Goldman Sachs, Merrill Lynch, Lehman Brothers, and Other Investment Firms Deal with Frozen Auction-Rate Securities

This week, Goldman Sachs told a number of investors that they could not withdraw money from their auction-rate securities investments. This move by Goldman came as a shock to investors-but the firm was not alone. Merrill Lynch, Lehman Brothers, and other banks have also found themselves notifying their investors that the market for these types of securities are frozen-along with their money. Just this week, there were nearly 1,000 failed auctions. The banks are now refusing to support the auctions and many investors are not sure when they’ll recover their investments.

Usually, auction-rate securities are considered safe alternatives to cash-and banks frequently recommend these bonds, considered long-term securities-to rich individuals and corporations. Banks regularly hold auctions to establish the interest rates and give holders an opportunity to sell their securities.

Auction-Rate Securities
The auction-rate market is valued at $330 billion. Tax-exempt institutions, including municipalities, student loan companies, closed-end mutual funds are among those who participate in the market.

Just because there is a failed auction does not mean the securities have defaulted. Issuers are allowed to pay interest at the “fail rate,” which is the higher rate.

Investors are not happy with the frozen state of the auction-rate securities market. Brokerage firms are not legally bound to make a market in auction securities or provide clients with a price.

One wealthy investors said he bought the securities after Goldman likened them to the equivalent of cash. Another investor, a New Jersey family, is suing Lehman Brothers because the value of its cash in auction-rate securities is decreasing. Drug manufacturer Bristol-Myers Squibb has already had to write-off the $275 million it invested in auction–rate securities because of the failed auctions.

These investments were often compared to money market funds. Many investors were told there was little or no risk in these investments, even after reports surfaced which indicated danger of owning such securities. Some financial firms reportedly encouraged individual investors to purchase these securities as they worked to reduce their own exposure and that of their large institutional clients.

Shepherd Smith Edwards & Kantas LTD LLP is a stockbroker fraud law firm that represents investors that wish to recover money they have lost because of the misconduct or negligence of an investment adviser, broker, or firm. One of our investment fraud lawyers would be happy to speak with you during a free consultation.

Related Web Resources:

New Trouble in Auction-Rate Securities, New York Times, February 15, 2008
Muni Regulators Seek Disclosure on Auction-Rate Bonds,, February 15, 2008