Oppenheimer in N.Y., Mass. ARS Deals

Oppenheimer & Co. agreed to buy back from clients tens of millions of dollars of auction-rate securities under settlements with two states announced yesterday.The New York-based investment bank was accused by New York and Massachusetts of marketing ARS as safe, liquid alternatives to cash, without explaining the risks.

After ARS auctions began failing in droves two years ago, the securities became unsalable. Investors who thought they were playing it safe were trapped in illiquid investments.

Under the settlements announced yesterday, Oppenheimer agreed to buy back many of these securities at par. The New York attorney general estimated its settlement will restore $31 million to investors nationally. Oppenheimer neither admitted nor denied the findings of the attorney general.

It is not clear how much the Massachusetts settlement is worth, but the state estimated 85% of its ARS investors will be reimbursed in the next year.

The attorney general of New York and the Massachusetts secretary of state separately described how Oppenheimer portrayed ARS to clients.

ARS are long-term bonds the interest rates on which reset periodically at an auction.

An investor who bought an ARS — typically from a municipality, a closed-end fund, or a student loan organization — held it until the next auction, which took place from every seven days to every 35 days.

Many investors were not aware of what would happen if an auction failed.

Because investors thought they were only holding the ARS for as few as seven days, they accepted interest rates comparable to very short-term instruments, even though ARS often carried maturities of as many as 40 years.

Oppenheimer encouraged its clients to think of ARS as cash, according to Massachusetts’ complaint.

The firm recorded ARS on clients’ statements as cash, and did not explain the auctions, the state alleged.

If an auction failed, the investor was stranded with the security indefinitely at a penalty rate. 

Penalty rates on closed-end fund auction-rate preferred shares and student loan ARS are very low.

Nuveen Investments, a provider of closed-end funds, publishes the rates it pays on failed auction-rate preferred shares: 0.37%.

Many of Oppenheimer’s investors did not know they could be stuck with these securities if an auction failed, or what the penalty rates would be, the complaint alleged. In fact, many clients did not know any such a thing as a penalty rate existed because Oppenheimer never told them, according to the state.

In early 2008, Oppenheimer learned of dislocations in the market.

The underwriters that helped issue ARS typically supported the product by submitting bids to complete any unfilled auctions. That ensured that auctions did not fail.

As the credit crisis began to percolate, these underwriters grew cagey about submitting bids to support auctions.

The Massachusetts complaint claims the underwriters did not want to accumulate an inventory of an illiquid bond with a low interest rate and indefinite holding period.

Having learned of the probable fallout in the market, Oppenheimer executives opted not to inform their clients. Instead, they dumped about $3 million of their own ARS holdings, according to the complaint.

In February 2008, the auctions began to fail. Many investors were saddled with low-yielding, illiquid securities.

The Massachusetts complaint describes several anonymous clients who were encouraged to use ARS as a short-term stash for things like setting aside money to pay taxes.

Oppenheimer told some clients ARS were even safer than money market funds — “as safe as safe can be,” according to the complaint.

Much of these clients’ money was stuck in investments that were “unrecognizable and unfathomable” to them after the auctions failed.

At the time of the failed auctions, Massachusetts investors had $55.9 million of ARS in 176 accounts, according to the state. Now, ARS are held in 70 accounts in the state.

Oppenheimer agreed to buy back the ARS in 60 of the accounts at par. The remaining 10 will be offered “enhanced liquidity.”

Under the settlement with New York, Oppenheimer agreed to buy back the ARS from 1,246 accounts nationally and 230 accounts in the state.

The company will also reimburse customers who sold their ARS at below par.

The New York attorney general has reached settlements with 14 dealers leading to more than $60 billion in ARS buybacks.

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