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Brokerages Not Keen on Buying Back Auction Rate Securities

Aug 19, 2008 | Parker Waichman LLP

Some brokers who sold auction rate securities say they should not be expected to buy back the now-worthless investments from their customers.   Instead, the brokerages are arguing that the parties responsible for the auction rate mess - the investment banks that underwrote the vehicles and ran the auction where they were bought and sold - should be made to buy back all auction rate securities, including those sold by brokers.

Auction rate securities are long-term corporate bonds, municipal bonds and preferred stock on which the interest rates are reset periodically based on bids submitted through securities firms. Generally, rates are reset every seven, 14, 28 or 35 days. Because they can be sold during weekly or monthly auctions, banks and brokerages often touted auction rate securities as short-term investments or cash equivalents. Unfortunately, because of the credit crises, the market for auction rate securities crashed. Thousands of investors have been bewildered to find out that the investments they were sold as cash equivalents are now illiquid.

In the past two weeks, UBS AG, Citigroup Inc., J.P. Morgan Chase & Co., Morgan Stanley, Merrill Lynch & Co. and Wachovia Corp. have agreed to buy back more than $40 billion of auction-rate securities from their clients. But those deals do not cover an additional $160 billion worth of auction rate securities bought through mutual fund firms or brokers that didn’t underwrite the debt. Some investors still stuck with the worthless investments are looking to the brokerages to buy back the auction rate securities they sold.

But broker-dealers like Raymond James Financial Inc., Stifel Nicolaus & Co., Oppenheimer & Co. and Fidelity Investments say they have no intention of buying back the auction rate securities they sold.  They contend that they were deceived about the condition of the auction rate securities market in the same way investors were.  
 
"None of the rest of the market knew" about how "auction dealers allegedly controlled the whole auction process for 25 years,"  Michael Decker, chief executive of Regional Bond Dealers Association, which represents regional brokerages, told The Wall Street Journal.

The brokerages want the buy back deals struck with investment banks to cover all investors, including those who used their services to purchase the vehicles. According to The Wall Street Journal. the Regional Bond Dealers Association sent a letter Monday to regulators including New York Attorney General Andrew Cuomo, the Securities and Exchange Commission and the North American Securities Administrators Association asking that investment banks be required to buy back all the securities for which they conducted auctions, not just all the securities they sold to their own clients.

Lawyers for brokerage-firm customers who have filed arbitration claims over auction rate securities allege that many brokerage firms either knew exactly what they were selling or didn't bother to ask the investment banks hard questions about the risks of the securities.

For their part, securities regulators and others investigating the auction rate mess say they have not yet determined the culpability of the brokerages.  A spokesperson for Cuomo's office told The Wall Street Journal said that its investigation is not over yet.  "The culpability of downstream brokerages will depend on the facts uncovered in our investigation; what did they know about the liquidity risks of the auction-rate securities and when did they know it, and most importantly what representations, if any, did these brokerages make to their customers," the spokesperson said.


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