ARS battle no easy win for large investors

Two recent legal victories by securities firms involving the sale of auction rate securities suggest that institutional investors could find it tough to prevail in similar battles.

Last month, Smith Barney and Raymond James Financial Services Inc. prevailed in cases based on the sale of $118.7 million and $10.7 million, respectively, in auction rate securities. The ARS market seized up in February 2008 as a result of the credit crunch; at that time, it was valued at about $330 billion.

The win by Smith Barney was the most significant victory yet in auction rate securities cases for Citigroup Inc.

When it comes to lawsuits involving such securities, what looks like a slam-dunk at first for plaintiffs can turn out to be much more difficult, said Richard Ryder, president of Securities Arbitration Commentator Inc., which tracks arbitration cases.

“For institutional investors, auction rate securities is an uphill climb,” because members of the arbitration panel identify the banks and others as sophisticated investors who understood the risks of the market, he said.

That said, institutional investors have won some major ARS cases.

Institutional wins

For example, STMicroelectronics, a chip maker, in February was awarded $406 million by a Financial Industry Regulatory Authority Inc. arbitration panel in a dispute with Credit Suisse Group Inc. The case centered on the mishandling of the purchase of auction rate securities.

Mr. Ryder added that in arbitration cases involving such securities, decisions have to be looked at on a “case-by-case basis, particularly with larger cases.” With the stakes so high in such claims, both sides use “experienced legal counsel and are willing to pull out all the stops.”

In the Raymond James case, a Finra arbitration panel denied a claim from an investor who bought $10.7 million in auction rate securities from a Raymond James broker in 2006 and 2007, according to the arbitrators’ unusually detailed explanation of the award (Finra tends to not disclose details of its rulings in arbitration cases).

Smith Barney and Raymond James had very different roles in the market for auction rate securities. Smith Barney’s former parent, Citigroup, was one of the largest dealers of ARS, while Raymond James played a much smaller role in the market.

This year, Citigroup sold its Smith Barney brokerage group to Morgan Stanley. Raymond James Financial Services is the independent-contractor arm of Raymond James Financial Inc.

One source with knowledge of the Smith Barney victory, who asked not to be identified, said it was the “best result yet” for the firm. Citigroup argued that Banco Industrial De Venezuela’s Miami agency understood what it was buying. The source added that this was the first decision involving a significant institutional client.

Meanwhile, the Raymond James decision shows that brokers were not always sure what they were selling when it came to auction rate securities, a common criticism of the retail-securities business and its marketing of the product. The broker, Rick Woolfolk, “was poorly trained with respect to the ARS product,” the decision stated. “At various times, he described the investment as “unit trusts,’ “short-term paper’ or “short-term stuff.’”

The panel stated that the investor was sophisticated and used a certified public accountant to buy investments. Citing inadequate training and other deficiencies, the panel ordered Raymond James to pay $7,000 in fees for the various sessions in the hearing.

Alexander Samuelson, a Citigroup spokesman, declined to comment, as did Barton Sacher, an attorney for the Venezuelan bank.

In the Raymond James matter, a lawyer for the client declined to comment. Meanwhile, an attorney with Raymond James, Paul Matecki, said the firm is “happy” with the decision.

The panel decided that Raymond James “had confirmation that disclosed the risk of auction failure,” he said, although he is “not sure” how the panel concluded that Mr. Woolfolk was not adequately trained.

E-mail Bruce Kelly at [email protected].