Securities Law

Worried About Class Action Damages, Banks Block Private Auction-Rate Sales

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Among those who bought auction-rate securities based on widespread expectations that they could easily be sold is San Diego lawyer Chris Longman, 35. But now he and his wife reportedly have a problem. They want to use the $375,000 to buy a house, but they can’t liquidate, even at a loss, because the bank that sold them the auction-rate securities won’t cooperate with a secondary market sale.

Other banks are taking the same position, apparently because they fear that allowing buyers of auction-rate securities to sell at a loss in the secondary market would establish damages. And that would put the banks at a disadvantage in the class actions that are being pursued over alleged misrepresentations in the sale of the securities, Bloomberg reports.

Ordinarily, the securities—municipal- and student-loan-backed bonds and preferred shares—could easily be sold at auctions, which established the interest rate. But because of a worldwide credit crunch, the auction market died in mid-February.

Now, the only way for many holders to liquidate is to find a private buyer, at a significant discount over what they paid. But the banks that sold the securities typically aren’t required to cooperate with such secondary market sales, John Duvall Sr., a former Merrill Lynch broker and expert witness, tells the news agency.

Although penalty interest rates that kick in when auction-rate securities aren’t sold are higher than what would be expected under ordinary circumstances, buyers aren’t happy about that situation if they need their money back. Meanwhile, as discussed in an earlier post, it may be difficult for plaintiffs to prove damages if they are being paid higher interest than expected.

Some customers, however, are being offered bank loans, using the auction-rate securities as collateral, according to Bloomberg.

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