Do ARS Pacts Make Treasurers Jittery?

Banks are promising to repay investors for illiquid auction-rate securities, but activity in the secondary market for the instruments is on the rise.

The number of multibillion-dollar settlements agreed to by banks that allegedly duped investors into thinking auction-rate securities were as liquid as cash grew to six this week. JPMorgan Chase, Morgan Stanley, and Wachovia joined Citigroup, Merrill Lynch, and UBS, which previously agreed to try making ARS investors whole over the next year or two.

The agreements were forced upon the banks after investigations by the Securities and Exchange Commission and the New York State Attorney General’s office revealed allegedly abusive sales tactics by the banks.

Yet companies that hold the securities don’t seem comforted by the preliminary settlement agreements. Indeed, recent activity on the Restricted Securities Trading Network, an exchange that sells ARS in the secondary market, shows an uptick in the number of corporations that want to sell off their ARS at a discount.

In fact, reported earlier this month that a review of data released by Pluris Valuation Advisors and RSTN showed that out of 460 auction-rate holders that made public filings by the end of last month, 281 have taken write-downs worth a total of $2.11 billion. Moreover, of 179 companies that have not yet filed their second-quarter reports, Pluris expects 100 to take impairments this month.

ARS are long-term bonds and preferred stocks that resemble short-term instruments because their interest rates are reset periodically — usually every 7, 28, 35, or 49 days. The rate is reset by a modified Dutch-auction process, and because investors are supposed to be able to buy and sell the securities so frequently, they have been generally regarded as equivalent to cash.

Barry Silbert, CEO of RSTN, speculates that companies may be cashing in now because in some cases, retail investors are scheduled to be repaid ahead of institutional investors. He also points out that some banks released press statements noting that they would be making their “best effort” to repay institutional investors (see list below). Such a statement, posits Silbert, may give corporate treasurers the jitters.

The list below contains the most recent information collected by RSTN, which updated its ARS settlement Web page to include Friday’s Wachovia announcement. The data is collected from public statements released by the banks, the SEC, and the New York State AG’s office; the settlement amounts are estimated based on the public documents.

Citigroup — Proposed settlement announced August 7, 2008
Client holdings: $19.3 billion
Individual investors: $7.3 billion
Institutional investors (best efforts): $12 billion
The settlement start date for individual investors is not listed; the end date is November 5, 2008. For institutional investors, the start date is not listed; the end date is December 31, 2009.
• Individual investors refers to all natural persons, small institutions, and charities.
• Investors must have purchased before February 11, 2008.
• Institutional investors: best efforts attempt to liquidate securities by the end of 2009
• Will make whole any losses sustained by customers who purchased securities before February 11, 2008, and sold such securities after that date for a loss


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