Auction-Rate Case Is Lesson In Liquidity For Advisors

(Dow Jones) An $81 million ruling against UBS AG's (UBS, UBSN.VX) brokerage will chiefly compensate a client for its lost business. There's also an indirect message for all advisors to heed in terms of safeguarding client liquidity.

In the case against UBS Financial Services Inc., an arbitration panel of the Financial Industry Regulatory authority found the unit of UBS liable for business damage that investor Kajeet Inc. suffered while its money was tied up frozen auction-rate securities. The company markets cellphones for youngsters.

For many investors in auction-rates, the issue is getting the money they invested back. That was, for instance, what an investor recently sought and won in a $2.5 million case against Raymond James Financial Inc. (RJF)

But that wasn't the case here. UBS had entered into an ARS settlement with the Securities and Exchange Commission. Clients such as Kajeet, who participated in the settlement, and those on behalf of other brokerages, may use a special Finra arbitration procedure that allows them to seek consequential damages, or reimbursement for losses they suffered because their assets were frozen, such as missed business opportunities.

The panel in Kajeet's case ordered UBS to pay 10 times the amount the company originally invested in auction-rate securities. It actually asked for even more, $110 million, when it filed its claim in 2009.

"This teaches a lesson to the industry that consequential damages are available when their clients go through a liquidity crisis," says Gregory Lawrence, a lawyer in Baltimore who represented Kajeet. "You have to have the funds to pay for your operations, and if those are locked up, the consequences are fairly predictable, whether it be a securities firm or local deli."

Daniel Neal, Kajeet's CEO, says because assets were frozen, they lost distribution deals with major retailers such as BestBuy Co. Inc. (BBY) and Target Corp. (TGT). It now markets via the Internet, where, he says, customers are less likely to buy phones. "We're obviously very pleased with [the] decision by [the] panel. We believe that justice was served," says Neal.

A UBS spokeswoman said the company "strongly disagree[s] with the arbitration panel's decision" and that the outcome is "unwarranted under both the facts and the law." It plans to try to overturn the decision, she said.

Kajeet was among 40,000 UBS customers who held a total of more than $35 billion in auction-rate securities, according to a 2008 SEC complaint. It ultimately sold $4 million of its auction-rate securities in May 2008 at a 10% loss, which was later made up by UBS. It then sold its remaining $4 million in January 2009 under a regulator-mandated UBS buyback plan.

Settlements between regulators and brokerages typically require providing liquidity to smaller investors, but the damage was often done by the time those deals were reached, says Michael Gass, a Boston-based lawyer who specializes in securities litigation.

"There's certainly been a recognition out there that there's a difference among those who were harmed by the auction-rate market and those who faced very real, practical problems," he says.

Consequential damages awards are "somewhat unusual," says Adam Gana, a New York-based securities lawyer, and it may not deter Wall Street from engaging in certain practices. The Finra panel, as is customary, didn't give an explanation for its award in the case. Still, Gana says, it shows how the Finra process should work when a brokerage has done something wrong.

"Claimants are starting to get their day in court and awards that reflect what they should get," he says.