Brokers Kiss 200,000 Wealthy Clients Goodbye
Kurt Brouwer August 19th, 2008
In this piece, Joe Mysak of Bloomberg eviscerates Wall Street firms for walking away from auction-rate securities that they sold to thousands of clients. Auction-rate securities are generally long-term, tax-exempt securities issued by municipalities and other issuers.
However, the magic came from the fact that brokerage firms held weekly or monthly auctions on these securities at which point rates were reset and investors could cash out. Unfortunately, when the going got tough with these auctions, the brokers and bankers got out of the auction business, leaving thousands of their clients holding the bag.
Bankers Get Ready To Kiss 200,000 Clients Goodbye (Bloomberg, August 19, 2008, Joe Mysak)
The real numbers to look at in the auction-rate securities settlements are the ones in thousands, not billions.
By the time this is finished, and we’re probably months away from that, it looks like securities firms will return money to more than 200,000 individual investors.
And prepare to kiss them goodbye.
The ultimate loser in the auction-rate market collapse is going to be the U.S. securities brokerage business.
It is hard to see how the dealers involved are going to retain the customers they treated so cavalierly in February, when they decided to stop supporting auctions and blew up the market.
…Did they, the top officers of the securities companies, really think their customers could be separated from their money for any length of time and not complain?
Now, I cannot read the minds of the CEOs of large brokerage firms and big banks. However, if history is any guide, these folks thought the gravy train would keep on chugging. I’m sure it never occurred to them that this lucrative business could blow up. And, once it did blow up, they must have panicked.
…At the same time, of course, the big securities firms advertised almost endlessly, emphasizing trust and reputation, and how they could take care of you if you were their client. Those ads showed a world of ease and comfort.
…Now those illusions are shattered. The thousands of investors who will be reunited with their cash are now disabused of the notion that a brokerage account means they have arrived…
Actually, problems surfaced with auction-rate securities a few years back as this New York Times piece spells out:
…In 2006, the Securities and Exchange Commission reached a $13 million settlement with 15 investment banks, and the industry agreed to impose a voluntary code of conduct for the auction-rate market.
The S.E.C. investigation centered on how bidding was conducted for these securities. Critics complain that investment banks have the upper hand in bidding because they can bid after seeing what other investors have bid…
Unfortunately, the regulatory problems did not slow the business down and investors continued to pour in the assets under the assumption that these were really solid, short-term investments. But, once problems arose, the firms that sold these investments backed off until state securities regulators pushed them to make a deal. Bloomberg continues:
…And they all know that, no matter how the companies themselves spin it, none of them would see a single dollar if the states hadn’t forced the firms to cough up the cash, and in the most humiliating way possible — by pulling back the curtain and revealing what was going on backstage. It wasn’t a pretty sight.
It is passing strange that this disaster occurred not with stocks or bonds, but with something called auction-rate securities, that were touted — securities professionals hate the word, which connotes a gamble — as safe cash-equivalents.
Or, as Merrill Lynch & Co. put it in December 2007, “We remain convinced that auction market preferreds of closed-end funds are a conservatives’ conservative security with respect to credit risk.”
The real question in the months ahead is where the wistful victims of the Great Auction Securities Freeze of 2008 are going to take their money. If I were a betting man, I’d bet that you are going to see a lot of that money going home to local banks, if not under mattresses…
On this final point, I hope these investors get the message and leave Wall Street for Main Street. As the co-founder of an independent, fee-only financial advisory firm, it may seem self-serving, but I really I hope many of these clients will turn — not to banks or brokers — but to fee-only advisers.
By way of background, fee-only financial advisers are generally registered with the SEC as investment advisers. As such, they are considered to be fiduciaries and are required by law to act in the client’s best interest.
Hopefully, some of these investors will figure out that they should be getting investment advice from an independent source.
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