing statements are in a difficult position. Most face mandatory arbitration clauses contained in standard form agreements that, in may cases, they were never even provided, and they have damages that are too small to justify the costs of effectively pursuing an arbitration claim. The only alternative for many is to rely on class action suits. Meanwhile, their own brokers are providing no substantial advice as to how much their particular instruments are actually worth, such that the investors can make an informed decision as to whether to take advantage of the developing secondary market. At the same time, customers have been offered only the interim solution of loans on terms that are just as misleading as the original marketing, in that, essentially, they are having to borrow money, rather than receive a refund, and they are paying interest to the very institutions that placed them in the position that they now find themselves.

Given the absence of credible investment advice, we believe that customers should seek an independent valuation of their investment, and independent counseling as to the nature of the securities that they hold. We also believe that a unity of action by holders of the bonds or preferred shares issued by a particular entity would provide the highest return to those investors. Given the size of many offerings, this may not be practicable at this time, and therefore we further recommend that investors seek individual advice as to their legal alternatives. Investors with positions large enough to justify active legal steps should now be considering moving forward.
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