Auction-rate securities scandal is another reminder that buyers must beware
Some investments need a plain-language warning sticker like those you find on a stepladder or a crib.
Caution was lacking for auction-rate securities, complex vehicles sold by brokers to institutions and individuals. They were bonds or preferred stocks that had interest rates periodically reset through auctions.
Why did individual investors get the idea these securities were liquid cash equivalents, like money-market funds? The disclosure from brokers wasn't adequate. People such as Julian Dibbell, a Chicago writer, bought them on the premise you could get your money out at any time.
But the $330 billion auction market for these securities collapsed, and investors couldn't cash out.
The $200,000 that Dibbell invested through Chase Investment Services Corp. was frozen; his statement at one point indicated the value of the securities, tied to student loans, was zero.
"Chase has settled with the New York State attorney general's office and will be buying my troubled shares back at par value," Dibbell said. "I'm taking this for a happy ending so far."
When he was sold the securities, Dibbell said, "there was no discussion of risk." Since he bought them from a large regulated bank, he didn't question their safety or liquidity.
"Based on the hundreds of complaints received, investors were not informed of the liquidity risks and received little disclosure," said Karen Tyler, president of the North American Securities Administrators Association, a state regulators group. "They were marketed as a safe, money-market cash equivalent."
Now regulators are inspecting about 40 brokerage firms to see if they gave ample warning. So far, they have reached settlements with eight major banks and broker-dealers to buy back more than $35 billion of the securities from investors. The firms have been fined more than $522 million - paling in comparison with the $5 billion for the mutual-fund late-trading scandal in 2003.
Small investors seemed to be the last to find out about auction-rate pitfalls. The Securities and Exchange Commission cited problems going back to 2003. It fined 15 firms more than $13 million combined in May 2006, and issued cease-and-desist orders, citing "violative practices."
"Auction-rate securities have been a cesspool for a long time," said Andrew Stoltmann, a Chicago securities lawyer. "In the last seven years, they've spread to moms and pops in $25,000 increments."
Have you been burned in an auction-rate security? You have some options.
John F. Wasik is a Bloomberg News columnist. He can be reached at jwasik@bloomberg.net.
