In Search of the Perfect Investment

Wall Street is a product machine. It creates what it can sell you. It has NO interest in the future of what it sold you.

Understanding this is fundamental to your dealings with Wall Street and protecting yourself and your few saved shekels.

Some of Wall Street’s new products succeed. Some crash and burn. Many destroy vast amounts of investors’ money.  A few years ago, Wall Street invented something called an auction rate security (ARS). The pitch was that it was “as safe as a money market, but paying a little more interest.”

Brokers got paid a commission on the sale of ARSs, but didn’t get paid for putting their client’s money into money markets. Hence they had a real interest in pushing auction rate securities on their clients. It’s fair to say that none of the clients who bought the ARS nor the brokers who sold the ARS ever read the ARS prospectuses. The brokers simply believed what their bosses told them — safe as a money market.

The auction rate security market completely froze in February 2008. One day you could redeem your ARS for cash. The next day you couldn’t. You were stuck.

Some of us — I had some  — got out of ARS and got our full money back. But many didn’t. And that’s the subject of yesterday’s piece by the Wall Street Journal’s Daisy Maxey:

For Many Auction-Rate Investors, the Freeze Goes On

By DAISY MAXEY, in the Wall Street Journal

Four years ago the market for auction-rate securities, an investment touted as safe and liquid, froze up. Four years later, despite various settlements and repayment efforts, many investors are still fighting for the return of their money.

All told, about $100 billion from individual and institutional investors remains outstanding in the former $330 billion market, according to SecondMarket, a broker-dealer and secondary market for illiquid assets. Auction-rate securities are debt instruments with interest rates that are meant to be reset periodically at auction.

As the uncertainty has lingered, investors have put off buying homes, expanding businesses or retiring. Others have stood by, their money on the sidelines, as financial markets made a tremendous recovery in the wake of the financial crisis and global recession.

Thomas Martin, president of Americas Watchdog, a private consumer group in Washington, said he has received phone calls from numerous investors still trapped. “Where’s the outrage?” he asked. “Here comes another spring and these poor people don’t know where their money is, what their retirement situation is; they’re forgotten. Where are the regulators?”

Municipalities, nonprofit hospitals, utilities, housing-finance agencies, student-loan finance authorities and universities were among the frequent issuers of auction-rate securities. Among the investors in the securities were corporations, charities and individual investors. Many purchased them on the advice of brokers, who touted them as a safe, liquid alternative to cash.

But in February 2008, the market froze amid the credit crunch. By the fall of 2010, dozens of big banks and brokerages that underwrote the offerings had repurchased billions of dollars of the securities in settlements with regulators. Since then, various brokerages have redeemed some securities in batches and some investors have won their money back via arbitration. But some banks and brokerages fell through the cracks or have been slow to cash out investors.

The situation is fraught for investors. Many of those who can afford attorneys have hired them because they faced a statute of limitations on filing arbitration claims. Others fear they’ll be placed at the end of the line in any redemption process should they speak out. Brokers who hold the securities in their own accounts fear losing their jobs if they discuss the issue.

The exit avenues aren’t appealing. Investors can sell the shares on the secondary market, but that generally means taking a sizeable loss. Investors may file an arbitration claim, and many have. But for those holding securities worth less than $1 million, it’s difficult to justify the costs, which can run to $100,000.

“It’s kind of a black hole now,” Mr. Martin said. “We’ve got retail investors, small-timers, then big commercial investors who are in these things for tens of millions of dollars, and we don’t know what’s happening to them all.”

Ed Dowling, the owner of a clothing maker in New York City, originally had about $2.6 million stuck in the securities and still has $1.175 million stranded, all of which were sold by Oppenheimer, a subsidiary of Oppenheimer Holdings Inc. “I think it’s absolutely foul and disgusting. I think the whole system is either broken or corrupt.”

For three big sellers of the auction-rate securities-Charles Schwab Corp., E*Trade Financial Corp. and BlackRock Inc.-accords were struck to unfreeze investors. While some securities remain outstanding at the firms, the terms of the wind-down have been set.

But investors who purchased shares from some firms, including Allianz SE ‘s Pacific Investment Management Co. or Oppenheimer, still have no explicit word on when or whether their investments will be redeemed.

Pimco and Nicholas-Applegate Capital Management-since rebranded Allianz Global Investors Capital-had $5.3 billion in auction-rate preferred shares outstanding in March 2008. About 44% of the shares issued by companies’ closed-end funds have since been redeemed. Pimco said it hasn’t made any redemptions since 2009.

Allianz told shareholders in a December letter that it’s evaluating market alternatives. It isn’t possible “to determine if and when a solution will be identified,” Allianz said at the time. Pimco had no further comment.

The issues at play are perhaps most acute at Oppenheimer, one of the largest sellers of auction-rate securities to individuals. It had about $377 million stranded in auction-rate securities as of Dec. 31, according to a regulatory filing by the company. That amount excludes securities owned by qualified institutional buyers and those transferred to the company, purchased by clients or transferred from the company to other securities firms after February 2008, it said.

Oppenheimer stands out among the major brokerages because its settlement with regulators didn’t result in a timely redemption for individual investors, said Todd Higgins, a managing partner at law firm Crosby & Higgins LLP in New York.

Oppenheimer reached settlements with the New York attorney general’s office-then led by current New York Gov. Andrew Cuomo-and the Massachusetts Secretary of the Commonwealth’s office in 2010, and purchased $69.3 million in auction-rate securities from clients. The settlement committed Oppenheimer to a financial review every six months to see if more funds are available buy additional auction-rate securities from holders. The company must report to the attorney general’s office on those reviews.

“That’s the only one that I’m aware of that’s ended up in a repurchase process that has the potential to drag on for many, many years,” said Mr. Higgins, who has represented about a dozen claims against Oppenheimer, five of which are pending.

Oppenheimer said it is purchasing the securities on a periodic basis in accordance with its settlements. The company noted that it is committed to purchase a total of $57.3 million in the securities from clients through 2016 and will pay about $2.5 million as a result of legal settlements with clients. Oppenheimer had no further comment.

Danny Kanner, a spokesman for New York State Attorney General Eric Schneiderman’s office, said, “This office is routinely scrutinizing the expenditures of the firm, which is conducting buybacks periodically throughout the year.”

Steve Cohen, former chief of staff to Mr. Cuomo, said, “The auction-rate-security settlements speak for themselves, putting billions of dollars back into the pockets of victims across the country who were misled into believing they were buying cash equivalent investments”

Investors say they fear Oppenheimer is waiting them out, hoping they will sell at a discount on the secondary market in desperation before any redemption comes their way.

Phillip Aidikoff, a partner in the law firm Aidikoff, Uhl & Bakhtiari, has represented investors in about 50 arbitration cases related to auction-rate securities since the market froze. Most have been resolved through regulatory settlements or settlements with broker-dealers, he said.

The settlement Oppenheimer reached with Mr. Cuomo’s office was “stunningly inept,” Mr. Aidikoff said. “It allows the broker-dealer to do whatever it wants to do.”

The market plunged 200 points yesterday. There were a thousand reasons — from war with Iran to slowdown in China. But no one knew definitely. And no one ever will. The key is to look at each of your stocks and ask two questions:

1. Are the trends right for owning this stock?

2. Does the chart look OK.

I’ve owned BHP for a while but lately there have been too many negative stories about the stock, and the chart looks awful:

Hence I sold it.

I used to like 15% stop loss orders. Investors Business Daily likes 8%.  I’m tending towards 5% to 6% today. This market remains squirrelly, though it has done well in recent months.My preference remains for  dividend-paying stocks. The payments really add up.

Apple announces its newest iPad today. I’m guessing that will help the stock.

Preschoolers in Surgery for a Mouthful of Cavities. Send a copy of this disturbing article to all your friends with young children.  This details what happens to young teeth when the parents neglect and indulge their kids. It’s frightening. Click here.

Harry Newton who doesn’t like to inject politics into this column, but is occasionally reminded of the fact that his parents fled the Nazis in 1939 and most of their friends and many of our relatives perished in the holocast that followed. This piece was originally published five years ago in March. It’s worth reading and perhaps passing on to your friends:

Why the Peaceful Majority is Irrelevant.
History lessons are often incredibly simple.
by Paul E. Marek, a second-generation Canadian, whose grandparents fled Czechoslovakia just prior to the Nazi takeover.

I used to know a man whose family were German aristocracy prior to World War II. They owned a number of large industries and estates. I asked him how many German people were true Nazis, and the answer he gave has stuck with me and guided my attitude toward fanaticism ever since.

“Very few people were true Nazis,” he said, “but many enjoyed the return of German pride, and many more were too busy to care. I was one of those who just thought the Nazis were a bunch of fools. So, the majority just sat back and let it all happen. Then, before we knew it, they owned us, and we had lost control, and the end of the world had come. My family lost everything. I ended up in a concentration camp and the Allies destroyed my factories.”

We are told again and again by experts and talking heads that Islam is the religion of peace, and that the vast majority of Muslims just want to live in peace. Although this unquantified assertion may be true, it is entirely irrelevant. It is meaningless fluff, meant to make us feel better, and meant to somehow diminish the specter of fanatics rampaging across the globe in the name of Islam.

The fact is that the fanatics rule Islam at this moment in history. It is the fanatics who march. It is the fanatics who wage any one of 50 shooting wars world wide. It is the fanatics who systematically slaughter Christian or tribal groups throughout Africa and are gradually taking over the entire continent in an Islamic wave. It is the fanatics who bomb, behead, murder, or execute honor killings. It is the fanatics who take over mosque after mosque. It is the fanatics who zealously spread the stoning and hanging of rape victims and homosexuals. The hard, quantifiable fact is that the “peaceful majority” is the “silent majority,” and it is cowed and extraneous.

Communist Russia was comprised of Russians who just wanted to live in peace, yet the Russian Communists were responsible for the murder of about 20 million people. The peaceful majority were irrelevant. China’s huge population was peaceful as well, but Chinese Communists managed to kill a staggering 70 million people. The average Japanese individual prior to World War II was not a war-mongering sadist. Yet, Japan murdered and slaughtered its way across Southeast Asia in an orgy of killing that included the systematic murder of 12 million Chinese civilians – most killed by sword, shovel and bayonet. And who can forget Rwanda, which collapsed into butchery? Could it not be said that the majority of Rwandans were “peace loving”?

History lessons are often incredibly simple and blunt; yet, for all our powers of reason, we often miss the most basic and uncomplicated of points. Peace-loving Muslims have been made irrelevant by the fanatics. Peace-loving Muslims have been made irrelevant by their silence. Peace-loving Muslims will become our enemy if they don’t speak up, because, like my friend from Germany, they will awaken one day and find that the fanatics own them, and the end of their world will have begun.

Peace-loving Germans, Japanese, Chinese, Russians, Rwandans, Bosnians, Afghanis, Iraqis, Palestinians, Somalis, Nigerians, Algerians and many others, have died because the peaceful majority did not speak up until it was too late. As for us, watching it all unfold, we must pay attention to the only group that counts: the fanatics who threaten our way of life.