In February 2008, the market for auction rate securities (“ARS”) in the United States experienced significant disruption when many auctions failed. Widespread litigation ensued in which plaintiffs asserted claims under the federal securities laws against various market participants. Three years later, the district courts have spoken in a nearly uniform voice. Most actions alleging violations of the securities laws arising from ARS auctions have been dismissed for failure to state a claim. Appeals from two of those dismissal decisions are pending before the Second Circuit.1
Background
Auction rate securities are bonds and preferred stock with interest rates or dividend yields that are reset at periodic auctions typically held every seven, 14, 28, 35 or 49 days. The securities are issued by closed-end funds, states or state agencies, municipalities, student loan originators and other corporations. At a reset date, a “Dutch” auction is used to establish a new interest rate or dividend yield for the next period. Bids with the lowest rate and successively higher bids are accepted until all sale orders have been filled. The “clearing rate,” the lowest rate at which all orders can be filled, is thereby established until the next auction. If there are not enough bids to cover the securities for sale, then the auction fails. In those circumstances, ARS investors receive a pre-determined above-market return that is specified in the offering documents, but they might not be able to sell their securities until the next successful auction which could result in a loss of liquidity.
