Though multi-billion dollar auction rate securities settlements were announced to great fanfare some months ago, litigation involving auction rate securities continues to mount (as I previously noted, here). Two recently filed proceedings highlight the fact that notwithstanding the settlements, many investors’ grievances are yet to be addressed.


As a result, while regulatory authorities continue to press for additional settlements, other investors may feel that the settlements do not remedy their particular claimed harm, and may seek to pursue individual litigation, in effect opting out of the regulatory settlements already reached.



I note that I raised the possibitliies for these further disputes when the settlements first emerged, here.



The Hutchinson Auction Rate Securities Lawsuit


First, on November 14, 20008, Hutchinson Technology filed a securities lawsuit in Minnesota federal court against UBS and related entities, accusing the defendants of fraud in connection with their purchase on Hutchinson’s behalf of approximately $70 million in illiquid auction rate securities under a discretionary cash management agreement.



Hutchinson’s complaint, which can be found here, alleges that UBS sought to protect its own balance sheet by seeking “secretly to shift the risk from its swelling inventory of ARS onto clients like Hutchinson by pitching ARS as safe, liquid, ‘cash equivalent’ investments while knowing that, in fact, the purported liquidity of the ARS had become an illusion.”



The complaint quotes extensively from UBS e-mails and other internal documents allegedly showing that the defendants had conflicts of interest with their own clients to whom they sold the securities, as well as a growing awareness of the dangers associated with a failing ARS marketplace. The complaint alleges that the defendants violated federal and state securities laws as well as other state statutory and common law duties.



What makes the Hutchinson complaint of particular interest is that it expressly acknowledges UBS’s August 2008 auction rate securities settlement, which the complaint also implicitly acknowledges applies by its terms to Hutchinson. However, the complaint alleges that the settlement “does not resolve the dispute between Hutchinson and UBS” in that the settlement’s terms “do not return Hutchinson to the position it would otherwise be in but for UBS’s fraud.”



Though the settlement contains UBS’s commitment to redeem the securities as par, “the purchases will take place over several years, and corporations with positions of more than $10 million (like Hutchinson) will not be able to start selling their position to UBS until June 30, 2010.” And thought the settlement required UBS to provide “liquidity loans,” any borrowing client would “remain obligated to repay the loan on demand even if the value of the ARS declines.”



Hutchinson’s complaint cites several alleged deficiencies with these arrangements. First, “it is uncertain whether UBS will have the means to satisfy its obligations or indeed survive as a firm.” (Ouch.) Second, Hutchinson “has needs for liquidity well in advance of that date,” including, for example, the need to redeem $150 million in convertible notes due in March 2010. Third, the value of Hutchinson’s ARS has “dropped considerably,” causing the company to mark down the securities on its balance sheet, with further writedowns potentially ahead, which in turn could have the effect of “potentially negatively impacting the price of its stock.”



Hutchinson is basically attempting to opt out of UBS’s regulatory settlement regarding the auction rate securities. Though the settlement promises eventually to make Hutchison whole, it is the word “eventually” that is giving Hutchinson concern. Hutchinson’s litigation objective may be discerned from its offer in its complaint to tender its auction rate securities investments “at par value plus all interest accrued.” Hutchinson wants its own deal, without having to wait, in effect contending that the delay itself constitutes an additional form of harm.



Hutchison may or may not succeed. Many of the harms it claims have not yet occurred, but merely threaten. But to the extent other investors perceive, like Hutchinson, that their interests are better served or will be advanced by separately litigating their claims rather than participating in the settlements, the utility of the regulatory settlements could be substantially undermined.



Because of this risk, UBS may have to vigorously contest Hutchison’s claim (and other claims like it) or face the prospect of a multitude in individual disputes and pressure to enter a multitude of individual deals that could bleed the company on a timetable accelerated from the more leisurely scheme contemplated in the regulatory settlements.



This potentially could become a process for the administration of a thousand cuts – and it potentially affects not just UBS, but Citicorp, Wachovia, Merrill Lynch and the other large institutions (or their successors in interest) that tried to effect a comprehensive solution to the auction rate securities debacle.



The Massachusetts Regulatory Action Against Oppenheimer


While the financial firms that have reached regulatory settlements could face continued litigation notwithstanding the settlements, other firms that have not yet reached settlements could face continued regulatory pressure to do so.



For example, on November 18, 2008, the Massachusetts Securities Division filed a complaint (here) to initiate an adjudicatory proceeding against Oppenheimer for alleged violations of state securities laws in connection with the company’s sales of auction rate securities to the firm’s clients in the state.



The complaint alleges that Oppenheimer “significantly misrepresented not only the nature of the ARS, but also the overall stability and health of the market when marketing the product to clients.” The complaint further alleges that “Oppenheimer executives and ARS Department personnel sold their own ARS as they learned that the market was in danger of imploding.”



The complaint, which was filed with the Office of the Secretary of the Commonwealth, seeks an order among other things, “requiring Oppenheimer to offer rescission of sales of ARS at par” and “requiring Oppenheimer to make full restitution to investors who already sold these instruments at less than par.” Basically, the complaint seeks to compel Oppenheimer to provide substantially the same relief as other firms previously have agreed as part of their regulatory settlements.



The one thing that is clear from these two new proceedings is that, despite the high profile settlements earlier this year, litigation surrounding the auction rate securities continues to mount. First, there are firms like Oppenheimer that have not yet reached regulatory settlements that will face pressure to do so. But second, there are continuing disputes, like those raised by Hutchinson, that continue even with respect to the firms that have already reached regulatory settlements.



If nothing else, it seems likely that the auction rate securities litigation will churn on for some time to come, with no end yet in sight.