ARS Failures at Brokerage Firms So Bad Even Their Own Association is Critical!

The Financial Industry Regulatory Authority (FINRA) conjures thoughts of jack-booted cops looking to “perp-walk” those who take advantage investors. Yet, FINRA is just the new name of the National Association of Securities Dealers. The NASD was, and FINRA is, a non-profit organization of all securities dealers, with a structure similar to a country club, which fines or expels those who embarrass its membership.

Yet, even FINRA is critical of its members for mishandling auction rate securities (ARS). For example, in a press release, FINRA acknowledges that “Investors who purchase ARS are typically seeking a cash-like investment that pays a higher yield than money market mutual funds or certificates of deposit.” This confirms, despite objections by firms, that investors believed they were getting liquid instruments, not 20 to 30 year obligations or even “no maturity” preferred shares
“If you need your money in a hurry, loss of liquidity is a financial hardship,” states John Gannon, FINRA’s Senior Vice President for Investor Education. “We want investors who have been affected by the recent auction failures to know what options are available to them.”

FINRA then mentions alternatives for “ARS investors who cannot liquidate their holdings because of failed auctions,” including (1) continue to hold; (2) sell in the secondary market; (3) borrow on margin; and, (4) liquidate other investments.

After stating that most ARS investors sought liquidity, it is strange that FINRA would recommend holding the securities. Importantly, recommending the holding of such securities to one who needs liquidity, violates FINRA’s own Rules of Fair Practice regarding unsuitability! While investors can not sell until there is a market, liquidation when possible may indeed be the only option for victims.

Selling in the secondary market, when possible, is the second option and should strongly be considered by ARS holders! The law holds that victims can recover losses from those who misrepresent securities to them, but the law also says victims must “mitigate” losses as soon as possible. As with any other investment, if you would not buy an investment at a price, you should not hold it for the same reason. Also, When others think the market can only get better with time it is usually best to run for the hills!

FINRA is not enthusiastic about “borrowing on margin,” stating that “[s]ome firms are offering to lend customers money to help them meet their cash flow needs. Be aware that the interest rate charged on these loans may exceed the yield you’re getting on the underlying security. Also, borrowing against a tax-exempt security may cause you to lose the ability to deduct some or all of the margin loan interest from your taxes.”

We also note that margining illiquid and troubled securities is in itself quite dangerous, and that firms are charging lucrative interest rates to those who are victims of that firm’s own bad acts concerning ARS securities.

FINRA adds: “You might also consider selling other securities in your portfolio. When weighing this option, be sure to consider factors such as the total transaction costs you would incur, whether the sale would trigger adverse tax consequences and how the liquidation would impact the balance of your portfolio.” FINRA fails to mention that selling other securities at depressed prices can create even greater damages than in the ARS which are the source of the problem.

Moreover, FINRA fails to mention that anyone with legal problems should contact an attorney, before making statements to brokerage firms or regulators who share such information with brokerage firms. Ever heard this? “You have a right to an attorney” and “anything you say can and will he held against you in a court of law.” Did you wonder why the person then keeps talking? Sending a complaint to a firm or a regulator without an attorney is – well – exactly the same thing!

The securities law firm of Shepherd, Smith, Edwards and Kantas LTD LLP has for decades handled claims by investors worldwide against brokerage and other financial firms. We are currently working on claims for both institutional and individual investors whose funds are now locked into ARS securities. Contact us to arrange a free, no obligation consultation with one of our attorneys regarding your situation or if you wish to receive our weekly newsletter regarding ARS securities.

LINK TO ARTICLE ON ARS SECURITIES: (Our firm does not endorse the opinions or statements of of the article’s author.)

ARC and ARP Securities: How Wall Street Brokerage Firms May Have Defrauded Their Clients Out of Billions Overnight Trading, February 24, 2008 (Author’s name withheld by request)