The scandal over how auction rate securities (ARS) were marketed to investors grinds into the middle of its second year. Companies that remain the target of investigations are digging in to resist settlements and-in at least in one case-attempting to qualify for government bailout money to pay stranded customers back.

Still to come are resolutions of major cases against Charles Schwab Corp., Wells Fargo & Co., and Oppenheimer & Co., the brokerage, not the mutual fund. And it's Oppenheimer that has taken the most daring tack to date to fund the repurchase of some or all of the close to $1 billion in now-frozen ARS it sold to clients. It's asking for federal funds to do so.

"In terms of the fallout from all of the issues, [the scandal] still has quite a tail," says Andrew Sandler, co-chairman of law firm Buckley Sandler LLP. "It will probably be three to five years before all the litigation and enforcement issues are resolved."

In an internal document titled "Auction Rate Securities Update" obtained by Securities Industry News and dated June 2009, Oppenheimer & Co. lays out a series of corporate actions it is taking to attempt obtain government money to repay customers regulators say it betrayed. Initially, the documents say, Oppenheimer Trust Co. applied for and received approval to become a commercial bank as a means of "providing a liquidity solution to a large group of our clients."

Since Opco now believes that option "holds limited value," the firm says Canadian parent Oppenheimer Holdings, Inc. has moved its place of incorporation to Delaware "so that we make become eligible for existing or future federal programs designed to provide liquidity to markets."

Opco has also been working with Congress, it says, "to request that TALF [Troubled Asset Lending Facility] legislation be amended to include ARS as an eligible asset class for FDIC guarantees." Opco is also trying to gain access to Federal Reserve Lending Facilities, it says, as a source of financing to pay small clients back the money it may be ordered to return via regulatory settlements.

Opco has no comment on its ARS situation, according to a spokesman, Brian Maddox.

Opco Probes

Opco customers held $929.6 million of ARS just before the market collapsed in February 2008. Massachusetts regulators charged Opco with "fraud and unethical conduct" in November in the sale of auction rate securities, a case that is ongoing. Chief Massachusetts securities regulator William Galvin is seeking to censure Opco and require the firm to return to customers the $56 million in ARS it sold to retail investors in the state. "Oppenheimer executives betrayed the trust of their clients by continuing to market these ...as safe cash equivalents when they knew this was not the case," Galvin said in bringing the charges.

ARS were sold to investors as safe and liquid, even though their interest rates were determined by periodic auctions. In early 2008, hundreds of those auctions failed, the securities no longer could be sold and regulatory and legal actions against banks and brokers began.

Oppenheimer is also the target of at least two other state probes, and is named as a respondent in a number of arbitrations and two class action lawsuits relating to its sale of ARS.

The firm is clearly worried about the consequences of being ordered to pay the money back. "Before purchasing any of these securities, the company would need to assess whether it had sufficient regulatory capital or borrowing capacity to do so," Opco said in its 2008 annual report.

But experts question whether a government bailout is the answer. "It sounds improper and seems to be problematic," said one Wall Street attorney, who asked that he not be named because of client involvement. He notes that it is standard for firms to pay regulatory settlements out of their own pockets: "To turn around and use funds from the government that are earmarked for a different purpose seems to be against the intended purpose," he says.

"This is a new one on me," says Bob Webster, director of communications for the North American Securities Administrators Assn. (NASAA), a group of state regulators that has been instrumental in bringing ARS actions. Last year, NASAA formed a multi-state task force "to investigate whether prominent Wall Street firms systematically misled investors when placing them in auction rate securities."

Since the market collapsed, state and federal regulators have entered into settlements mandating some $61 billion in ARS buybacks. Civil penalties to date total $597.3 million and there are numerous unresolved actions (see list). In its internal assessment, Opco says it believes that in the aggregate, large banks and brokerage firms that were the primary underwriters and supporters of ARS will be on the hook for $65 billion in buybacks.

Noting that in the current environment "there has been no lending available through commercial sources," Opco says in the internal document that "we therefore have looked at various federal programs as a solution to this pressing problem." Opco would not comment further on how these efforts are progressing.

$330 Billion Market Meltdown

"This is a $330 billion market that melted down," says Matthew Kitzi, commissioner of securities for the state of Missouri and co-chair of NASAA's ARS task force.

"It was developed by the largest investment banking firms. It is going to play out over time."

In the case of the NASAA task force, Kitzi says that the focus has been on giving "full and immediate relief to investors....There are families that do not have access to important funds," he says. "Some clients, 18 months later, are stuck with the same liquidity problems."

The Securities and Exchange Commission, working with state regulators, continues to announce settlements, most recently on July 20, when TD Ameritrade agreed to repurchase $456 million in ARS. As is typical in these cases, investors can elect to participate in an arbitration process run by the Financial Industry Regulatory Authority (FINRA) to claim additional damages. FINRA spokesman Brendan Intindola said that as of the end of June, 145 ARS arbitration claims had been filed this year. In 2008, 299 ARS claims were filed, he said.

Hitting Mainstream America

ARS are long-term bonds issued by municipalities, corporations and student loan companies, or preferred shares issued by closed-end mutual funds. They have interest rates that are reset by auction weekly or monthly. When the auction failures hit in early 2008, investors' assets were tied up in securities that could not be sold.

In February 2008, regulators began receiving complaints from thousands of investors about their purchases of the illiquid securities from brokers who told them they were as safe as cash. Regulators say that typically, representations were made that ARS were equivalent to CDs or money market accounts. As a result, small investors ill prepared to lose access to their money were unable to recover it.

Regulators say victims include homer buyers, small business owners, retirees and farmers. "This is hitting mainstream America," Karen Tyler, North Dakota securities commissioner, told Securities Industry News after the market collapsed last year.

"Holdout Firms"

Now, with numerous investigations still open, Sandler says that some firms, including Schwab and Opco, appear reluctant to settle and are choosing to fight back. As for Opco's dilemma, Kitzi notes there is an open investigation of the way Opco sold the securities in his own state of Missouri. "They need to address their regulatory issues," he says. "We are just as interested in where the money is coming from as anybody else. We don't want a resolution to create bigger problems."

Kitzi adds that he is not aware of any firm that has reached a national settlement using government programs to fund their buybacks, as Opco is trying to do. "There are federal gatekeepers that will have to weigh the benefit of that," he says. "We have some holdout firms that don't want to be held accountable. It is unfortunate that some firms are not falling in line with their peers and taking care of their clients."

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