Frozen Liquidity: Investment Firms UBS AG, BlackRock, Merrill Lynch, Citigroup, Morgan Stanley and Wachovia Securities Hope Spring Thaws Auction Rate Securities Market

As part of the fall-out from the subprime lending debacle, many investors in auction rate securities markets are trapped in their investments. Auction rate preferred shares (longer-term floating-rate bonds with rates that frequently reset), also known as ARPS, auction reset rate preferred shares, or auction rate preferred stock, have long been pitched by brokerage firms as a safe, cash alternative for their investments. The selling points were higher interest rates than other cash alternatives; safe, top-rated securities; and near immediate liquidity. The market for ARPS is estimated to be around $330 billion.

Recently, however, the stability of the auction rate securities market has disappeared as the bank driven market for them has dried up. This appears to be the latest sign of upheaval from the subprime lending meltdown, with investors shunning ARPS for fears that problems may develop stemming from complex subprime related securities. Where liquidity was once the hallmark of ARPS, the auctions at which they trade have been failing by the hundreds. While a failed auction does not necessarily mean a loss in principal, it does result in the investment being locked-in, and an illiquid position. What was once a resource waiting to be tapped is now frozen.

Failed auctions typically result in a penalty rate paid to the investor, however, this does not cure the investors’ need for liquidity, and moreover, because interest rates have fallen in the U.S. resulting from rate cuts by the Federal Reserve, the penalty rates being paid are often less than the auction-set rates the funds were paying a few months ago. Not only are the funds locked, but they are locked in at low rates.

Some brokerages are attempting to free up investors’ money, but none yet have been willing to extend interest free loans on the locked cash. UBS AG, Citigroup, Morgan Stanley, and Wachovia Securities are offering margin loans; however this results in an investor paying interest to access his or her own money. Other firms are preparing for an extended freeze --- BlackRock, Inc. says on its website that “clearing auctions may not occur for a long period of time, if ever.” Lehman Brothers, J.P. Morgan Chase and Goldman Sachs are also experiencing failed auctions.

If your money is locked in an auction rate security, or if you had to spend money or lost money to access your money, we are interested in talking to you. Please contact Chuck Marshall of Green Welling, LLP either by emailing him at cdm@classcounsel.com or by phone at (415) 477-6700.