Auction Rate Securities Hamper Deals
The once-liquid tool is challenging investments ranging from NFL stadium constructions to already-completed M&A, forcing management and buyers back to the bargaining table before arbitrators.
July 23, 2008
Let’s see Tom Brady try and get the New England Patriots out of this one.
2008 has not been kind to this decade’s National Football League juggernaut, which now finds itself reportedly engaged in a law suit with Ambac Financial Group, its insurer, over fees surrounding its stadium construction debt, which in turn includes auction rate securities.
Auction rate securities are long-term holdings with rates that are renewed at each pre-determined bidding period—they come as often as once weekly, others are subject to new bids once monthly. Until recently, that is.
In February, a dwindling stream of liquidity began pushing auction bidders away from this instrument. Almost immediately, 80% of the market froze thanks to would-be investors’ newfound reluctance to make bids. All of a sudden, the auction rate securities many alleged were marketed to them as always easily-exited turned into long-term holdings with no opt-out. Converting the bonds is no mean feat either; associated charges the Super Bowl Champion New York Giants, Dallas Cowboys and Indianapolis Colts—each of which are also constructing or finishing new game venues—are expected to cost into the millions. Talk about fourth and long.
In July, reports surfaced stating the Patriots had invested $71 million in auction rate debt tied to the construction of their new stadium, and that the team’s suit against Ambac stemmed from the Pats’ loss on this position and fees their insurer had charged them. Both the Patriots and Ambac declined to speak on the matter.
The woes of team owner Robert Kraft—if one can assert the owner of a three-time Super Bowl champion who also ranks on the Forbes’ 400 Richest Americans list does, indeed, experience woes—reflect a new, budding dispute in the US M&A community: post-merger deals circling back to the negotiating table to hash out arguments over auction rate securities. Companies that invested in auction rate securities are feeling the pinch just as much as investors and football teams—and it is beginning to show.
Kevin Hanley, director in the post-acquisition dispute resolution practice at BDO Consulting, a division of BDO Seidman, has already seen firsthand a deal disintegrate into an auction rate securities fight. Hanley, whose firm is often called into Fortune 500 companies’ disputes when none of the Big Four accounting firms can be used, thanks to pre-existing conflicts of interest, said the classification of these investments became a sticking point after a deal closed.
In one instance, it was argued that the auction rate securities should, according to the company’s buyer—which Hanley declined to identify—have been placed on the acquired company’s working capital balance, thrusting the burden of unloading these newly illiquid investments onto its management. The acquired company—which Hanley also did not reveal—argued that, because the investments are illiquid, the operations of the company would be hampered by a lack of capital. Further, because of the market freeze, the company’s management argued, the auction rate securities investments once open to short-term purging were now long-term balance sheet fodder.
The buyer, of course, felt that since the acquired company bought the securities, they should be held responsible for them. Eventually, the seller’s points stuck.
“Before” the February auction rate securities freeze, “you could get out of them in a day,” Hanley said. Now, he said, of the ongoing auction rate securities fallout, “I don’t think it’s a situation that’s going to go away.”
Hanley said the deal on which he worked was struck in January, prior to the freeze on the auction rate securities market. But even those agreed to after the February freeze could be impacted; all it takes is a misclassification of the investment instrument to throw off the working capital balance sheet and both buyer and seller will have to wrangle out a new agreement.
Jason Fenwick, a director with KeyBanc Capital Markets, noted that while some sellers of auction rate securities currently might catch a break should they have had the accidental foresight to place money in municipal bonds, others are either stuck eating a deeply-discounted sale at a loss or toughing it out with the long-term investment.
Ken Csaplar, senior managing director for domestic M&A at Trenwith Securities, notes that it is not terribly common that parties which have already agreed to a merger or buyout find themselves back at the negotiating table—it is under 10% of all deals, he said. Of course, with 2008’s deal volume—while still significantly off from the first-half pace of 2007, when nearly 22,000 deals were done—hitting the 18,500 mark halfway through the year, that still allows for plenty of arguments.
“The buyer’s view of an appropriate level of reserves is often different from the seller’s,” said Tom Dutton, senior partner with Greenberg Traurig.
And now, Hanley said, as markets continue to struggle through the summer, M&A that was conducted without explicitly handling auction rate securities will see new partners back at the bargaining table over these stale investment tools.
Part of the exacerbation of the auction rate securities trading stems from aggressive selling of them, some of which has resulted in Bank of America being sued by a class of investors who claimed they were misled about the cash-management instruments over a four year period; Wachovia Securities being investigated following numerous complaints and Goldman Sachs’ probing as well.
UBS, on the other hand, elected to buy back auction rates securities in July from its customers, without disclosing at that point what the anticipated effect of the compromise would be.
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