Citi Settles $72 Million Lawsuit Involving Auction Rate Securities
Two months ago we reported that Citigroup Global Markets, Inc. had asked a New York court to dismiss a $72 million lawsuit filed against it by KV Pharmaceutical Co. Last week it was announced that Citi had agreed to settle with KV.
In its complaint, KV alleged that it was left holding $72 million in illiquid auction rate securities after the auction rate securities market collapsed in early 2008. While Citi has already agreed to regulatory settlements requiring it to pay hundreds of millions of dollars to redeem auction rate securities held by individual investors, most corporate and institutional investors were not covered by the regulatory settlements—although in an SEC consent order, Citi did agree to help all investors get liquidity on their securities whether they were subject to redemption under the settlement or not. While Citi has defended suits against it by claiming that investors were not defrauded by Citi’s representations and they did not suffer any economic harm from the loss of liquidity, they have settled cases.
Auction rate securities (ARS) are debt instruments – usually municipal bonds or preferred stock-- for which interest is regularly reset through a Dutch auction. Auction rate securities were once routinely marketed as safe, cash equivalents that were highly liquid, but the broker-dealers who sold them failed to disclose that liquidity was entirely dependent upon the success of the auction process, which was being artificially supported by the undisclosed participation of brokers bidding in auctions where they had an interest. Auctions were held every 7 to 35 days by the brokerage firms that dealt in auction rate securities, but because of the subprime lending crisis and its effect upon the financial markets, ARS auctions ground to a halt in February 2008 because they were no longer viable investments and broker-dealers who had previously propped up the market by bidding in their own auctions were no longer inclined to invest in them. The result has been that ARS holders have been unable to cash out even at a loss, and investors who were led to believe that they were purchasing cash equivalents have learned that they essentially have no liquidity at all.
According to Craig T. Jones, an attorney with the Atlanta law firm of Page Perry LLC who is representing several investors in auction rate securities cases, “Citigroup is not alone because this was a flawed product that was misrepresented by everyone involved in the auction rate market. But not everyone is settling these cases.” Jones points out that the statutes of limitations in some states are now beginning to bar claims relating to the sales of auction rate securities. “It is important that anyone who invested in a auction rate securities that are still illiquid get a lawyer and make a claim as soon as possible,” he says. “Once the legal deadlines expire, it will be too late.”
Most of Jones’ auction rate securities clients are filing arbitration claims due to mandatory arbitration clauses in brokerage contracts, which generally take less time to resolve than lawsuits filed in court. “Some of the cases we have filed have already settled,” says Jones, “while I know other investors who have not pursued claims that are still waiting for something to happen. You know what they say about the squeaky wheel getting the grease.”
There is a secondary market for failed auction rate securities, and Jones’ firm has advised several investors to sell their securities at a discount. If they are able to do so, they at least obtain partial liquidity and can take a loss for the difference. That loss enables them to fix the amount of their damages if they make a claim, plus they can seek consequential damages if they can show that they have incurred costs or lost business opportunities as a result of being unable to cash out sooner. Most investors are also claiming attorney’s fees and punitive damages, which are only awarded for willful and reckless misconduct. While punitive damages are rare in arbitration, which is where most claims against broker-dealers get decided, “the facts in these case cry out for a significant punitive award,” says Jones. “We are preparing each of our cases not just to win compensation for our clients, but to send a message to the financial industry that the types of abuses that occurred in the auction rate market will not be tolerated.” Jones’ firm, Page Perry, is based in Atlanta but represents investors in securities fraud cases all over the country.
