You know, the big banks and brokerage house, the ones that lost all that money on mortgage backed securities, were not just holding those securities, they were also selling them. The financial services world has created all kind of new investments by slicing, dicing, and repackaging underlying investments. You may not know what is in your personal portfolio, pension plan, 401k, or foundation. This month's Registered Rep Magazine has an instructive article entitled, A False Sense of Security. Here is a scary outtake:
Perhaps you have a client like Stephen Joffe, a former professor of surgery and a laser-vision pioneer who lives in Cincinnati. Joffe invested $1.35 million of his charitable organization's cash in a now illiquid auction-rate security, specifically in preferred stock of the Eaton Vance Limited Duration Fund. Joffe, in a FINRA arbitration claim against UBS, alleges he did this upon the recommendation of his advisor, Michael Fitzgerald. All he wanted, Joffe says, was something safe, a vehicle that had no risk of loss of principal and was 100-percent liquid.
“On Thursday, February 14, I get a call out of the blue from my advisor,” Joffe says. “He essentially says, ‘Your charitable foundation is illiquid.’ Friday, he apologizes profusely, and says, ‘By the way, UBS is really going to help their clients with this by offering to borrow 50 percent of the value; interest rates will hopefully be a wash, etcetera.”
Joffe was incensed by UBS' offer — a loan against his money (later determined to be at a rate of LIBOR, plus 25 basis points in fees to UBS): “I was absolutely horrified that it occurred, but also that this was the way they were going to handle it.” He told his advisor he was absolutely not going to borrow from the firm that was holding his money hostage.
“Weeks earlier I had been reading the papers with my son, and I was saying, ‘Thank God, we're not in any of that stuff,’” he says. In fact, Joffe says he even put in a call to his advisor around that time. Fitzgerald told him his money was safe; the risk was nil.
Did he ever know that he was in an ARS? “No, no, no, never.” UBS declined to comment on Joffe's case but a spokesperson said the firm is “committed to addressing our clients' concerns about … the breakdown of liquidity for auction-rate securities.” He added that UBS is now offering as much as 100 percent margin loans and that it is working with the industry to restore liquidity.
As a result of Joffe's situation, The Joffe Foundation, a charity established by Joffe and his wife, has shut its doors to new funding requests, and hasn't been able to fulfill outstanding payments.
Joffe is, of course, not alone.
Client financial losses, a crisis of confidence in the securities industry, and class action law suits seem likely. Fiduciaries managing endowments and foundations may be left wondering how they bought this stuff.
Apparently, according to the article, over half of these auction rate securities were issued by municipalities and other public entities like hospitals and universities. The freezing up of the market for auction rate securities may make it harder for these entities to borrow needed money.
Transparency of markets and investments - how do we get back to that? Will it take regulation? Self-regulation of the industry?