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Monthly Archives: July 2008

Arbitration Fairness?

Imagine, after the market collapsed you were forced to sell your auction-rate securities at a significant discount, even though you were advised beforehand that these securities were as safe as money-market funds. Then, at your arbitration hearing, one of the three panel members charged with deciding your case is an employee of another firm that also sold auction-rate securities. Do you expect you will receive a fair and unbiased hearing?  

That is the question posed by Jane Bryant Quinn in her commentary on today’s

According to Ms. Quinn, the recent arbitration claims regarding auction-rate securities illustrate how the odds are stacked against investors in the securities-industry arbitration.

All claims exceeding $50,000 require that the panel of decision makers includes two public members and one industry representative. The industry rep often acts as the “talking head” for Wall Street. Their job is to explain the industry’s point of view to the others, but of course will likely be favoring the exact practices you are there to protest. To make matters worse, as a “specialist”, their opinion is considered superior and their input may be given greater weight.  

The industry and FINRA have always rejected investor lawyers’ wishes to rid the system of the industry position. However, last year when the Arbitration Fairness Act emerged in congress (containing a clause requiring all public members on panels) FINRA hedged their position, slightly. Just last week, FINRA announced a two-year pilot project that allows as many as 420 cases to be heard by the proposed all-public panel.

Many lawyers embraced the plan as a trivial, small step to fairness. But this path to fairness was interrupted by FINRA after the Public Investors Arbitration Bar Association (PIABA) asked that potential panelists who had worked for firms that originated or sold auction-rate securities be excluded from hearings on auction-rate cases. FINRA shot down the idea and decided arbitrators are merely required to disclose if they worked for firms that sold auction-rate securities, sold them themselves or supervised anyone who did after January 1, 2005. The decision to select those arbitrators will then be left in the lawyers’ hands.  

Though it sounds like a fair proposal, the decision has lawyers irritated. “The steam is coming out of my ears,” said Phillip Aidikoff of Aidikoff, Uhl & Bakhtiari. “Where are the people who speak for individual investors?” 

Panels are chosen by both sides of the case, and then ultimately named by FINRA. Each party gets three lists of eight names, randomly picked by a computer from the arbitrator pool (one list for the industry panel and two lists for the public members). Each side is permitted to strike up to four names for whatever reason they want, and rank the remaining four. Then FINRA chooses the arbitrators most acceptable for both parties.  Since the arbitrators involved with auction-rate securities are still in the panelists pool, it forces the lawyers to use up their challenges to get rid of them. These challenges may have been used for reasons such as ridding of someone whose awards consistently disfavor of the industry, or challenged for cause – meaning direct and definite bias or interest.

If you have an auction-rate case against a large brokerage firm and get an industry panelist from a different large firm, how can they award the investor damages when his company is up against the same charges? That question has yet to be answered by FINRA.

UBS Charged In Auction-Rate Wrongdoing

UBS AG is facing charges for promoting auction-rate securities as conservative, money-market funds at a time when the auction-rate market was plummeting.

New York Attorney General Andrew Cuomo alleges that UBS is responsible for repurchasing $25 billion in auction-rate securities from its investors rather than the mere $3.5 billion it is currently offering to buy back, according to a July 24, article.  Although UBS claims it has not committed any illegal activity and does not have a deceptive, nationwide campaign to reduce their $11 billion auction-rate debt, it acknowledges that some of its individual employees are being evaluated for disciplinary action.

This case highlights the ongoing problems brokers and investors are encountering with auction-rate securities. Many investors had bought auction-rate securities with the understanding that they were holding safe, liquid investments, only to see the market collapse in February and leave them with substantial losses.

Other state regulators are also investigating the offers and sales of auction-rate securities. Massachusetts Secretary of State William Galvin is investigating UBS, Bank of America, and Merrill Lynch. In addition, the SEC and FINRA are cracking down on banks that are being suspected of advertising auction-rate securities as liquid funds to investors.

Wachovia Raided by Regulators

A team of investigators inspected Wachovia Corp.’s securities division Thursday as part of an ongoing investigation into the company’s sales of auction-rate securities. Regulators from more than five states searched the St. Louis headquarters to uncover information about sales practices, internal evaluations of the auction-rate securities market and marketing strategies. Wachovia executives and agents were issued over a dozen subpoenas. 

Wachovia was warned Wednesday about the raid because the company had not “fully complied with the Missouri probe,” Missouri Secretary of State Robin Carnahan said.  This search is another strike for Wachovia, which ousted CEO Kennedy Thompson in June after a $708 million first-quarter loss.  

It looks like the bank will encounter even more setbacks.  According to a June 17, article, Wachovia is expected to record a loss of at least $2.6 billion for the second quarter. 

In May, Wachovia reported it had received inquiries and subpoenas from the SEC and state regulators concerning underwriting and sales of auction rate securities, and that it expected “further review and inquiry.” 

Wachovia clients have filed more than 70 formal complaints to the state since February, totaling over $40 million in frozen assets. Hundreds of Missouri investors have called the Secretary of State’s office because of inability to access money needed to run their business make medical payments or pay tuition.  

Over $218 billion of auction-rate bonds sold by student-loan providers, municipalities and closed-end mutual funds remain frozen since firms quit roles of last minute buyers in February.

Auction-Rate Securities: Can Investors Recover?

In response to the collapse of the auction-rate securities market, many investors are left questioning what to do next about their illiquid holdings. Investors should realize that there is not one correct solution that all auction-rate securities investors should follow. Whether investors decide to sell their securities or wait for the market to improve, here are some key points that investors should take into account when making their decision: 

Trends in the Market 

Some of the top brokerage firms agree that the auction-rate securities market has little hope of recovering, but some investors have had their securities refinanced. According to a June 6th Bloomberg article, municipal issuers either made plans to refinance or refinanced about $76.1 billion of auction-rate securities. In addition to municipal auction-rate securities, some investors have also been redeemed for their auction-rate preferred stocks. Although additional refinancings are expected to occur, investors should be aware that not all stock issuers are willing to refinance auction rate securities. Some issuers have decided to not refinance while others have only refinanced portions of their investors’ losses.  

Student loan auction-rate securities, which constitute $85 billion of the market, are among the most illiquid and unlikely to be refinanced. According to a July 10th Bloomberg report, less than 4% of student loan auction-rate securities have been refinanced so far. This is because issuers are not charged high penalty interest rates when auctions fail, leaving them little incentive to refinance. Auction-rate securities issued by CDOs, or Collateralized Debt Obligations, are also highly illiquid.   

Weighing Options 

When investors face the decision of what to do next with their auction-rate securities, factors such as liquidity and future expectations should be taken into consideration. For example, investors who do not want to risk their securities in the market any longer and need liquidity in the near future may choose to sell rather than wait. Or, investors who do not need liquidity any time soon and their issuer is being charged penalty interest rates should consider waiting rather than selling. Investors should learn what their issuers’ future plans are for refinancing. In addition, other resale markets are available where investors can dispose of their illiquid auction-rate securities. There is no guarantee, however, that this market will be successful in the future. So far, only one private market has had successful dispositions of illiquid auction-rate securities: Restricted Securities Trading Network (to learn more, visit  

Finally, investors should decide whether or not they are going to take legal action against their issuer to recover their losses. If so, then it is in the best interest of investors to take action as soon as possible rather than waiting to file a claim so they do not risk reducing the amount of damages they can recover.   

To Sell or Not to Sell? 

Investors could see many advantages to selling their auction-rate securities. First and foremost, investors receive liquid cash from selling and avoid the stress of worrying about future harm to their investments that could occur in the unpredictable market. Also, investors are able to better pursue legal action because they have made an effort to reduce their damages upon discovery of their investment losses.  

Investors can benefit from waiting because they could potentially be refinanced from their issuer. If an investor is refinanced, he or she no longer has to worry about lawsuits or illiquidity. Also, selling one’s auction-rate securities immediately will usually not earn an investor the face value of their investments. Waiting to sell avoids this discount problem. 

Student Loan Auction-Rate Securities Continue to Suffer in the Market

Investors continue to have a difficult time retrieving money they have invested in student loan auction-rate bonds. These securities, originally perceived by millions of investors as safe, money-market funds, have turned out to be highly illiquid and have forced investors to sell them at a loss.

UBS AG and Citigroup are among the firms who have been accused of seriously underwriting these securities. 

A July 10th Bloomberg article noted that Pluris Valuation Advisors LLC discovered that that about two-thirds of companies responsible for valuing student-loan auction rate securities have written down the debt, some as much as 35%.

The consequences of the failing auction-rate securities market have fallen most heavily upon bonds backed by federally guaranteed loans, where many lenders have been forced to lay off employees or reduce the amount of loans they issue to clients. Student Financial Aid organizations are scrambling to find solutions to raise more money and refinance the debt.  

Although some student loan issuers such as Sallie Mae are attempting to slowly regain some of its losses, retirees who heavily invested in student loan auction-rate bonds see almost no signs of hope of the market recovering and unable to access their money.

SEC Urges Top Three Credit-Rating Firms to Raise Standards

After a 10-month investigation, the Securities and Exchange Commission (SEC) found that some of the most prominent credit-rating firms such as Moody’s Corp., McGraw-Hill Cos.’ Standard & Poor’s unit, and Fimalac SA’s Fitch Ratings have been giving low-quality ratings and following poor procedures when analyzing subprime mortgage debt. With such inflated ratings, the credit-rating firms were able to collect higher fees from clients.  

According to the SEC, analysts from these firms have downplayed the amount of risk of certain deals, ignored conflicts of interest, or knowingly gave low-quality ratings to collateralized-debt obligations. One rating firm even gave lower loss expectations than it should have on subprime second-lien mortgages, which are particularly risky mortgages that have incurred large losses.  

The SEC also noted that it could file lawsuits against any rating firm if it has violated antifraud laws. So far, Standard & Poor and Moody’s Corp. have made efforts to improve their rating models, and Fitch denies that the SEC has found any problems with their firm’s analytical processes.

The SEC plans to continue examining several other rating firms in the near future. Unless rating firms make better quality ratings a higher priority than profits, the market could lose confidence about their securities, which are based on these ratings. 

Evergreen Investments CEO to Retire

Evergreen Investments, the mutual fund operation and money-management unit of Wachovia Corp., will soon get a fresh start. The company announced Tuesday that Chief Executive Dennis Ferro will retire at the end of this year, just five years after assuming the position. Peter Cieszko, Evergreen employee since mid-2006 and current head of global distribution, will be his successor.  

In August, Evergreen Investments also plans to fill the abandoned chief investment officer position with David Germany, a former investment manager for Morgan Stanley. Ferro was the interim fill in after former CIO Chris Conkey unexpectedly left last year.  

Wachovia seems to be following in the footsteps of Evergreen with “top-level” struggles. The bank’s CEO G. Kennedy Thompson was ousted last month due to substantial losses and write-downs. These leadership changes come in the midst of struggles for Evergreen.

In the past year their funds’ mortgage- and asset-backed investments have been overwhelmingly troublesome.  Wachovia was forced to step up and buy such securities from Evergreen’s money-market funds to prevent them from breaking the buck – – when their net asset value per share falls below the $1 money market standard. The bank also reported a loss of over $40 million on the asset-backed securities purchased from Evergreen’s money funds.  

Last month, Evergreen was forced to liquidate one of its bond funds, Evergreen Ultra Short Opportunities Fund, because it lost half of its value in a mere six months due to subprime mortgage investments.

Evergreen’s closed-end funds, like many others, have suffered from the auction-rate preferred securities they issued. The investors of these securities were unable to withdraw their money when the market froze up in February.  

Mr. Cieszko claims the main reason for the mutual-fund investor evacuation is that, in recent years, Wachovia’s wealth-management unit started using non-Evergreen funds. Some Evergreen funds were even removed from of the Wachovia wealth-management operation since they were not “top of class”. According to a July 8, 2008 Wall Street Journal article by Shefali Anand, Evergreen’s mutual funds have had net outflows of nearly $10 billion since beginning of 2008. It now has $41.5 billion in fund assets and manages $258 billion overall.

Brokers Target Retirement Plans

America’s baby boomers are increasingly becoming targets for investment brokers who put their hard-earned “nesteggs” at risk.  

Many examples are emerging where retirees are losing significant funds from their pensions and 401(k) accounts because they are seduced into turning them over into high-fee investments that promise high returns. Studies show that as much as 69% of pre-retirees miscalculate how much money they can annually withdraw from their retirement accounts, which gives rogue brokers the opportunity to take advantage of these investors in order to generate more commissions. 

Brokers and brokerage firms gain access to groups of workers who are close to retirement through free seminars and advisory services offered through the workers’ employers. These presentations have the potential to be misleading for workers who have limited knowledge or experience investing money. Studies show that 10% of these so-called seminars have explicitly offered fraudulent advice and given unrealistic guarantees on high rates of return. 

In January, a group of Kodak and Xerox retirees from Rochester, NY, filed a class-action lawsuit against two of Morgan Stanley’s top brokers, Michael Kazacos and David Isabella, and branch manager Ira Miller. These Kodak and Xerox employees were advised to withdraw 10% from their portfolios annually with the promise that they would still have plenty of money leftover, perhaps millions, in their accounts.

Many other investment brokers in Rochester lost clients to Kazacos because they were capping the amount in which the employees could withdraw from their funds at 4%.  However, at 10%, many of these workers almost depleted their long-saved retirement funds. Some of these retirees are being forced to return to work again. Kazacos, Isabella, and Miller could face disciplinary actions for breach of fiduciary duties and using deceptive sales tactics.  

Morgan Stanley’s policy is to cooperate with the investigation and claims that many of the clients’ losses were caused by the market downturn of 2000-02 and other excessive withdraws from the clients. Investor attorneys have filed a number of arbitration claims on behalf of Kodak and Xerox employees.  

InterSecurities, a financial firm in St. Petersburg, FL, gave similar explanations to why some of its investors lost money from their retirement funds. Two of InterSecurities’ brokers were accused of promising a 13% return on investments made by a group of Kansas City Southern employees. These brokers earned a high commission of 7.25% for each investment sale.

Likewise, in 2006, 32 former ExxonMobil employees won $13.8 million in an arbitration case against Securities America because one of its top brokers told the employees that they would receive 18% return and still withdraw sums of money equal to their salaries. Since then, Securities America has greatly improved its oversight and policies.  

Investors should be on the lookout for brokers who recommend they withdraw money from their retirement plans in order to make other investments.  Oftentimes the only one who wins under these circumstances are the brokers themselves.

Citigroup is Expected to Writedown Another $8.9 Billion

Citigroup Inc., the bank with the largest reported losses due to the mortgage market collapse, is expected to take an additional $8.9 billion in net writedowns for the second quarter. Citigroup is already staggering from the $42.9 billion defeat in credit related losses. 

Goldman Sachs Group Inc. has lowered its ratings for U.S. brokerages from “attractive” to “neutral”, because the deterioration rate of the industry appears to be far worse than they originally believed. Goldman also slashed Citibank’s six-month price target to $16 and put the bank on its “conviction sell” list, after it closed at $18.85 in trading last week. Citibank has dropped about 16% this year. 

Goldman sees more struggles in the near future for Citigroup. Cathy Chan reported in a recent Bloomberg article that Goldman expects the bank to face risk of further writedowns, higher consumer provisions and the potential need for additional capital raisings, dividend cuts or asset sales. Goldman is not alone in these forecasts for Citigroup. UBS AG and Merrill Lynch & Co. also predicted more writedowns. Merrill Lynch analyst Guy Moszkowski believes the bank will report another $8 billion of writedowns this year.  

Citibank CEO Vikram Pandit announced an additional 13,000 job cuts this year. He also expects “substantial” additional writedowns and more losses on consumer loans. Goldman believes Citigroup may writedown $7.1 billion of collaterized debt obligations and associated hedges, as well as $1.2 billion for other asset classes. They also said the bank may need to post a $600 million loss to reflect the market-to-market value of its own structured note liabilities.  

It is unlikely that Citigroup will be able to keep its current 7% dividend yield, and they need to make more capital. It’s estimated they could generate $3.5 million in capital a year by cutting payouts in half.

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