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Options for Holders of Auction Rate Securities

In the four months since auction-rate securities collapse, many investors are left with nothing else to do, but take out loans, sell their securities at discounts, file arbitration cases against brokers, or wait and hope the market returns to normal.  

One of the many investors affected by the current market was advised by her broker to invest her entire $375,000 divorce settlement into auction-rate securities last December. She was planning on using this money for her daily needs, but has yet to see a dime since the market froze up.  

Her brokerage, UBS AG, offered a margin loan backed by her account to get by with day-to-day expenses. But, later UBS marked down the value of the securities and demanded she repay part of the loan. She received her second margin call requesting money last week after UBS marked down her securities again by about 50%.  Unfortunately, this is not uncommon.    

An investor with A.G. Edwards fell into a similar situation last September when she came into $1.25 million from the sale of a business. She planned on using the funds for a tax payment. Her broker also advised she stash her money into auction-rate securities issued by mutual-fund companies.  She eventually had to take out a home-equity line of credit to pay taxes.  She left A.G. Edwards and moved to a new firm. The new firm advised her to sell the securities (for a loss) on a secondary market- the Restricted Stock Trading Network.  

Brokers recommended auction-rate securities to investors who wanted a safe, liquid investment. Individuals and companies purchased auction-rate debt from municipalities, charities, student lenders and closed-end mutual funds for years because of the pitch as a safe investment with a higher yield than a money market fund. 

In February, it became almost impossible to find bidders for these auctions as the subprime crisis extended to nearly all areas of the credit market. Wall Street firms refused to support the $330 billion market as well, causing it to freeze up and leave many investors out of luck. 

The student-loan backed security, an $80 billion portion of the auction-rate market, was hit predominantly hard because the interest rates reset to such low levels, in some cases 0%. The interest rates on auction-rate securities issued by mutual finds or municipalities have been much stronger, because when the auction fails the rates automatically reset above a benchmark rate.   

According to the Financial Industry Regulatory Authority, the securities industry’s nongovernmental regulator, about 80 arbitration claims dealing with auction-rate securities have already been filed.  More are coming.

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