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For Many Auction-Rate Investors, the Freeze Goes On

Wall Street Journal

Four years ago the market for auction-rate securities, an investment touted as safe and liquid, froze up. Four years later, despite various settlements and repayment efforts, many investors are still fighting for the return of their money.

All told, about $100 billion from individual and institutional investors remains outstanding in the former $330 billion market, according to SecondMarket, a broker-dealer and secondary market for illiquid assets. Auction-rate securities are debt instruments with interest rates that are meant to be reset periodically at auction.

As the uncertainty has lingered, investors have put off buying homes, expanding businesses or retiring. Others have stood by, their money on the sidelines, as financial markets made a tremendous recovery in the wake of the financial crisis and global recession.

Thomas Martin, president of Americas Watchdog, a private consumer group in Washington, said he has received phone calls from numerous investors still trapped. “Where’s the outrage?” he asked. “Here comes another spring and these poor people don’t know where their money is, what their retirement situation is; they’re forgotten. Where are the regulators?”

Municipalities, nonprofit hospitals, utilities, housing-finance agencies, student-loan finance authorities and universities were among the frequent issuers of auction-rate securities. Among the investors in the securities were corporations, charities and individual investors. Many purchased them on the advice of brokers, who touted them as a safe, liquid alternative to cash.

But in February 2008, the market froze amid the credit crunch. By the fall of 2010, dozens of big banks and brokerages that underwrote the offerings had repurchased billions of dollars of the securities in settlements with regulators. Since then, various brokerages have redeemed some securities in batches and some investors have won their money back via arbitration. But some banks and brokerages fell through the cracks or have been slow to cash out investors.

The situation is fraught for investors. Many of those who can afford attorneys have hired them because they faced a statute of limitations on filing arbitration claims. Others fear they’ll be placed at the end of the line in any redemption process should they speak out. Brokers who hold the securities in their own accounts fear losing their jobs if they discuss the issue.

The exit avenues aren’t appealing. Investors can sell the shares on the secondary market, but that generally means taking a sizeable loss. Investors may file an arbitration claim, and many have. But for those holding securities worth less than $1 million, it’s difficult to justify the costs, which can run to $100,000.

“It’s kind of a black hole now,” Mr. Martin said. “We’ve got retail investors, small-timers, then big commercial investors who are in these things for tens of millions of dollars, and we don’t know what’s happening to them all.”

Ed Dowling, the owner of a clothing maker in New York City, originally had about $2.6 million stuck in the securities and still has $1.175 million stranded, all of which were sold by Oppenheimer, a subsidiary of Oppenheimer Holdings Inc. “I think it’s absolutely foul and disgusting. I think the whole system is either broken or corrupt.”

For two big sellers of the auction-rate securities—Charles Schwab Corp. and E*Trade Financial Corp.—accords were struck to unfreeze investors. While some securities remain outstanding at the firms, the terms of the wind-down have been set.

BlackRock Inc.’s BlackRock Advisors said in May that it’s in negotiations with liquidity providers and will redeem outstanding securities over the next 12 months based on facts and circumstances surrounding each fund if those negotiations are successful. “There is no guarantee that all or a portion of a particular fund’s ARPS will be redeemed,” it said.

But investors who purchased shares from some firms, including Allianz SE ‘s Pacific Investment Management Co. or Oppenheimer, still have no explicit word on when or whether their investments will be redeemed.

Pimco and Nicholas-Applegate Capital Management—since rebranded Allianz Global Investors Capital—had $5.3 billion in auction-rate preferred shares outstanding in March 2008. About 44% of the shares issued by companies’ closed-end funds have since been redeemed. Pimco said it hasn’t made any redemptions since 2009.

Allianz told shareholders in a December letter that it’s evaluating market alternatives. It isn’t possible “to determine if and when a solution will be identified,” Allianz said at the time. Pimco had no further comment.

The issues at play are perhaps most acute at Oppenheimer, one of the largest sellers of auction-rate securities to individuals. It had about $377 million stranded in auction-rate securities as of Dec. 31, according to a regulatory filing by the company. That amount excludes securities owned by qualified institutional buyers and those transferred to the company, purchased by clients or transferred from the company to other securities firms after February 2008, it said.

Oppenheimer stands out among the major brokerages because its settlement with regulators didn’t result in a timely redemption for individual investors, said Todd Higgins, a managing partner at law firm Crosby & Higgins LLP in New York.

Oppenheimer reached settlements with the New York attorney general’s office—then led by current New York Gov. Andrew Cuomo—and the Massachusetts Secretary of the Commonwealth’s office in 2010, and purchased $69.3 million in auction-rate securities from clients. The settlement committed Oppenheimer to a financial review every six months to see if more funds are available buy additional auction-rate securities from holders. The company must report to the attorney general’s office on those reviews.

“That’s the only one that I’m aware of that’s ended up in a repurchase process that has the potential to drag on for many, many years,” said Mr. Higgins, who has represented about a dozen claims against Oppenheimer, five of which are pending.

Oppenheimer said it is purchasing the securities on a periodic basis in accordance with its settlements. The company noted that it is committed to purchase a total of $57.3 million in the securities from clients through 2016 and will pay about $2.5 million as a result of legal settlements with clients. Oppenheimer had no further comment.

Danny Kanner, a spokesman for New York State Attorney General Eric Schneiderman’s office, said, “This office is routinely scrutinizing the expenditures of the firm, which is conducting buybacks periodically throughout the year.”

Steve Cohen, former chief of staff to Mr. Cuomo, said, “The auction-rate-security settlements speak for themselves, putting billions of dollars back into the pockets of victims across the country who were misled into believing they were buying cash equivalent investments”

Investors say they fear Oppenheimer is waiting them out, hoping they will sell at a discount on the secondary market in desperation before any redemption comes their way.