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Institutional Investors Neglected in ARS Settlement

Settlement agreements that took place in the summer of 2008 when Wall Street banks and investment firms agreed to buy back billions of dollars worth of auction-rate securities from retail investors and small businesses neglected to include thousands of institutional investors corporate investors that bought auction-rate securities on the premise they were cash equivalents. The settlement agreements were negotiated as a way to settle state and federal charges alleging misrepresentation of the instruments.

Auction-rate securities are long-term bonds or preferred stocks that pay interest or dividends at rates determined through auctions held every seven, 14 or 28 days. In February 2008, the market for auction-rate securities essentially collapsed, leaving both retail and institutional investors holding a supposedly liquid investment now considered worthless.

Approximately $330 billion of auction-rate securities were outstanding when the auctions began collapsing in February. About $160 billion of auction rates remain outstanding following the settlements, according to a May 24, 2009, article in Investment News, with most paying very low “penalty” rates under the terms of the failed auctions.

The ARS buyback programs that were announced by brokerage firms in August 2008 failed to provide liquidity relief to institutional investors, offering instead only vague commitments to work with corporate investors on finding a solution for their ARS holdings. Even then, it could be years before institutional investors see any of their auction-rate securities redeemed for cash.

In the midst of this, the list of individual lawsuits from institutional investors against companies such as Citigroup, Wachovia, Merrill Lynch, and UBS Financial Services all seem to be growing. In February 2009 a decision by a Financial Industry Regulatory Authority (FINRA) arbitration panel awarded European chipmaker STMicroelectronics $406 million over a dispute with Swiss bank Credit Suisse Group for the unauthorized purchase of auction-rate securities, thereby setting a legal precedent for other investors who had money tied up in illiquid auction rate bonds.