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“Lehman Sued Over Conflict in Auction-Rate Securities”

Posted by Larry Doyle on June 10, 2009 8:02 AM |

Why does a $190 million lawsuit receive scant coverage? Why does a $100 billion plus financial fraud pass below the radar screen?  With the exception of Bloomberg News, the scandal surrounding Auction Rate Securities receives very limited serious coverage.

Well, with figures the magnitude of those mentioned above, Sense on Cents is highly energized to publicize the scandal and the embedded conflicts in this fraud.

Bloomberg reports, Lehman Sued Over Conflict in Auction-Rate Securities:

June 9 (Bloomberg) — Lehman Brothers Holdings Inc. was sued by two companies seeking more than $190 million over claims the bankrupt investment bank misrepresented the risk of auction- rate securities and had a conflict of interest in their sale.

The complaints against Lehman Brothers, which filed the biggest bankruptcy in U.S. history last September, were filed in federal bankruptcy court in Manhattan. Ceradyne Inc. and Western Digital Corp. claim Lehman had a conflict of interest serving as underwriter and seller of the securities.

Lehman Brothers wrongly asserted that interest rates on the securities were set through a well-established market, and that they were tradable, liquid, short-term investments, according to the complaint.

“The reality, well known to Lehman Brothers Holdings Inc. but undisclosed to Western Digital Corp., was that, in fact, auction rate securities was not supported by a broad, fully- functioning market and therefore could be subject to failed auctions and illiquidity,” according to the complaint.

The $330 billion auction-rate market collapsed in February, 2008, sparking a series of regulatory probes into how brokerages marketed the long-term securities. One year later investors were stuck with as much as $176 billion of the securities even after regulators have forced banks to buy back more than $50 billion of auction-rate debt that was marketed as safe, cash-like instruments.

Justice Department Probe

Last month, the Wall Street Journal, citing unnamed sources, reported that former Lehman executives have been questioned by U.S. Justice Department officials in an investigation of the company’s auction-rate securities sales.

Ceradyne is a Costa Mesa, California-based maker of ceramic body armor for U.S. soldiers, and Western Digital Corp., based in Lake Forest, California, manufactures hard-disk drives.

Lehman spokeswoman Kimberly Macleod didn’t immediately return a call seeking comment after business hours.

The case is In re Lehman Brothers Holdings Inc., 08-13555, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

The key phrase in this story from my perspective is “conflict of interest.”  The claimants are asserting that Lehman should have known and revealed the embedded risks in ARS and that they did not because they were benefitting both as issuer and underwriter.

Having written extensively about the ARS scandal here at Sense on Cents (newer readers can access all posts by writing Auction Rate Securities in the search window in the upper right hand corner of the home page), I would STRONGLY encourage Ceradyne Inc. and Western Digital Corp. to engage Finra in their suit. How so and why?

Would Finra need to be subpoenaed or merely interviewed? I am no lawyer so I will defer on that point.  That said, if Lehman were conflicted, I believe every ARS investor would benefit from knowing if Finra also had a conflict of interest in the ARS market.

Recall that Finra’s  mission is to protect investors. Finra was an ARS investor itself, and liquidated $647 million in Auction Rate Securities in Spring 2007. Finra did not publicly apprise investors of the ARS meltdown until the market had totally frozen in February 2008. Shortly thereafter, Finra posted a warning on its website. Thanks for very little!!

From my ARS archives, please check out:  U.S. Attorney and SEC Investigating Lehman’s Auction Rate Securities Sale; They Should Also Investigate Finra’s.

$190 million lawsuit. $176 billion of ARS. That is “real” money and it spells one enormous conflict!!


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