Auction-Rate Securities to be Priced this Weekend by UBS – Others to Follow?

After weeks in limbo, some holding auction rate securities may gain some insight about their fate this weekend as UBS reports it will be “pricing” ARS securities in its customers’ accounts.

Brokerage firms and other financial institutions sold many ARS securities as comparable to money market funds, commercial paper and other liquid investments. Investors were later shocked to learn that the auctions “failed,” they were unable to sell securities and given little if any guidance in evaluating their situation. Many have been told their securities retain their “full value” but they would have to wait on their funds.

Perhaps realizing that this sham can go on no longer, using an internal model to value the securities, UBS will reportedly mark these down this afternoon and inform clients of such valuations via their online statements. Markdowns will apparently range from a few percentage points to more than 20%. Many believe that a portion of ARS securities are worth far less.

Yet, the UBS valuations will not actually reflect a true market because UBS states that it is not prepared to honor such prices or buy the securities at any price, leaving one to wonder what such prices will actually represent. It remains to be seen whether this move will comfort or exacerbate unrest among investors.

According to Moody’s Investors Service, the currently seized–up ARS market, estimated at over $300 billion, includes investments issued by corporations, municipalities and other borrowers, including through the issuance of “preferred” shares by Nuveen and other mutual funds.

Although many of the issuers are fairly creditworthy, “default” interest rates paid on many ARS securities will not be competitive as long term instruments. The further problem is that a huge amount of these now long term securities are in the hands of investors who seek liquidity. This, along with the stain of the present situation, will no doubt put further strain on any attempt to establish a market for ARS securities.

Auctions on ARS securities failed because, as buyers who were privy to the potential problems bailed out, less sophisticated investors could not absorb the volume. UBS, Goldman Sachs, Merrill Lynch, Citigroup and Wachovia, which conducted more than 100 ARS auctions per day, had taken up the slack in auctions they managed. While this feature was sold to many investors as a guarantee, in late February, these and other firms all balked on this practice almost in concert.

UBS’s planned pricing action may serve as the test for other brokerage firms, some of which have indicated that they may soon take similar action. Merrill Lynch priced its clients’ ARS securities at full value or “par” in their February statements, but warned that the value these securities could fall based on illiquidity. There has been no further comment from the firm.

A broker at RBC Wealth Management said that auction-rate securities were still being carried at par value on his clients’ electronic accounts. A spokesman at Oppenheimer said the firm had not decided whether to mark the securities to market. A Morgan Stanley spokesman declined any comment. However, it is rumored that other firms plan to follow UBS’s lead in pricing.

UBS, Deutsche Bank AG, Merrill Lynch, Morgan Stanley and Citigroup have been named in a suit in U.S. District Court in Manhattan alleging deceptive marketing of ARS securities. As other lawsuits are anticipated, firms have denied any improper conduct and say they are working with clients on a case-by-case basis to address liquidity issues. Some firms have made loans to their clients – while charging lucrative rates on such loans.

The securities law firm of Shepherd Smith Edwards & Kantas LTD LLP has for decades handled claims by investors worldwide against brokerage and other financial firms. We are currently working on claims for both institutional and individual investors whose funds are now locked into ARS securities. Contact us to arrange a free, no obligation consultation with one of our attorneys regarding your situation or if you wish to receive our weekly newsletter regarding ARS securities.

LINK TO ARTICLE ON ARS SECURITIES: (Our firm does not endorse any opinions or allegations of the article’s author but believes the information and opinions stated therein are helpful in understanding the nature of this debacle.)

ARC and ARP Securities: How Wall Street Brokerage Firms May Have Defrauded Their Clients Out of Billions Overnight Trading, February 24, 2008 (Author’s name withheld by request)