Auction-Rate Woes Dissolve for Oppenheimer and a Merrill Broker

Summary of Keypoints

• Oppenheimer & Co. absorbed significant losses to unwind auction-rate securities exposure: In the third quarter, Oppenheimer recorded $8.1 million in pretax losses (and a $6 million net loss impact) after selling a substantial portion of its auction-rate securities (ARS) holdings below par as interest rates rose, aiming to finally resolve a decade-long ARS overhang.
• The firm continues addressing legacy ARS obligations from the 2008 crisis: As of the end of 2017, Oppenheimer still held about $114 million in ARS repurchased from retail investors and remained obligated to buy nearly $50 million more, following agreements with regulators after the ARS market froze in 2008.
• A Merrill Lynch broker won expungement of an ARS-related complaint: Josephine White, a Merrill broker in Oakland, California, successfully obtained expungement of a 2008 customer complaint alleging misrepresentation and unsuitable sale of auction-rate securities.
• The arbitrator placed responsibility on Merrill, not the broker: The arbitrator found the allegations against White “misplaced,” concluding they should have been directed at Merrill for failing to disclose regulatory actions and the illiquidity risks surrounding ARS, including SEC enforcement activity.
• The expungement was uncontested and cleared the broker’s record: Merrill and the customer did not oppose the expungement request, leaving White with no remaining disclosures on her BrokerCheck record following the FINRA arbitration decision.

Oppenheimer & Co. recorded a loss of $6 million during the third quarter on sales of auction-rate securities that have bedeviled its profitability for a decade, while a California broker at Merrill Lynch has won expungement of a customer complaint accusing her of misrepresenting potential dangers of buying the securities.

Oppenheimer, which has fewer than 1,100 brokers, made a strategic decision to sell “a significant portion” of its ARS holdings in the third quarter as interest rates rose, the New York-based firm said in reporting third-quarter earnings of $5.1 million on Friday.  It recorded $8.1 million of pretax losses from the transactions, reflecting sale of the securities at below-par prices to issuers and a revaluation of securities it owns or has committed to repurchase from customers.

“The company expects that a continued rise in short-term interest rates will help the company finally put this issue behind it,” Albert ‘Bud’ Lowenthal, Oppenheimer’s chairman, chief executive  and largest individual shareholder, said in a prepared statement. “The company believes that it can put the capital previously devoted to ARS purchases to more productive uses and that this is extremely positive from a liquidity perspective.”

As of the end of 2017, Oppenheimer held about $114 million of auction-rate securities that it had repurchased from retail investors since 2010 under agreements with regulators after the auction market froze in 2008. It is obligated to purchase almost another $50 million of ARS from retail investors, according to its most recent annual report.

Auction rate securities, debt and preferred-stock instruments whose rates reset at auctions held every seven to 30 days, were sold as conservative investments with money-market characteristics prior to the 2008 financial crisis. But auctions began failing as credit dried up in the run-up to the crisis, leaving retail investors with $330 billion that they were not able to sell.

Large Wall Street firms that underwrote the auctions reached billion-dollar agreements to repurchase the securities from investors, but Oppenheimer, which was not an underwriter, did not have the capital for a mass tender offer. It has been fulfilling its legal and regulatory obligations as capital constraints permit, and also agreed in 2010 to reimburse investors who borrowed money from it to buy the securities and to resolve investors’ claims in a special arbitration process.

On Thursday, Josephine White, a Merrill Lynch broker in Oakland, Calif., won an unusual arbitration case in which the firm was told to expunge a 2008 complaint from a customer alleging that she misrepresented the ARS market and unsuitably sold the securities.

The unnamed customer had complained in another arbitration procedure against Merrill that White failed to tell her in advance that auction-rate securities would be illiquid if the auction system failed.

The allegations that appear on White’s BrokerCheck record are “misplaced” because they should have been pressed against Merrill, according to the decision of arbitrator Herb Schwartz in San Francisco. It failed to advise the customer of a Securities and Exchange Commission press release that said it was suing Merrill and 14 other broker-dealers for misrepresenting the securities, the arbitrator wrote.

White also testified that Merrill’s research department failed to advise her that the ARS market was illiquid or that the securities “were under a cloud of regulatory enforcement,” according to the award decision published on Finra’s dispute resolution website. The document does not say when White sold the securities at issue to the investor.

Merrill accepted no responsibility for its “failure to advise of its role in violating the SEC rules,” the arbitrator wrote, but did reach a settlement with the customer. Neither Merrill nor the customer opposed White’s request for expungement, according to Schwartz’s opinion.

A Merrill spokesman declined to comment. White, who has worked at Merrill since beginning her brokerage career in the summer of 2005, did not return a request for comment left at the firm’s Oakland office. She has no other disclosure besides the 2008 customer complaint on her BrokerCheck record.

Michael Bessette, her lawyer in the expungement proceeding, did not respond to requests for comment.

October 26, 2018 by AdvisorHub Staff

https://www.advisorhub.com/auction-rate-woes-dissolve-for-oppenheimer-and-a-merrill-broker/