New exchanges to the rescue?

Companies holding auction-rate securities have a new escape option: an emerging secondary market for trading the now-illiquid instruments. But experts say the secondary market is no cure-all for holders of these investments. Some investors are turning to legal action instead — and the growing threat of claims against broker-dealers may be contributing to continued chaos in the marketplace. A new venture by the Restricted Securities Trading Network recently started listing failed auction-rate securities for sale. As of March 7, around 115 issues were available for purchase, said chief executive Barry Silbert, who believes he's running the only operating secondary market for failed auction-rate securities. The New York-based RSTN is managed by Restricted Stock Partners, also based in New York. The website for the Securities Industry and Financial Markets Association, based in New York and Washington, has a list of other firms that have expressed interest in getting involved in the trading of illiquid auction-rate securities. But bid-offer spreads on the investments are still "fairly wide," said Mr. Silbert, explaining that most sellers have been holders of failed securities who are strapped for liquidity, while buyers have tended to be vulture investors. "We're far from an efficient secondary market right now. There are too many disparate sources of liquidity and supply." Still, Mr. Silbert expects spreads to tighten as more buyers and sellers enter the market. "Once there's a little more transparency, there will be a better idea about who has securities that are worth par, and we'll see more secondary trading and more successful auctions because of that." Some observers remain skeptical. "I think people are being forced to find a secondary market, rather than doing so willingly," said Joe Morgan, head of portfolio management for SVB Asset Management in San Francisco. "From what we hear, it's painful. It's ill-informed — there's not a tremendous amount of transparency — and markdowns are not making any of the original investors very happy." "The secondary market offered up looks suspect," said Lance Pan, director of investment research for Newton, Mass.-based Capital Advisors Group Inc. "People looking to have an exit point will not be able to get out at a good place." Indeed, Mr. Pan said, some holders of auction-rate securities have sold for as little as 60 cents on the dollar. Mr. Silbert said that the RSTN is the only entity through which corporate treasurers and others currently can find out what their failed securities might fetch. RSTN's sister company, Pluris Valuation Advisors Inc. of New York, is attempting to calculate the value of specific failed-auction issues, he added. "We are trying to be part of the solution, and to provide liquidity and a level of transparency so that a larger percentage of auctions start to succeed again," he said. "Until Wall Street figures out solutions to specific issues, this is a place to go for information about how the market is developing." Some experts suggest that companies try approaching their broker-dealers for help first even though the same firms allowed auctions to fail over the past few months. "We have asked clients to work actively with dealers — that's their best source of liquidity," said Mr. Pan. A spokesman for Zurich, Switzerland-based UBS AG said the bank is working with clients on a case-by-case basis, offering some investors lines of credit and margin loans. Mr. Morgan said it's important for investors to call their broker the day before each auction date with an order to sell their holdings into the auction. "If you're not giving your broker that order to sell," he explained, "there may be an auction, but if you put in no order, it is assumed that you want to hold your position." Others say treasurers should not be surprised if they don't get much help from their broker-dealers. "Some brokers aren't speaking with their clients very much," said Adam Dean, president of SVB, citing fear of legal action. "What they say can and will be used against them." "What these brokers did was not follow [the client companies'] investment policies, in either letter or spirit, which is causing the uproar on the client side," Mr. Morgan said. It's no surprise, then, that some investors in auction-rate securities have begun pursuing legal remedies. Dallas-based telecom firm Metro-PCS Communications Inc. in October filed a lawsuit against New York's Merrill Lynch & Co. Inc. in a Texas state court, alleging that Merrill brokers invested $133.9 million in auction-rate securities that had been backed by collateralized debt obligations. And a wealthy New Jersey family in January filed a $1.4 billion claim with the New York- and Washington-based Financial Industry Regulatory Authority Inc. against Lehman Brothers Inc. of New York alleging they'd lost access to $286 million due to the illiquidity of auction-rate securities. Jacob Zamansky, a securities arbitration attorney in New York, claims he has been fielding calls for weeks from companies, individuals and institutions that have suffered losses related to failed ARS. "I've spoken with businesses that had virtually all of their working capital tied up in auction-rate securities and are now unable to fund business operations," he said, citing Merrill Lynch, UBS and Citigroup Inc. of New York as the firms that tend to come up most frequently during those conversations. (Merrill and UBS declined to comment. Citigroup did not respond to a request for comment.) Some observers believe that mounting confusion in the ARS market signals its inevitable end. "We believe the security class is going to die," Mr. Dean said. "There's been a loss of faith in the broker model as a cash manager."