Recent developments in the credit market have led many auction rate securities - ARS - auctions to fail, which may inhibit existing ARS holders from selling their holdings. Consequently, many ARS investors who treated ARS as a ready source of cash are finding themselves short on liquidity. In response, ARS issuers have announced redemptions of shares - most of the time at par value. However, not all outstanding shares are redeemed by the issuer. This dilemma may leave many investors with holdings they will be unable to liquidate.
ARS are unlike traditional bonds that are issued with a set interest rate for the life of the bond or preferred stocks that specify a dividend yield. Generally speaking, ARS refer to long-term investments with a short-term twist: the interest rates or dividends they pay are reset in intervals through auctions. Investors interested in ARS are seeking cash-like investments that pay higher yields than money market mutual funds or CDs. There are typically two types of ARS: bonds with long-term maturities (20 to 30 years) and preferred shares that pay cash dividends. Both the interest paid by the bonds and the dividends paid by the preferred shares vary based on rates that are set through auctions for a specified term usually measured in days - 7, 14, 28, or 35 days. Auction rate bonds are issued by municipalities, student loan-authorities, museums, and many other institutions, and auction rate preferred shares are issued by closed-end funds.
When auctions fail, liquidity issues arise. It is important to know how ARS auctions in order to understand how they fail. Prior to each auction, current ARS investors have the ability to request either to sell their ARS, hold their position at a particular interest rate or dividend yield, or hold whatever new interest rate or dividend yield is established by the auction. The size of the auction will depend on how many ARS investors want to sell and want to hold. Prospective purchasers then indicate how much they wish to buy and what interest rate or dividend yield they are willing to accept. Buy orders with the lowest rates get accepted first, followed by higher bids until all available securities are sold. The highest rate accepted, or the "clearing rate," then becomes the interest rate or dividend yield that applies to all the ARS at the next auction. ARS auctions fail when supply exceeds demand - when there are not enough bids to purchase all the securities offered for sale in the auction. Current ARS holders will continue to hold their securities and will typically receive an interest rate or dividend yield set above market rates for the next holding period up to any maximum disclosed in the offering documents. Recent developments in the markets such as credit downgrades have caused a significant number of investors who counted on having access to their funds without any options.
Issuers of ARS have started to redeem shares to address the failed auctions. In many cases, the issuers are calling the entire issue for redemption. In other cases, the issuers are offering to redeem only some of the outstanding shares. Investors need to be aware that in a partial redemption, it is possible that a broker-dealer holding ARS shares may not be allocated redemptions. Customers of broker-dealers that do not get an allocation will not be able to participate in the partial redemption. Customers should also be aware that a brokerage firm that receives an allocation might not be able to redeem all the shares of all its customers.
Did you purchase auction rate securities, but have not been able to redeem them? If so, call Robert Pearce at the Law Offices of Robert Wayne Pearce, P.A. for a free consultation.
The most important of investors' rights is the right to be informed! This Investors' Rights blog post is by the Law Offices of Robert Wayne Pearce, P.A., located in Boca Raton, Florida. For over 30 years, Attorney Pearce has tried, arbitrated, and mediated hundreds of disputes involving complex securities, commodities and investment law issues. The lawyers at our law firm are devoted to protecting investors' rights throughout the United States and internationally! Please visit our website, www.secatty.com, post a comment, call (800) 732-2889, or email Mr. Pearce at email@example.com for answers to any of your questions about this blog post and/or any related matter.