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Investors holding securities tied to the stalled auction-rate market, which sets interest rates for certain types of bonds at periodic auctions, are filing lawsuits and arbitration proceedings alleging, among other things, that investors were deceived. At least 16 lawsuits have been filed since mid-March in federal courts in New York, California and Georgia, and more plaintiffs’ lawyers are filing arbitrations with the Financial Industry Regulatory Authority to recover their clients’ cash. And New York Attorney General Andrew Cuomo is scrutinizing how auction-rate securities were promoted and marketed. The lawsuits allege that the brokerage companies violated federal securities laws and U.S. Securities and Exchange Commission (SEC) rules by deceiving investors into thinking auction-rate securities were liquid investments suitable for parking cash for short-term gains. They also claimed that the companies failed to disclose key information about the securities and artificially propped up the auction rate market by buying them. According to the lawsuits, the auction-rate market collapsed in mid-February when major brokerage houses stopped buying enough securities to support it. Brokerage agreements often contain clauses requiring customers to arbitrate disputes, so plaintiffs’ lawyers must win class action status to bring cases to court. Defense lawyers contend that these lawsuits face two major hurdles: winning class action status for fraud claims, and calculating damages claims for investments that are suddenly illiquid but haven’t decreased in value. What’s more, the market is likely to recover in the wake of SEC and Internal Revenue Service actions to restart trading, lawyers say. To be sure, investors stung by the auction-rate trading halt are scrambling for legal help. Dozens, if not hundreds, of investors have contacted St. Louis-based Carey & Danis, but the firm is still sifting through claims to find committed class action plaintiffs and sending other disputes to arbitration, said attorney Joseph Danis. One client, for example, needs to pay taxes with about $1 million tied up in auction-rate securities at Merrill Lynch & Co., Danis said. “We need clients that don’t need the money as bad and are 100% committed to be a name representative,” Danis said. “Those are more difficult to come by.” Levi & Korsinsky in New York has already found five such clients in New York and Georgia. They are bringing suits that include LHB Insurance Brokerage Inc. v. Citigroup Inc., No. 1:08-cv-03095; Stanton v. Merrill Lynch & Co. Inc., No. 1:08-cv-03054 (S.D.N.Y.); and Zisholtz v. SunTrust Banks Inc., No. 1:08-cv-01287 (N.D. Ga.). Partner Ed Korsinsky said the involved investors thought they were buying something akin to a money market account, not securities. “People didn’t realize that they were buying securities,” Korsinsky said. “It hit them like a frying pan on their forehead.” Korsinsky also said that verbal, and even written, disclosure of the risks of auction-rate securities wasn’t readily available. Brokers didn’t tell their customers about the risks, didn’t stock or distribute prospectuses or make them available online, Korsinsky said. Since starting the cases, he’s obtained prospectuses from some defendants that date back to the 1980s, he said. “Any defendant who wants to point to the risks and disclosure in the prospectus is going to have a hard time,” he said. Through spokespeople, Merrill Lynch and SunTrust Banks Inc. called the lawsuits “without merit.” Morgan Stanley and UBS A.G. said they’re looking at clients’ liquidity needs on a case-by-base basis, sometimes offering loans. Morgan Stanley, along with Citigroup Inc., emphasized that the problem is an industrywide issue. “We are actively supporting industry groups in developing a solution that will deliver the quickest and most transparent price discovery by broadening demand, serving the best interests of both dealers and investors,” said Citigroup spokesman Alexander Samuelson. Widespread erroneous information stemming from brokerage houses is exactly why the lawsuits are strong cases, said Jonathan Levine of San Francisco-based Girard Gibbs, which has already filed 10 federal cases in New York, and one California case. “The misrepresentations and omissions appear to be uniform and fairly egregious,” Levine said. Girard Gibbs has active lawsuits against the same companies as Levi & Korsinsky, except SunTrust Banks, plus six other major brokerages. Kraemer v. Deutsche Bank, No. 1:08-cv-02788; Oughtred v. E*Trade Financial Corp., No. 1:08-cv-03295; Defer L.P. v. Raymond James Financial Inc., No. 1:08-cv-03449; Humphrys v. TD Ameritrade Holding Corp., No. 1:08-cv-02912; and Waldman v. Wachovia Corp., No. 1:08-cv-02913 (S.D.N.Y.); plus Van Dyke v. Wells Fargo & Co., No. 3:08-cv-01962 (N.D. Calif.). Deutsche Bank A.G., TD Ameritrade and Wachovia declined to comment. Raymond James “intends to seek prompt dismissal.” E*Trade spokeswoman Pamela Erickson called the lawsuit “an attempt to piggyback” on cases filed against other companies. Wells Fargo said the company is “doing what we can to support our customers.” Brokerage arbitration clauses can be a hurdle, but fraud claims can be brought to court, Danis said. Danis believes that brokerage houses and the auction-rate issuers had relationships that were more lucrative than traditional money market relationships, and that both sides benefited by getting individual brokers to misrepresent the securities to customers. “The brokers themselves were completely unaware,” Danis said. “Their employers were aware and they financially gained from it.” It’s difficult to build a class action on misrepresentation or fraud claims, said securities litigator and corporate lawyer Christopher Litterio, managing shareholder at Boston-based Ruberto, Israel & Weiner. “If 5,000 brokers across UBS or Merrill Lynch talked to thousands of different clients and had a different sales pitch, those are probably more difficult to get certified as a class action,” Litterio said. What’s more, civil cases that lack calculable damages are always hard to prove, Litterio said. Korsinsky acknowledged that proving damages is easier if the securities have been marked down, as they have at UBS, but he emphasized that established damages models for liquidity do exist. UBS said it has decreased the value of about 90% of its customers’ auction-rate securities by 5%. Such arguments may be a moot point by the time the cases reach the discovery or motion to dismiss phase because the market may correct itself, said Gregg Zucker, a securities defense lawyer at DLA Piper. “In some instances, I think that the market is going to correct some of these problems,” Zucker said. Zucker and others pointed to recent advocacy from the Securities Industry and Financial Markets Association, which led to guidance from the SEC for dealers and issuers participating in the auction-rate securities market. The SEC’s March 14 letter to the association said issuers can buy back their own securities, and broker-dealers can make bids on those securities to prevent auctions from failing, as long as they disclose such actions on Web sites and to industry securities groups.

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