Investors burned in auction-rate meltdown

July 18, 2008
By Christina Rexrode
The Charlotte Observer

State regulators inspect Wachovia Securities’ HQ in Missouri in the latest fallout of market’s collapse.

Eileen Selkis had some money left over from selling her house in Connecticut, and she knew she couldn’t afford to lose any of it.

She says her broker at Wachovia Securities pointed out that she could get a good return – better than the money market account it was in – by moving it to something called auction-rate securities.

The higher interest rate was appealing, but Selkis wanted to make sure she’d be able to access her money easily.

“They’re as good as liquid cash,” she recalls her broker telling her, in late 2006. “You can get to your principal any time; you just need to let me know about seven days ahead.”
That was before the market for those securities began to dry up in February, another result of the tumultuous state of the financial services industry. That means that many investors can’t sell their holdings and get their money out of those securities, and they allege that brokers understated the risks of such investments.

Major financial institutions across the country – including Charlotte’s Bank of America and Wachovia – are facing lawsuits and regulatory inquiries over how they marketed those securities. The latest twist came Thursday, when securities regulators from Missouri and other states showed up to inspect the St. Louis headquarters of Wachovia Securities, seeking documents and other records related to the sale of such bonds.
The Missouri secretary of state launched an investigation involving Wachovia and other banks in April, after hearing from hundreds of people who complained that they couldn’t access their money.

Selkis, who lives in Fort Mill, S.C., remembers when her broker called in April, on her 59th birthday, to say she couldn’t access her funds.

“He said, ‘Well, Eileen, I never knew the risks. These things have been safe for 20 years,’” she said. “That’s when my whole world collapsed.”

She has succeeded in getting about a quarter of her investment out of the securities, but she’s anxious to get at the rest of it. She works two part-time jobs, but health problems prevent her from returning to her full-time job as an oncology nurse.

Auction-rate securities are bonds with interest rates that reset periodically, usually every seven, 28 or 35 days. They can be issued by municipalities, hospitals, student-loan companies and other special entities.

Some financial advisers say they were viewed as safe and stable for years, but that ended abruptly in February when the country’s banks, beset by dismal earnings, backed away from submitting the bids that reset those interest rates. As a result, investors have largely been unable to sell their bonds, and can’t access their investments.

“It was just a house of cards,” said Lawrence L. Klayman, a senior partner at Klayman & Toskes in Florida.

He says his firm is hearing from dozens of investors, most with at least $1 million in claims, who want to sue their financial institutions. Some investors have been able to sell their auction-rate securities on secondary markets, but they’re earning only 40 to 70 cents on the dollar, according to the law firm.

The SEC and the Financial Industry Regulatory Authority, which regulates brokerages, are examining how dealers sold securities before the market froze. Watchdogs in 11 states have formed a task force.

Massachusetts Secretary of State William Galvin filed the first lawsuit in the sweep on June 26, seeking to make Zurich- based UBS reverse sales and compensate clients. UBS said it “will defend the specific allegations.”

North Carolina, Wachovia’s home state, wasn’t involved in Thursday’s inspection, said Liz Proctor, a spokeswoman for Secretary of State Elaine Marshall. North Carolina is conducting its own investigation of Wachovia and other firms regarding auction-rate securities, Proctor said, declining to provide further details.

Wachovia stressed that investors who hold auction-rate securities “may be facing challenges no matter the firm with which they are doing business,” said bank spokeswoman Christy Phillips-Brown.

“While some liquidity is returning to parts of the (auction-rate securities) market, many securities are not immediately salable,” she added. “Wachovia Securities is working diligently on solutions to this industrywide problem, seeking to return liquidity to our clients as quickly as possible. As an interim solution we are providing loans against clients’ securities to assist them in meeting immediate needs.”

Still, the issue is another black eye for Wachovia and its crosstown rival, Bank of America. Both banks, which report earnings next week, are struggling with declining earnings and rising loan losses.

The regulators’ visit Thursday to the St. Louis headquarters of Wachovia Securities came because Wachovia had “not fully complied with” requests from Missouri regulators for documents related to auction-rate securities, the Missouri Secretary of State said. The office has also subpoenaed more than a dozen Wachovia Securities agents and executives.
“Hundreds of Missouri investors have called my office because of inability to access their money,” said Secretary of State Robin Carnahan. “They were told these investments were safe and easy to cash in, but now they cannot run their business, make medical payments, or pay school tuition.”

Thursday, the state stressed that Wachovia had cooperated with the inspection. No charges have been filed against Wachovia in the investigation.

“Many securities firms, including Wachovia, are responding to inquiries from regulators about the auction-rate securities industry,” Phillips-Brown said Thursday.

The effects of a frozen market are far-reaching. In its latest earnings report, Matthews-based Family Dollar Stores Inc. said its working capital was more than cut in half – to $238 million from $517 million – over the year, primarily because it had to reclassify its frozen auction-rate securities as long-term assets, instead of current assets.

C.C. Dockery, a retired insurance executive who splits his time between Blowing Rock and central Florida, wishes he had stuck with money markets instead of investing in auction-rate securities last year, like his Bank of America broker advised. He had planned to invest the proceeds from a property sale for a few months, then use it to pay taxes, so he says he stressed to his broker that he didn’t want to take any risks.
His money is now frozen.

“There is no way in the world I ever would have invested in these had (the broker) explained to me the risk factors or given me the prospectuses to read on my own,” said Dockery, who is 75.

Bank of America spokesman Jon Goldstein said the bank fully recognizes “the impact this is having on some of our clients, and we are committed to working with those clients during this difficult period to help manage their liquidity needs.”

Dockery, meanwhile, keeps calling his broker for updates.

“He’s a very nice guy, but he knew nothing about the products he was selling,” said Dockery. “I sat with him the other day, and he’s as distraught as I am. Not quite, since it’s my money. But almost.”

Bloomberg News contributed to this report

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