If you bought auction rate securities, you probably thought you could get a higher interest rate than with other highly liquid alternatives. You likely also believed you could get your money back, with interest, within a week. And Blawgletter bets you’ve gotten so mad that you almost can’t see straight when you learned recently that, no, you can’t tap into your cash just now — and might not get it back for weeks or months, if at all.
A Bloomberg report today highlights the problem. It tells of how college students parked liquid funds in ARSs only to find that they’d suddenly turned illiquid — and the students now face the prospect of having to sit out a semester or more.
ARSs depend for their liquidity on periodic auctions in which potential investors bid on the shares available for purchase. If the auction succeeds, the sellers get their money back. If it fails — as many of them started to do on February 7, 2008 — the existing holders of the ARSs must hang onto them or sell them in a secondary market at a below-par price.
The flood of auction failures since February 7 has frozen the funds of a great many investors, all of whom presumably chose ARSs precisely because they promised a high degree of liquidity. Some companies have already taken write-offs on their ARS holdings. MetroPCS, for example, reported in February that it took an "impairment charge of $83 million related to the Company’s investment in auction rate securities."
Those with the ability to hold the ARSs until maturity or until auctions start working again may choose that route. But the indefinite-hold option won’t compensate people who have incurred losses because they missed a deadline to pay creditors, fund purchases of goods and services for their businesses, or acquire other investments or because they sold at a loss in a secondary transaction.
What can they do? Blawgletter sees state securities laws as a possibility. Under state "blue sky" statutes, investors may recover "rescissory" damages or, if they sold the ARSs, actual damages. The rescissory remedy allows investors to get the money they invested back plus interest less any "income" they received on the security. (Note that people who want to receive rescissory damages may need to tender the ARSs back to the issuer promptly.) Actual damages typically reflect the difference between the price the investor paid plus interest less what she received on selling the security.
An analogous federal statute, section 12(2) of the Securities Act of 1933, applies only to the first public offering of a security and thus may not provide a remedy for transactions involving ARSs.
We’ll continue looking at the ARS debacle. Please chime in with your thoughts in the meanwhile.