2008 Auction Failures
Beginning on Thursday, February 7, 2008, auctions for these securities began to fail when investors declined to bid on the securities. The four largest investment banks who make a market in these securities (Citigroup, UBS AG, Morgan Stanley and Merrill Lynch) declined to act as bidders of last resort, as they had in the past. This was a result of the scope and size of the market failure, combined with the firms' needs to protect their capital during the 2008 financial crisis.
On February 13, 2008, 80% of auctions failed. On February 20, 62% failed (395 out of 641 auctions). As a comparison, from 1984 until the end of 2007, there were a total of 44 failed auctions.
On March 28, 2008, UBS AG said it was marking down the value of auction rate securities in brokerage accounts from a few percentage points to more than 20%. The markdowns reflected the estimated drop in value of the securities because the market had frozen, while UBS didn't offer to buy the securities at the new lower prices.
Beginning in March 2008, class action lawsuits were filed against several of the large banks. The lawsuits were filed in federal court in Manhattan alleging that these investment banks deceptively marketed auction rate securities as cash alternatives.
On July 17, 2008, a national task force, said to be composed of officials from several states including Missouri, began investigating at the St. Louis, Missouri headquarters of Wachovia Securities, a division of Charlotte, North Carolina-based Wachovia Corporation. Some in the media were calling it a raid; officials called it a "special investigation" at the St. Louis offices. Media reports also said that the "special investigation" was prompted by the failure of Wachovia Securities to comply with requests by officials. In addition, it was reported that other securities firms were also a part of the investigation. The Missouri state action came after complaints to the state about a total of more than $40 million of investments that were frozen.
On August 1, 2008, the New York State attorney general notified Citigroup of his intent to file charges over the sale of troubled auction rate securities and claimed Citigroup destroyed documents.
On August 7, 2008, in a proposed settlement of state and federal regulators' charges, Citigroup agreed in principle to buy back about $7.3 billion of auction rate securities it had sold to charities, individual investors, and small businesses. The agreement also called for Citigroup to use its "best efforts" to make liquid all of the US$12b auction-rate securities it sold to institutional investors, including retirement plans, by the end of 2009. The settlement allowed Citigroup to avoid admitting or denying claims that it had sold auction rate securities as safe, liquid investments.
Also on August 7, a few hours after Citigroup's settlement announcement, Merrill Lynch announced that effective January 15, 2009, and through January 15, 2010, it would offer to buy at par auction rate securities it had sold to its retail clients. Merrill Lynch's action created liquidity for more than 30,000 clients who held municipal, closed-end funds and student loan auction rate securities. Under the plan, retail clients of Merrill Lynch would have a year, beginning on January 15, 2009, and ending January 15, 2010, in which to sell their auction rate securities to Merrill Lynch if they so wished.
In August 2008, the Securities and Exchange Commission's Division of Enforcement engaged in preliminary settlements with several of the larger broker-dealers including Citigroup, JPMorgan Chase, Merrill Lynch, Morgan Stanley, RBC Group and UBS. The proposed settlement called for these broker-dealers to repurchase outstanding ARS from their individual investors.
In November 2009, JPMorgan Chase settled a lawsuit brought by the SEC over failed ARSs issued with Jefferson County, Alabama (Birmingham area). The specific charge was bribery, not securities fraud, but the bank agreed to pay $75 million in penalties and drop a $647 million charge against the heavily indebted county.
In his financial blog Sense on Cents, Larry Doyle referred to the marketing and distribution by Wall Street of auction-rate securities as "the single greatest fraud ever perpetrated on investors".
Read more about this topic: Auction Rate Security
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