Bank of America has been named in a class action lawsuit involving auction rate securities. Plaintiffs in the suit allege brokers at Bank of America hid the true risks of auction rate securities when it sold the instruments to investors.
Auction rate securities are long-term corporate bonds, municipal bonds and preferred stock on which the interest rates are reset periodically based on bids submitted through securities firms. Generally, rates are reset every seven, 14, 28 or 35 days. Because they can be sold during weekly or monthly auctions, banks and brokerages often touted auction rate securities as short-term investments or cash equivalents.
Unfortunately, because of the crisis in the credit markets, auctions of these securities haven’t been successful because of worries that bond insurers guaranteeing many of the $330 billion in outstanding auction bonds would be downgraded. Bloomberg.com has also reported that brokers such as Goldman Sachs Group Inc. and Citigroup Inc. also purposely permitted the auctions for preferred securities, which aren’t insured, to fail by not committing their own capital to sales when there weren’t enough bidders. As a result, the market for auction rate bonds has pretty much vanished, leaving a lot of investors holding auction rate securities they once thought were safe vehicles with no way to sell them.
The investors involved in the Bank of America suit bought their auction rate securities between June 11, 2003 and Feb. 13, 2008. It was on Feb. 13 that all of the major broker-dealers, including Bank of America, withdrew their support for the auctions, leaving the market to crumble and investors unable to access their money.
Some legal experts have asserted that banks or brokers could be held liable for investors’ auction rate securities loses if the vehicles were represented as short-term investments or cash equivalents. The plaintiffs involved in the Bank of America auction rate securities class action lawsuit claim that brokers did just that.
The lawsuit alleges that Bank of America failed to disclose the following facts to investors:
- 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.
- The auction rate securities were only liquid at the time of the sale because Bank of America and other broker-dealers were artificially supporting and manipulating the market to maintain the appearance of liquidity and stability.
- Bank of America and other broker-dealers routinely intervened in the auctions for their own benefit to set rates and to prevent all-hold auctions and failed auctions.
- Bank of America continued to market auction rate securities as liquid investments even after Bank of America and other broker-dealers determined that they would likely be withdrawing support for the periodic auctions and that a freeze of the auction rate securities market would result.
The Bank of America auction rate securities lawsuit was filed the same day a group of state regulators visited Wachovia Securities St. Louis headquarters as part of a probe into its handling of auction rate securities. Morgan Stanley and Merrill Lynch also face investor lawsuits over the auction rate securities debacle, and Massachusetts’ securities regulator filed a civil fraud lawsuit last month against UBS AG, one of the largest players in the auction rate securities market. Finally, the Justice Department’s U.S. attorney’s office for New York’s Eastern District is conducting a criminal investigation into whether two former Credit Suisse Group brokers lied to investors about how they placed their money into auction rate securities.
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