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Auction-Rate Securities Update

What is new on the auction-rate securities (ARS) front? Plenty. For one, investors still hoping to win back part of the $330 billion they invested three years ago may be getting some help from the Securities and Exchange Commission (SEC) and a legal brief filed last week supporting their claims that Merrill Lynch & Co. rigged the ARS market.

According to the brief, Merrill Lynch (which is now part of Bank of America Corp.) failed to adequately inform investors about its alleged role in “propping up” the ARS auctions. In February 2008, dealers, which had routinely bid to prevent auction failures, withdrew their money and stopped bidding. As a result, the once $330 billion ARS market collapsed, leaving investors with investments they couldn’t sell and many issuers with high penalty rates in the double digits.

Many legal analysts believe that if the court agrees with the SEC’s argument, it could very well lead to the reversal of other dismissed auction-rate cases in which brokers and dealers are accused of rigging the ARS market.

The SEC’s friend-of-the-court brief  may affect the appeals panel, where the agency has “generally been fairly persuasive and deferred to,” said James Cox, a Duke University law professor in Durham, North Carolina, in a July 22 Bloomberg story.

Lawsuits by state regulators have thus far returned at least $60 billion to individual ARS investors. About $55 billion of the debt remains outstanding, according to the Municipal Securities Rulemaking Board.  Some believe the figure is much, much higher, however. Trading in the market is down by nearly 60%.

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