Oppenheimer Ordered to Repurchase $5.98 Million in Auction Rate Securities

In January 2012, a Financial Industry Regulatory Authority arbitration panel in New York ordered Oppenheimer to repurchase certain Auction Rate Securities sold to Claimant Nicole Davi Perry for $5.98 million, plus payment of $134,108 in legal fees. The award was posted in FINRA's arbitration database this Monday. See this related report from Reuters. Dr. O'Neal at SLCG testified on behalf of the Claimant; Dr. O'Neal and Dr. McCann have authored a report on ARS previously.

Auction rate securities are usually issued by municipal agencies, mutual funds and structured trusts. They are always traded at par in periodic auctions. The interest rate paid over a coupon payment period is determined in an auction at the beginning of that period, but subject to a cap, often called the 'maximum interest rate.' Beginning in 2007, when investors started to demand more compensation than the maximum interest rate for increased credit and liquidity risk, auctions began to fail. This made the value of many Auction Rate Securities drop significantly.

Despite this possibility for auction failures, ARSs were still marketed by many broker-dealers, including Oppenheimer, as safe, liquid short-term investments, comparable to money market funds or certificates of deposit. This is simply not true. In September 2007, two months after Oppenheimer purchased around $6 million in municipal ARS for the Claimant, Financial Week reported that at least 60 auctions had failed in the preceding weeks, representing as much as $6 billion, or 2% of the ARS market. Interestingly, between December 1, 2007 and February 12, 2008, Oppenheimer CEO and Chairman of the Board Albert Lowenthal sold his personal holdings of ARS in the amount of $2.7 million. (Details about this could be found in the Administrative Complaint, Massachusetts Securities Division, 11/18/2008)

On February 28, 2008, the New Jersey Turnpike Authority Turnpike Revenue ARS Bond sold to Claimant Nicole Davi Perry failed in its auction and never had a successful auction again. Although the ARS was sold to the claimant as short-term liquid asset, its maturity date was January 1, 2030, and after the auction failure, was completely illiquid.

This case highlights many of the issues surrounding auction rate securities that remain even after the market-wide auction failures in 2008. Estimates of the market size at that time suggest that over $300 billion of auction rate securities were outstanding at that time, most of which will not mature for many years.