Thom Weidlich at Bloomberg reports that "[a]t least 24 proposed class actions have been filed since mid-March against brokerages over claims investors were told the [auction rate] securities were almost as liquid as cash." The cases stem from the collapse of auctions that supplied liquidity for ARSs in February. Investors could no longer sell the ARSs and so couldn’t get their money out.
Mr. Weidlich explains that the class actions face two serious obstacles. The first concerns the merits. Many ARSs paid interest at rates a tad higher than other "liquid" alternatives, such as a money market account. But the failure of the auctions sent them into default, which in turn triggered a contractual obligation by the issuers to pay a higher rate. An investor earning interest at the default rate may run into trouble showing that she would’ve gotten a better return on her money but-for her inability to get at the cash she invested in an ARS.
This damages problem likely doesn’t apply to people who bought auction rate preferred securities, which don’t reset to a higher return after default. But the difference between the dividends on the ARPSs and earnings on alternative investments may not amount to much.
The second roadblock relates to the requirements for treating claims on an aggregate basis in a class action. A court generally won’t handle a case for damages on a class basis unless the lawyers can show, on a class-wide basis, that all class members suffered harm. Note the "class-wide basis" thing. If the nature of the class claims requires each class member to prove the fact of injury individually, class certification becomes an iffy proposition.
How does one establish class-wide harm? In price-fixing cases, plaintiffs typically do it by showing that the price fixers elevated the price by a minimum percentage — 10 percent, say. Some class members may have overpaid more than the 10 percent, but everybody overpaid by at least one-tenth.
Securities cases do much the same thing. Experts opine that the fraud inflated the market price of the relevant stock or bond by at least such and such percentage at the time of purchase; damages represent the difference between the purchase price and the "true" value of the security.
But the collapse of auctions for ARSs didn’t affect their underlying value. The issuer’s ability to pay didn’t change as a result of the withdrawal of liquidity from the auction market. So how can the investors demonstrate losses?
They conceivably could cite the difference between the buying price and the lower prices on secondary markets. But where will they get that information for each ARS? Unlike stocks and bonds, ARSs don’t trade publicly and so purchase and sale prices don’t show up in the business section of newspapers.
Conceivably an expert will find a way to calculate the minimum value of the liquidity feature of ARSs. Blawgletter shares Bloomberg’s skepticism about whether such an opinion will survive defendants’ savage attacks on it, but we will wait and see.
That leaves damages resulting from an investor’s inability to access his funds to use for a specific purpose. He can’t make his payroll, for instance. Or he has to break a contract to buy a company, a piece of land, or other investment. But such losses of profits don’t happen to everyone in a class and would require proof unique to each claimant. And brokerages that sold ARSs to such people have in some cases loaned them funds to mitigate their harm. Those sorts of individual circumstances often mean no class action.
ARS investors still may pursue individual claims. The best candidates are those who couldn’t get their money out in time to close a pending acquisition and lost a tidy sum as a result.
