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Harry Newton's In Search of The Perfect Investment Technology Investor. Auction Rate Securities. Auction Rate Preferreds.

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8:30 AM EST Wednesday, March 26, 2008: Brokers have told me they could make zillions if their brokerage house announced it would redeem the auction rate preferred securities they had foolishly sold their clients as "cash."

No one is stepping up to the plate, despite plummeting client goodwill.

There are real, honest, caring folk working on Wall Street who think about their customers long-term. Right now, it's hard to find them.

As to what we do next? I think all of us who own ARPs need to keep up the barrage of letters, emails, phone calls, complaints to our brokers, to our issuers, to the SEC, to Congresspeople, etc. Some people are filing class action suits, though I'm not joining one, yet.

I'm mulling my next steps. My ARPs are all Nuveen. I'm mulling the idea of funding a full-blown advertising program. The headline on my Wall Street Journal ads would be, "Why You Should Never, Ever, Do Business With Nuveen."

Reader David Chandler emails me:

My wife and I were unfortunate to have placed very large amounts into auction rated securities (over $1 million), while we were looking for other investments. We are now trapped. I recently joined the class action (and at the moment am the lead plaintiff) against UBS filed by Girard Gibbs, after detailed conversation with Jonathan Levine, who tells me he has spoken to you.
Some quick thoughts:

1. Please keep writing on this subject. You are now acting as something of a clearing house of information, a very valuable function;

2. Is there any way that we ARS victims can organize? We need a coherent spokesman and several representative individuals to present our situation before the public. For example, are there any plans to hold congressional hearings on this subject? If so, there should be members of the public who have gotten entangled in this mess to testify before Congress. Do you have any ideas how this can be organized?
Your suggestions, either directly or in your column would be most appreciated.

To answer David, I find that most ARPs investors are reluctant to come forward publicly at present. Money is a private thing and all that. Stupidity is to be concealed, etc. I suspect that, once this drags on for another month or two, more people will come out of the closet and then we'll have the beginnings of a revolution. Right now, it's early. Wait for the howl when people send their end-March brokerage statements.

By the way, I suspect most of us won't get cash out of our ARPs money in time for April 15. I don't see the IRS being sympathetic to our plight.

Class action suit filed against Morgan Stanley. The New York law firm of Levi & Korsinsky, LLP has filed this class action complaint on behalf of purchasers of auction rates securities from Morgan Stanley. According to Joseph Levi of the firm, "The suit seeks recission of the ARS sold by Morgan Stanley and/or damages for the period of time investors were unable to sell their holdings. Accordingly, even if a particular ARS becomes liquid, an investor should receive some compensation from the broker for the illiquid period. The damage measure will likely be greater if/when a secondary market emerges in which investors can sell their ARS at a discount to par. We therefore see the class action suits as an adjunct to any other business solutions that emerge to help make investors whole."

According to,

Mar 26, 2008: -- Investor Gary Miller has filed a lawsuit in the U.S. District Court in Manhattan against Morgan Stanley (NYSE: MS | news | PowerRating | PR Charts ) accusing the company of deceptively marketing auction rate securities.

The lawsuit, which seeks class-action status, said Morgan Stanley and other broker dealers had artificially supported the auction rate securities market and recklessly misrepresented the risks of such investments.

Auction rate securities are bonds that banks typically pitched as a safe alternative to cash. They are long-term securities, but the investment banks hold periodic auctions to set the interest rates and give holders the option to sell the securities. The securities have become harder to sell in recent months as auctions have failed to attract bidders.

The firm said it was working with clients to resolve their individual liquidity needs through various alternatives, including lending. Miller said in the lawsuit that the value of auction rate securities had been artificially inflated and that he and other investors were now stuck with investments they could not sell.

He is seeking an injunction that would compel Morgan Stanley to rescind millions of dollars it executed in auction rate transactions from March 2003 through February 2008, as well as compensatory damages for himself and other investors in those securities.

Merrill Lynch was also sued in a class action suit.

Chad Bray of Dow Jones Newswires wrote this piece yesterday::

NEW YORK (Dow Jones)-- Morgan Stanley (MS) and Merrill Lynch & Co. (MER) were separately sued Tuesday over alleged deceptive marketing of auction-rate securities.

The separate lawsuits, both filed in U.S. District Court in Manhattan, allege that Morgan Stanley and Merrill Lynch represented auction-rate securities to investors as liquid, cash alternatives equivalent to money-market funds and failed to make material disclosures about those securities.

"Instead of disclosing the true nature of ARS and the substantial liquidity risks associated with them, Morgan Stanley continued to push as many ARS as possible onto its customers in order to unload the inventory off its already troubled balance sheet," said the lawsuit against Morgan Stanley.

The lawsuits each are seeking class-action status on behalf of thousands of investors who purchased auction-rate securities through either Morgan Stanley or Merrill Lynch between March 25, 2003, and Feb. 13, 2008.

The Merrill Lynch complaint was filed on behalf of Frederick Burton, who allegedly purchased auction-rate securities underwritten and sold by the investment bank, according to the suit. The Morgan Stanley lawsuit was filed on behalf of Gary Miller, who purportedly purchased auction-rate securities from Morgan Stanley.

Auction-rate securities are long-term bonds that have a short-term debt component, in which interest rates are reset in auctions on a daily, weekly or monthly basis.

In February, several auctions failed, driving up the interest rates for issuers such as municipalities, student-loan providers and museums. The collapse of the auction-rate securities market has left investors locked into those illiquid investments.

"When Merrill and the other broker-dealers stopped artificially supporting and manipulating the auction market, the market immediately collapsed and the auction rate securities by Merrill became illiquid," according to the lawsuit against Merrill Lynch.

The suits comes on the heels of similar cases filed against Deutsche Bank AG (DB) and UBS AG ( UBS) earlier this month over their marketing of auction-rate securities.

"Morgan Stanley denies the allegations in the complaint. The challenges of the auction rate markets are industry-wide, and result from broader credit-market conditions," said Christine Pollak, a Morgan Stanley spokeswoman, in a statement. "The auction-rate securities market has existed for over 20 years without significant disruption until recent market events. In response to these events, Morgan Stanley is working to address its clients' liquidity needs, on a case-by-case basis, through various alternatives including lending."

A Merrill Lynch spokesman didn't immediately have a comment on the lawsuit late Tuesday.

More Auction Rate Lawsuits and Other Web Notes by Kevin M. LaCroix of The D&O Diary

Add Merrill Lynch and Morgan Stanley to the growing list of companies that have been sued in securities class action lawsuits by investors for allegedly deceptive representation in connection with the sale of auction rate securities. According to the plaintiffs’ attorneys’ March 25, 2008 press release, the plaintiffs’ have filed a securities class action lawsuit in the United States District Court for the Southern District of New York against Merrill Lynch and its asset management company on behalf of investors who purchased auction rate securities from Merrill Lynch between March 25, 2003 and February 13, 2008. A copy of the complaint can be found here.

According to the press release, Merrill Lynch “offered and sold auction rate securities to the public as highly liquid cash-management vehicles and as suitable alternatives to money market mutual funds.” The complaint alleges that Merrill Lynch failed to disclose that

(1) the auction rate securities were not cash alternatives, like money market funds, but were instead, complex, long-term financial instruments with 30 year maturity dates, or longer; (2) the auction rate securities were only liquid at the time of sale because Merrill Lynch and other broker-dealers were artificially supporting and manipulating the auction rate market to maintain the appearance of liquidity and stability; (3) Merrill Lynch and other broker-dealers routinely intervened in auctions for their own benefit, to set rates and prevent all-hold auctions and failed auctions; and (4) Merrill Lynch continued to market auction rate securities as liquid investments after it had determined that it and other broker dealers were likely to withdraw their support for the periodic auctions and that a “freeze” of the market for auction rate securities would result.

According to news reports, plaintiffs also filed a separate but substantially similar lawsuit against Morgan Stanley, raising more or less the same allegations on behalf of a class of investors who purchased auction rate securities from Morgan Stanley during the same class period as proposed in the Merrill Lynch lawsuit. ...

These two new lawsuits join a group of similar lawsuits, all filed by the same law firm on behalf of auction rate securities investors, against Deutsche Bank, Wachovia, TD Ameritrade and UBS. The law firm’s webpage describing these various lawsuits can be found here.

With the addition of these two new subprime-related securities class action lawsuits, my running tally of subprime related securities lawsuits, which can be accessed here, now stands at 59, of which 21 have been filed in 2008. Two of these 59 represent lawsuits brought on behalf of investors against mortgage-backed asset securitizers, six are class action lawsuits on behalf of auction rate securities investors, two are brought on behalf of mutual fund investors, and the remaining 49 of which are brought on behalf of public company shareholders.

FSI International held a F2Q08 Earnings Call. On that call:

Now, I will briefly discuss the changes and key balance sheet items from the end of fiscal 2007 to the end of the second quarter of fiscal 2008. Our cash, restricted cash, cash equivalent and marketable securities represented $24.4 million of our total assets at the end of the second quarter as compared to $24.5 million at the end of fiscal 2007.

Our investment portfolio at the end of the second quarter included approximately $8.5 million of auction-rate securities, which are investments with contractual maturities between 5 to 35 years. As of the end of the second quarter of fiscal 2008, these securities were re-classed from short term to long term as they are currently not trading. Conditions in the debt markets have reduced the likelihood that these securities will auction in the next 12 months. Of the auction-rates securities held by us, $7 million are backed by student loans and are guaranteed by the United States Federal Department of Education.

The remaining $1.5 million relates to manufactured housing that’s collateralized by the principal housing contract trust associated with related loans and are insured by third party. In addition, all auction-rate securities held by us are rated by the major independent rating agencies as either AAA or A, AA.

Beginning February 19, 2008 and forward, all of our auction-rate securities sales auction that sell orders exceeded by orders. These failures are not believed to be a credit issue but rather reflect a lack of liquidity. Under the contractual terms, the issuer is obligated to pay penalty interest rate due to an auction sale.

And that we need to access the funds associated with failed auctions, they are not expected to be assessable until one of the following occurs: the successful auction occurs; the issue or [redency] issue; a buyer is found outside of the auction process; or the underlying securities that matured.

We determine that no impairment losses existed as of March 1, 2008. However, if the issue of the auction-rate securities is unable to successfully close future auctions, it does not redeem the auction-rate securities or the United States government fails to support its guarantee of the obligation. We may be required to adjust the carrying value of the auction-rate securities and record impairment charges in future periods, which could materially affect the results of operation and financial condition.

Jane Bryant Quinn writes in today's Bloomberg:

The preferred shares often come in the form of auction-rate securities. They're perpetual investments with no fixed maturities but with short-term renewal dates, often once a week. Because of their long-term nature, they pay higher dividend rates than you get on cash.

The fund pays the dividends, recently in the 3 percent to 5 percent range. At every renewal, your shares go up for auction. You could either re-up at the current dividend rate or sell your shares to a new investor. Your money was locked up for only seven days at a time. Or so you thought.

When the markets seized up, new investors quit bidding for these preferreds. Existing shareholders couldn't sell. Their money is safe. In fact, they're earning a slightly higher dividend rate than they did before. But they may be stuck with those shares for months or even years.

A few taxable funds have said they're borrowing money to buy out the preferred shareholders, in whole or in part. Among them: Aberdeen Global Income Fund, three Eaton Vance funds, five Calamos funds, 13 Nuveen funds and two ING funds.

That's not so easy for the tax-exempt closed-ends. If they borrow at the higher rate applied to taxable debt, they may hurt the common shareholders, says Anne Kritzmire, a managing director at Nuveen Investments. Nuveen hopes to develop a new form of preferred share that will do the job but it will take time.

Common shareholders in these closed ends can still trade freely. They're affected by the mess in three ways: The bad headlines prompted some shareholders to sell, so the market price of the fund probably declined. The higher cost of carrying the frozen preferred shares may force the fund to cut its dividend. If the preferred shareholders get bought out, the fund's leverage will probably decline, reducing the yield earned by the common shareholders.

Does the distress of some closed-ends make them a good buy? Not yet, says Cecilia Gondor, an analyst at Thomas J. Herzfeld Advisors in Miami, specialists in closed-ends. Right now, their market price is averaging about 6 percent to 7 percent less than the net asset value of the securities they hold. She likes to buy when the price falls to 15 percent to 20 percent below net asset value.

"We're waiting for dividend cuts, if they happen,'' she says. She may not have to wait long.

Steve Carter filed a complaint against UBS with the SEC:

I am filing this complaint against UBS on behalf of:

Anthony and Marva DeFalco

1. Brokerage - UBS,

Financial Advisor - Steve Carter,
UBS Financial Services, Inc.
1801 13th St. Suite 100, Boulder, CO 80302

2. In September of 2007, Anthony and Marva DeFalco asked Steve Carter to place the bulk of their money (almost 2 million dollars) in a safe AAA credited and insured investment. They also specified that they needed to have access to the funds for operating costs for their business and to pay taxes. They were assured by Steve Carter that these funds would be available with 7 days notice.

3. A written prospectus from Eaton Vance was received in October of 2007.

4. The monthly statement from UBS characterizes the ARS funds as "Cash Alternatives" with a subsection titled as "Money Market Instruments." The actual fund listed under this is the "Eaton Vance Senior FTG RT TR SR AM 7-DAY AUCT PFD 4.220%.

The UBS website also characterized ARS investments as "(c)ash alternatives" and "highly liquid, short-term investments" that gave investors "the ability to quickly convert investments into cash when you need it." However, four days after a lawsuit was filed, UBS removed the ARS-related representations from its website

5. Steve Carter was never given any authorization to place the DeFalco's money in anything but AAA insured funds that were liquid within 7 days.

Neither UBS, nor Steve Carter notified the DeFalcos that their money was invested in ARS until UBS sent out a letter received March 15, 2008.

Neither UBS nor Steve Carter ever contacted the DeFalcos to give them notice that the auctions were failing or that their funds had been frozen. The DeFalcos received notice that the funds were frozen on March 17th when they attempted to contact Steve Carter to withdraw some of the money to purchase investment property.

6. The fraudulent misrepresentation on the part of UBS and Steve Carter has caused considerable financial and emotional hardship. The DeFalcos have already had to forgo a business opportunity and if the funds are not released by April 15th, the DeFalcos may be unable to pay Federal income taxes.

UBS knew, but failed to disclose to investors, material facts about ARS and mislead investors into believing that these investments were cash alternatives rather than complex, long-term financial instruments with 30 year maturity dates or longer. UBS failed to disclose that the ARS were only liquid at the time of investment because UBS and other institutions were artificially supporting and manipulating the auction market to maintain the appearance of liquidity and stability and that the ARS would become illiquid as soon as UBS and other institutions stopped manipulating the auction market.

We appreciate any help that the SEC can provide. Please feel free to contact me if you need any additional information.

Brandee DeFalco-Galvin, Esq.
(303) 254-5846

The Gabelli Convertible and Income Securities Fund Inc. to Redeem Auction Rate Preferred Stock. From a web site called

The Board of Directors of The Gabelli Convertible and Income Securities Fund Inc. (NYSE:GCV) has authorized the filing of a shelf registration of up to $100 million in preferred stock or debt securities. The registration process typically takes approximately one to two months. Upon its completion the Fund will have additional flexibility to take steps toward resolving the illiquidity that has occurred for holders of the Fund’s auction rate preferred stock.

The Board of Directors has agreed in principle to the redemption of the Fund’s auction rate preferred stock once the shelf registration is declared effective. The Fund currently has approximately $50 million of preferred stock outstanding, $25 million of which is auction rate preferred stock. This press release does not constitute an offer of any securities for sale.

The Gabelli Convertible and Income Securities Fund Inc. is a diversified, closed-end management investment company with $144 million in total assets whose primary investment objective is to seek a high level of total return through a combination of current income and capital appreciation. The Fund is managed by Gabelli Funds, LLC, a subsidiary of GAMCO Investors, Inc. (NYSE:GBL), which is a publicly traded NYSE listed company.

This prank took 207 people to pull off. They gathered at Grand Central Station in New York to pull off a 'frozen in place' act. The onlooking travelers who weren't part of the act were mystified as to what was going on. Check out the neat video.

How we came about
A little girl asked her mother, "How did the human race appear?"

The mother answered, "God made Adam and Eve and they had children and so was all mankind made."

Two days later the girl asked her father the same question.

The father answered, "Many years ago there were monkeys from which the human race evolved."

The confused girl returned to her mother and said, "Mom, how is it possible that you told me the human race was created by God, and Papa said they developed from monkeys?"

The mother answered, "Well, dear, it'll is very simple. I told you about my side of the family and your father told you about his."

This column is about my personal search for the perfect investment. I don't give investment advice. For that you have to be registered with regulatory authorities, which I am not. I am a reporter and an investor. I make my daily column -- Monday through Friday -- freely available for three reasons: Writing is good for sorting things out in my brain. Second, the column is research for a book I'm writing called "In Search of the Perfect Investment." Third, I encourage my readers to send me their ideas, concerns and experiences. That way we can all learn together. My email address is . You can't click on my email address. You have to re-type it . This protects me from software scanning the Internet for email addresses to spam. I have no role in choosing the Google ads on this site. Thus I cannot endorse, though some look interesting. If you click on a link, Google may send me money. Please note I'm not suggesting you do. That money, if there is any, may help pay Michael's business school tuition. Read more about Google AdSense, click here and here.

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