Phoenix Auction Rate Securities

On the advice of their brokers, thousands of investors in Phoenix, Arizona invested large sums of money into auction rate securities (ARS), believing that the securities were safe, liquid investments which could be converted into cash on very short notice. The liquidity of their investments was crucial; many of these investors could ill afford to have their funds tied up in long term commitments. Investment firms assured them such a thing would not happen, even going so far as to label Phoenix ARS bonds as "cash equivalents" on their statements.

In February 2008, the devastating truth was revealed. As broker-dealers pulled out of the Phoenix auction rate securities market in an attempt to reduce their growing risk exposure, hundreds of auctions failed, leaving investors holding now-illiquid bonds they could no longer sell.

Mechanics of Phoenix Auction Rate Securities

In reality, Phoenix auction rate securities were long-term bonds (i.e., with long maturity periods) with variable interest rates. The key selling point of ARS – liquidity – was achieved through periodic Dutch auctions at which a new interest rate was determined through the interaction of bondholder supply and buyer demand.

Those who wanted to purchase Phoenix ARS at auction would submit bids detailing the lowest interest rate they were willing to accept on their purchase. After all bids were tallied, the issue would be sold at the lowest interest possible – that is, the lowest interest rate at which all available shares were covered by buyers' bids. This rate, known as the clearing rate, became the new interest rate paid to bondholders until the next auction.

For two decades, this system appeared to work wonderfully. Demand was strong, and the frequent auctions delivered the liquidity that Phoenix investors wanted. Yet behind the scenes, the seeds of the market's February 2008 collapse were already being sown. While there was almost always sufficient demand to purchase Phoenix ARS at auction, investment firms' clients were not informed that this demand was frequently supplied by the broker-dealers that ran ARS auctions, and not by other investors.

Anatomy of a Market Collapse

As broker-dealers attempted to recover from their losses in the subprime loan market, few were willing to continue supporting the Phoenix auction rate securities market the way they had been doing for decades. Without broker-dealers to supply bids in auction, thousands of auctions were declared failures because of a lack of demand, leaving bondholders unable to sell their supposedly liquid securities.

As investor anger over the deceptive marketing strategies of Phoenix ARS investment firms swelled, several state governments, as well as the Securities and Exchange Commission (SEC) launched investigations into the practices of major firms, including UBS, Citigroup, and Merrill Lynch. As these investigations proceed, however, investors are still locked out of the money they legally own and desperately need.

If your funds have been trapped in the illiquid auction rate securities market, individual action may be the most efficient way to retrieve them. To learn more, contact an auction rate securities lawyer at 800-220-9341.