The Independent reports that Citigroup's (NYSE: C) Smith Barney took the $100,000 entrusted to it by a 76-year old mother and put it in now-illiquid Auction Rate Securities (ARS) -- bonds whose interest rates are supposed to reset in weekly auctions -- without her understanding. After she died earlier this year, her son discovered that what she had told him was "in an easy-to-sell money market fund" was in fact frozen in ARSs.
Since February, when I first posted on the $330 billion ARS market, a forum has gathered with 3,924 comments from people who have much of their savings frozen. This widow, like many of the people who comment there, had their money moved into ARSs without their knowledge or with the assurance that the money would be safe and would offer a higher than average return. One key question: Did ARS purchasers receive prospectuses or know of their risks?
But last year, an accounting rule change caused demand for ARSs to evaporate since companies could no longer account for them on their balance sheets as "cash equivalents." So the banks started to bid on the auctions themselves to keep the market going. But thanks to the credit crunch, banks no longer had sufficient capital to prop up the market. So the auctions failed and thousands of people, like this widow, have found that they can't get their money.
The Independent quotes Bruce Coughlin, the widow's son as saying, "We found out when we called the broker at Smith Barney and wanted to sell the securities," he said. "The fund is actually listed on their account breakdown as a 'long-term' investment. I pressed him: 'So you mean you sold a 76-year-old woman a fund that would be impossible for her to get out of?' Just how long a long-term horizon did he expect her to have?"
Citigroup declined to comment. But it's not the only one being investigated by the government. New York Attorney General, Andrew Cuomo, who has issued subpoenas to at least 18 banks, including Merrill Lynch (NYSE: MER), UBS and JPMorgan Chase (NYSE: JPM). Wachovia (NYSE: WB) said last week that it had been subpoenaed or received requests for information from the SEC and state regulators.
I wonder how Coughlin's mother would have felt if she had known that the money she thought was safe, was actually frozen. Meanwhile, would you want to trust your money to an investment firm that would do this to her and her son?
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He owns Citigroup shares and has no financial interest in the other securities mentioned.
Is the market always right?
Comfort Zone Investing: How this all might play out
Stock picks and pans for troubled times: AAPL, COST, EWBC, IBM, YUM, PG ...
Reader Comments (Page 1 of 1)
5-20-2008 @ 9:21AM
Harry said...
People should be very careful about following the advice of brokers and financial planners. Be careful. There is now plenty of inforamtion available via the Internet and people should take advantage of it...
5-20-2008 @ 10:11AM
alan said...
I am just amazed. The deeper you dig the more dirt one finds. I wanted to believe that these stories were the exceptions. a few renegade salesman running wild.
Unfortuneately, it seems that's not the case. It is more of an industry-wide problem. Greed has takrn over and let the buyer be ware. The commission basis comp has brought out the worst in Citi and the rest.
Look closely at the salesperson, a relatively young individual that recently obtained their series 7 and has no real understanding of market risk & reward.
The truth is they just want to make as much commission as possible-the majority do not expect to remain employed at the same firm for more that 2-3 years so there is little loyalty - except to themselves.
There needs to be some hard jail time for these excesses. Simply fining the company they work for will do little/nothing to curtail this terrible new trend in the investment community !!!!1
5-20-2008 @ 10:29AM
alan said...
I'm one of those holders of auction rates and trust me I guarantee most of us weren't given prospectuses or anything similar. In my particular case it was a phone conversation and I was fishing around asking for the risks especially cause it was happening at the same time as those mortgage insurers (MBIA, Ambac etc..) were having problems with their supposed AAA paper. I was informed these were backed by 2-3 times assets and they indeed were AAA quality because of that and I'll say that seems to be the case with regards to their creditworthiness. However, I was never told about auctions, failed auctions, penalty rates, etc...or any liquidity risks. It was sold to me as like a 7 day CD.
This wasn't people trying to get something for nothing or having pie in the sky dreams of huge returns. It was getting a few extra basis points in return for not having the money on immediate demand but having to wait the 7 or 28 day period for a particular security. Now it's totally locked up and I've been told it'll be worked out months down the line up to a year or so and these companies are working to find new sources of funding. I don't have a ton of faith in that but for now I have no choice but to wait. That'll be the last time I do anything like that even when I'm looking around for the landmines I don't get guidance from my financial adviser so what good are they. All the financial companies are the same, don't trust any of them.
5-21-2008 @ 12:04PM
Garrett said...
I also own about 300K of these ASR's from Merrill, issued by Cohen and Steers, I was not given a propectus, I must say that they have done very well over the last few years earning a decent rate for 7 day securities. I am actually able to borrow against these at a wash, the interest is still getting paid, the point that bothers me most is that alot of the 330 billion market has already been redeemed, only the Libor index rate ones are still out there, some of these ASR had a default rate of 12 -20%, you better believe that those have been bought back, its only the low interest ASR's that continue to be frozen, hey , would you rush to buy back your debt if you only have to pay 50 points over the libor? All we can do is wait, Finally, nobody especially brokers had any idea this was going to happen, it is not their fault, this market was an excellent tool for small companies to earn yield on their float, it was the greedy muni's and banks that got their hands in it that messed it up. Have faith, it will all be resolved late summer, there is less than 100 billion left frozen from the 330B,
Garrett
5-21-2008 @ 12:21PM
James Bond said...
I had the majority of my portfolio "safe" in tax free municipal bonds on the advice from my broker. Luckily, as the auctions failed and the rates started rising, two of my orders auctioned the first few weeks. The last chunk I was holding auctioned after the municipality announced that they would refinance their debt and recall the bonds. The muni's I held had underlying ratings of "A", so at least I could sleep at night. I was told that if I needed access to funds, I could "borrow" against my bonds at a rate which was lower than the bond rate, so at least an effort was being made to help people stuck in this mess. It was still a scary time. I hope others with short term investment goals will be successful in exiting this market.