Auction settlements snub corporate buyers

Recent regulatory settlements by Citigroup Inc. and other big banks have set the tone for what corporate investors can expect from the auction rate securities mess. The bottom line, some say, is: Wait and see, but keep your lawyers on speed dial. New York-based Citigroup last month said that it would buy back $7.5 billion in auction rate securities from retail investors, small businesses and charities within three months but would use only its "best efforts" to repurchase $12 billion from institutional holders by the end of next year. Also last month, Deutsche Bank AG of Frankfurt, Germany, and The Goldman Sachs Group Inc. and Merrill Lynch & Co. Inc., both of New York, settled with regulators, agreeing to buy back the securities from smaller investors but only to help large institutional investors find markets for their holdings. It stands to reason, given the impetus, one securities lawyer said. "Remember that attorneys general are elected by voters, not corporations," said John Coffee, a law professor at Columbia University in New York, referring to New York Attorney General Andrew Cuomo, who has been investigating the collapse of the ARS market. The Securities and Exchange Commission is also investigating the failure of that market. Some banks have mentioned specific redress for institutions. In its settlement, announced Aug. 8, UBS AG of Zurich, Switzerland, said that $10.3 billion would be set aside for them, but the bank has until June 2010 to pay up. Wachovia Corp. of Charlotte, N.C., gave itself until the end of next June to buy back $3.1 billion from such investors. But until then, an estimated $100 billion to $150 billion in auction rate securities remains on the books, leaving companies that are saddled with the illiquid securities facing uneasy choices: trying to make a deal with brokers, arbitration or litigation, selling or holding on. Some say deals are taking place. "There are a number of conversations," said Tim Batchelor, a managing director at investment banking and financial advisory firm Duff & Phelps Corp. of New York. "We're seeing a higher percentage of activity," he said. "I have half a dozen conversations every day with one side or the other." Some clients are receiving 90 cents on the dollar — above what they could get in the open market, Mr. Batchelor said. And terms may even improve because the firms are under pressure. "The genie is out of the bottle," said Adam Dean, president of SVB Asset Management in San Francisco. "Sooner or later, brokers will have to make [institutional] clients whole or face further legal pressure," he said. Mr. Dean said that he advises his clients to hold on to the securities if they can afford to and wait for a decent offer. When it comes to negotiations, companies may have the upper hand, given the amount of business they do with their brokers, Mr. Coffee said. When asked about negotiations with institutional clients, a spokeswoman at Wachovia said she couldn't comment beyond the press release. A Citigroup spokeswoman wrote in an e-mail that the bank "will continue to marshal its resources to work diligently with issuers and regulatory authorities to provide liquidity solutions for all holders of auction rates."

'MORE LIQUIDITY'

The ARS market fell apart in February when banks that had been buyers of last resort abandoned it. Recently, banks have pledged to buy back a total of about $35 billion. According to Tony Carfang, co-founder of Treasury Strategies Inc. of Chicago, just having some of the supply taken out is a good sign for the market. "What you have is a smaller problem and more liquidity," he said. But no matter what course of action a company decides to take, the first step is writing a letter to let the brokers know that it isn't happy, Mr. Carfang said. Mark Conner, owner of Corporate Treasury Investment Consulting LLC in Baltimore, agrees. "I'm advising companies to prepare for arbitration while they monitor other developments, because I think that's how it's going to turn out," he said. Since the market seized up, more than 200 ARS arbitration cases have been filed with the Financial Industry Regulatory Authority Inc. of New York and Washington, according to spokeswoman Nancy Condon. Arbitration is the most common route because it is a cheaper and more informal process, Mr. Coffee said. Also, companies usually have a securities arbitration agreement with their broker that restricts them to settling disputes in this manner. Because the market is still frozen, selling should be an option only for the most cash-poor, market participants agree, as they would be selling at a steep discount. Prices depend on the type of underlying asset behind the auction rate securities, according to Barry Silbert, chief executive of Restricted Stock Partners of New York, which operates an electronic trading marketplace for illiquid assets. Discounts are about 50% for auction rate securities backed by collateralized debt obligations, 2% to 8% for municipals, 5% to 15% for closed-end funds' auction rate preferred securities and 20% to 30% for student loans. Some who are less sanguine about the ARS market are advising their clients who need cash to sell and then file an arbitration claim. "I tell my clients to get what they can and then go after the haircut," said Philip Aidikoff, a securities lawyer based in Los Angeles. Mr. Silbert said that he has seen an uptick in the number of sales done on his Restricted Securities Trading Network, up from about 10 a week in April to more than 40 a week. Most sellers are wealthy individuals, he said, but more companies are joining in now. No matter what a company decides to do with its auction rate securities, the Norwalk, Conn.-based Financial Accounting Standards Board's FAS 157 requires that companies mark to market those securities on the books each quarter. Some who are in the valuation business say that even for private companies, determining the fair value may be a worthwhile exercise to help evaluate what the options are. If companies can afford to hold on and see how the market shakes out, thoroughness and patience are the best course, Mr. Carfang said. "Mark to market and over-disclose," he said. "And don't enter into any rash transactions." Hilary Johnson is a reporter at sister publication FinancialWeek.