The collapse of the market for auction rate securities (ARS) has generated a flood of litigation, mostly brought by angry ARS investors against the broker dealers who sold them the securities or against the mutual funds that allegedly failed to disclose that their assets were invested in these kinds of securities. More recently (refer for example here), companies that invested in ARS and carried the securities on their balance sheet have been sued by their own shareholders in connection with the companies’ ARS disclosures.
A recently filed lawsuit presents yet another variant of ARS litigation – in this most recent case, the directors and officers of a student loan originator that issued ARS have been sued by the company’s own shareholders for failing to disclose the company’s dependence upon and susceptibility to the weaknesses of the ARS marketplace.
Until it filed for voluntary Chapter 7 bankruptcy on February 9, 2009, MRU Holdings was an originator and holder of federal and private student loans which it marketed through its consumer brand My Rich Uncle. MRU collected its loans into student loan pools that were packaged and sold by broker-dealers (including Merrill Lynch) to investors. The interests in the pool were issued as auction rate securities. This securitization process freed up capital to make new loans and also generated fee income and other revenues. During its fiscal year ended on June 30, 2007, 58% of the company’s income came from securitizations, more twice the income the Company earned on interest from student loans.
On April 15, 2009, plaintiffs’ counsel filed a complaint in the Southern District of New York against four of MRU’s former directors and officers on behalf of persons who purchased MRU’s shares between July 9, 2007 and September 19, 2008. A copy of the complaint can be found here. The company itself, which is in bankruptcy, was not named as a defendant.
The complaint alleges that the company failed to disclose that the ARS market was illiquid and depended on the illusion of liquidity created by the broker-dealers’ undisclosed interventions to prop up the marketplace and prevent failures of the auction process. The complaint alleges that this illusion "allowed the Company to pay a lower interest rate" in the notes issued in connection with the company’s 2007 securitization, and that the spread allowed the company to realize a $16.3 million gain.
The complaint also alleges that the Company failed to disclose that once the "true nature of the ARS market became known," the Company’s future securitizations would not be as favorable and that "without the favorable terms available in the ARS market as a result of the manipulation by broker-dealers, the Company would not have sufficient capital to originate loans, making the Company’s business model untenable."
The complaint alleges that the Company failed to disclose the impact that the February 2008 collapse of the market for ARS would have on its ability to depend on securitizations to sell loans and free up capital. The complaint further alleges that on July 3, 2008, the Company announced the pricing of a $140 million private student loan securitization; however, on July 7, 2008, the Company further announced that the bonds to be issued in the pending securitization would be sold at a discount, and that rather than generating income, "the securitization would result in a significant write-down of assets."
Thereafter, the company’s share price declined, and Moody’s subsequently downgraded the company’s ARSs. On September 5, 2008, the Company announced that it would "pause" its student loan program. On September 19, 2008, the Company announced that its September 15, 2008 audit report contained a going concern opinion. The company later filed for bankruptcy.
As noted above, this new complaint against the former MRU directors and offices differs from prior ARS lawsuits, both in terms of who the plaintiffs are and in terms of the allegations raised. In the vast bulk of the ARS lawsuits filed under the securities laws, the plaintiffs are ARS investors who are suing broker-dealers who sold them the securities and whom the investors allege made misrepresentation in connection with the ARS. Similarly, mutual fund investors have sued the funds for failing to disclosure the funds’ investments in ARS. More recently, shareholders of companies that were ARS investors and that suffered balance sheet write-downs (and ensuing share price declines) have sued the companies because of the companies’ investment in ARS.
By contrast to those other case, the plaintiffs are neither ARS investors nor shareholders of companies that invested in ARS instruments. Rather, the plaintiffs in the MRU case are shareholders of a company that put loans into pools out of which the securities were issued.
And again by contrast to the other cases, the misrepresentation alleged in the MRU case are not about the nature of the ARS investments (as in the broker dealer cases}, or even about a balance sheet exposure to ARS investments (as in the prior public company cases), but rather about the company’s alleged dependence on the availability of the artificially favorable ARS marketplace as a way to generate income and as a way to free up capital.
While the MRU case may represent a new variant on the ARS theme, more cases of the now familiar forms of ARS litigation have continued to accrue.
For example, on April 16, 2009, Ashland Inc. filed a lawsuit in the Eastern District of Kentucky against Oppenheimer & Co. (copy of complaint here), in which Ashland alleged that Oppenheimer convinced Ashland to hold and to continue to invest in ARS "at a time when Oppenheimer knew the market for those ARS was collapsing."
The Ashland complaint alleges that after August 2007 disturbances in the marketplace for ARS based on municipal government bonds, that Oppenheimer steered Ashland toward ARS based on student loan obligations ("SLARS"). The complaint alleges that after the market for SLARS collapsed in 2008, Ashland was left "with approximately $194 million of illiquid Oppenheimer-brokered SLARS."
In a separate complaint also filed on April 16, 2009, Braintree Laboratories and related entities sued Citigroup Global Markets in the District of Massachusetts (complaint here). Braintree alleges that between June 2008 and August 2008, Citigroup sold Braintree approximately $33.3 million of ARS, which Citigroup allegedly had referred to not as ARS but as "seven day rolls" and as "government backed ‘money market’ investments."
Braintree alleges that despite its admissions in its various regulatory settlements, Citigroup has refused Braintree’s demand for rescission of the transactions. Among other things, Braintree alleges that in connection with the sale of the ARS to Braintree, "Citigroup acted with criminal and flagrant indifference to the rights, interests and property of the Braintree Entities and the public" and that the sales "resulted from ongoing fraudulent practices."
The Braintree complaint also alleges that the ARS sales to Braintree "fell close in proximity to Citigroup erasing recordings of conversations involving employees at its auction rate desk." The complaint alleges that "when engaging in these acts of spoliation of evidence and obstruction of justice, Citigroup acted willfully and with scienter."
If nothing else, the one thing that is absolutely clear about the breakdown of the auction rate securities marketplace is that it has proven to be an absolute litigation generating machine.
The Ashland and Braintree cases also demonstrates, as I have argued elsewhere (refer here), that neither the dismissal of the UBS auction rate securities lawsuit nor the ARS regulatory settlements marked the end of ARS litigation. As I noted more recently (here), the ARS litigation has continued to come in – and as the Braintree lawsuit demonstrates, interesting new allegations (such as the spoliation charge) continue to emerge.
The MRU lawsuit also shows that the auction rate securities litigation wave has continued to evolve as it has continued to grow. Further lawsuit variants seem likely as the wave continues to progress.
I have in any event added the MRU lawsuit to my table of credit crisis related class action securities litigation, which can be accessed here.
Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the MRU complaint.
A Tribute to Susan Boyle: If you have not yet seen the video of Susan Boyle, an unemployed 47 year-old, singing a song from Les Miserables on the April 11, 2009 episode of Britain’s Got Talent, then you must drop everything and watch the video right now. Due to YouTube restrictions, I can’t embed the actual video in this post, but the video can be seen here.Take the time to watch the entire video; it is worth the seven minutes it takes to watch it. (Hat tip to the Drug and Device Law Blog, here, for the link.)
The video is even more moving if you follow the lyrics of the song she is singing, which are as follows (thanks to the Conglomerate blog, here, for the lyrics):
I dreamed a dream in time gone by,
When hope was high and life, worth living.
I dreamed that love would never die,
I dreamed that God would be forgiving.
Then I was young and unafraid,
And dreams were made and used and wasted.
There was no ransom to be paid,
No song unsung, no wine, untasted.
But the tigers come at night,
With their voices soft as thunder,
As they tear your hope apart,
And they turn your dream to shame.
And still I dream he'll come to me,
That we will live [our lives] together,
But there are dreams that cannot be,
And there are storms we cannot weather!
I had a dream my life would be
So different from this hell I'm living,
So different now from what it seemed...
Now life has killed the dream I dreamed...