Wednesday, April 02, 2008

E*TRADE hit with class-action lawsuit over auction-rate securities

I have no idea how many lawsuits have been filed to-date over auction-rate securities (ARS), but E*TRADE just got hit with one today by Girard Gibbs LLP. The press release is entitled "Girard Gibbs LLP Announces Class Action Lawsuit Filed Against E* TRADE Financial Corporation (Nasdaq:ETFC)" and says that:

The law firm of Girard Gibbs LLP (http://www.girardgibbs.com) announces that it is has filed a class action lawsuit on behalf of persons who purchased Auction Rate Securities from E*TRADE Financial Corporation (Nasdaq: ETFC) and E*TRADE Securities LLC, between April 2, 2003 and February 13, 2008, inclusive (the "Class Period"), and who continued to hold such securities as of February 13, 2008.

The class action, captioned Oughtred v. E*TRADE Financial Corporation, et al., 08-cv-3295 (SHS), is pending in the United States District Court for the Southern District of New York. The class action is brought against E*TRADE Financial Corporation and its wholly-owned broker-dealer subsidiary, E*TRADE Securities LLC.

The Complaint alleges that E*TRADE violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by deceiving investors about the investment characteristics of auction rate securities and the auction market in which these securities traded. Auction rate securities are either municipal or corporate debt securities or preferred stocks which pay interest at rates set at periodic "auctions." Auction rate securities generally have long-term maturities or no maturity dates.

The Complaint alleges that, pursuant to uniform sales materials and top-down management directives, E*TRADE offered and sold auction rate securities to the public as highly liquid cash-management vehicles and as suitable alternatives to money market mutual funds. According to the Complaint, holders of auction rate securities sold by E*TRADE and other broker-dealers have been unable to liquidate their positions in these securities following the decision on February 13, 2008 of all major broker-dealers to "withdraw their support" for the periodic auctions at which the interest rates paid on auction rates securities are set.

The Complaint alleges that E*TRADE failed to disclose the following material facts about the auction rate securities it sold to the class: (1) the auction rate securities were not cash alternatives, like money market funds, but were instead, complex, long-term financial instruments with 30 year maturity dates, or longer; (2) the auction rate securities were only liquid at the time of sale because broker-dealers were artificially supporting and manipulating the auction rate market to maintain the appearance of liquidity and stability; (3) broker-dealers routinely intervened in auctions for their own benefit, to set rates and prevent all-hold auctions and failed auctions; and (4) E*TRADE continued to market auction rate securities as liquid investments after it had determined that broker dealers were likely to withdraw their support for the periodic auctions and that a "freeze" of the market for auction rate securities would result.

I offer no opinion on the validity of this lawsuit or whether it is worthwhile to participate in it.

I would note that this is the first time that I have heard that a firm smaller than the big banks got involved in peddling auction-rate securities to clients.

Personally, I am beginning to wonder whether any of us retail investors may get the opportunity to buy some of these "failed" ARS securities at fire-sale prices that could make them fairly attractive as medium-term investments. I would think twice about doing that since prices could decline further especially if the unwinding of the ARS market takes longer than current holders are willing to tolerate.

-- Jack Krupansky

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