BL: Auction Failure Damages Face Burden of Proof Eluding Lawyers
By Thom Weidlich
May 27 (Bloomberg) -- Lawyers who sued broker-dealers, including Citigroup Inc. and Morgan Stanley, for steering investors to the now-failing $330 billion market for auction-rate securities may be unable to prove their clients lost money or collect fees for themselves.
At least 24 proposed class actions have been filed since mid-March against brokerages over claims investors were told the securities were almost as liquid as cash. Auctions for the investments, typically municipal and student-loan-backed bonds and preferred shares, have been failing since mid-February, leaving investors unable to sell their securities.
Even so, investors continue to make money, corporate defense lawyers not involved in the cases point out. The interest --reset every 7 to 35 days at bidding managed by the dealers --gets raised to a higher penalty rate, sometimes as much as 20 percent, when auctions fail.
``I don't see how you get around the fact that, for the most part, the investors are doing better,'' said David Gourevitch, a former U.S. Securities and Exchange Commission lawyer now practicing in New York who isn't involved in the lawsuits.
The existence of the penalty reset rate proves investors knew the auctions might fail, said Daniel J. Tyukody, a partner at Orrick, Herrington & Sutcliffe in Los Angeles who isn't involved in the cases.
The investors' lawyers argue that clients were damaged because they couldn't use their money for other purposes.
John Coffee, a Columbia University securities law professor, said there are ``some problems'' with that claim. ``I don't know that you can easily measure the loss of liquidity,'' he said.
Lost Opportunities
Stephen N. Joffe, former chief executive officer of vision- correction company LCA-Vision Inc., says he can measure it -- in the problems it caused for the foundation he started to fund laser surgery for low income people and AIDs prevention. Last February, he learned from his UBS AG broker that $1.35 million that his charity had invested in auction-rate securities wasn't liquid and wouldn't be available for grants.
``I was pretty angry and upset,'' the 65-year-old Cincinnati ophthalmologist said. New York lawyer Jacob H. Zamansky representing Joffe said arbitration was more appropriate for the doctor because class actions take years.
Arguing investors lost chances to use their money might create an obstacle to winning class-action status. Each missing opportunity might present unique facts, while a class action, which would give investors settlement leverage and keep costs down, requires similar loss situations.
``If it's a lost opportunity, then it's an individual set of facts,'' Tyukody said.
Arbitration Preference
Zamansky, who has filed ``six or seven'' arbitration claims over auction-rate securities, also sees the hurdle.
``I don't think the class actions will succeed,'' he said. ``From the 50 or 60 investors I've spoken to, there are too many individual issues.''
UBS spokeswoman Karina Byrne said the bank wouldn't comment on the suits or arbitrations. ``We are working with clients, on a case-by-case basis, to address immediate liquidity needs, offering such solutions as loans of up to 100 percent of the par value of their auction rate securities holdings at preferred lending rates,'' she said in an e-mail.
Citigroup was sued in at least three cases and Morgan Stanley in two in New York federal court. Alex Samuelson, a spokesman for Citigroup didn't return a call for comment. When the first suits were filed, he said they were without merit. Morgan Stanley denies the claims and auction-rate ``challenges'' result from market conditions, said spokeswoman Christine Pollak.
Legal Gamble
Filing suits is a gamble for the plaintiffs' lawyers, who get paid only if they secure settlements or win damages at a trial. In the meantime, they have to spend time and money on the litigation. Such expenses can run into the millions.
William Lerach, former lead counsel for Enron Corp. investors, said in 2002 that his firm spent $3 million in expenses and $5 million in lawyer time before it secured its first settlement -- $40 million on a fraud claim. Eventually the firm won $7.2 billion in settlements. It is seeking $688 million in fees.
``We do not bring cases unless we think there is a very good basis,'' said Jerome Congress, a partner with Milberg LLP, a New York firm that filed a class action against Citigroup. Milberg was Lerach's firm when he filed the Enron suit.
Lawyers who have decided to take cases include Stephen A. Weiss of New York-based Seeger Weiss, who estimated damages are ``in the many billions of dollars.'' Weiss represents clients in 12 of the class actions.
Lower Return
Weiss said the investors received a lower return on their investment than they would have from fixed-rate bonds for the easier ability to sell them. Given the auctions' failures, the bonds should have paid a higher rate, he said.
Faced with the high penalty-rate interest, some issuers are buying back auction-rate securities. Municipal borrowers have refinanced, converted or indicated they will redeem at least $68 billion of auction bonds by July 7, according to data compiled by Bloomberg.
Some investors such as Bristol-Myers Squib Co. have written down auction-rate investments as required by U.S. accounting rules that could also enable them to reset the value higher if market conditions improve. Companies such as Google Inc. have written down more than $1.8 billion since the market collapse.
The Citigroup cases include LHB Insurance v. Citigroup, 08- cv-3095, and Swanson v. Citigroup, 08-cv-3139, U.S. District Court, Southern District of New York (Manhattan).
To contact the reporter on this story: Thom Weidlich in New York at tweidlich@bloomberg.net.
Last Updated: May 27, 2008 00:01 EDT
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