Deranged Monkey Criticism
Long Auction Nightmare Over

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By greenmartian4
October 15, 2009

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Posted why? So you can learn from my mistakes:

*I don't recall exactly recall when but I started to buy closed end preferred auction notes as a partial money market fund substitute a few years ago. I did some due diligence, but basically never questioned why these investments were called auction notes in the first place. For example, would the auctions ever fail, and if they did, what were the liquidity issues involved in getting the money back. I basically relied on a Nuveen commentary, posted on their website, that emphasized that in over 20 years, the auction process had never failed.

*In Feb 2008 the auctions failed. I should had suspected something was going on when my auction purchase the week before did not go through. However, when i called TD Ameritrade to inquire as to why, I was told that there were likely too many people bidding on them. Either he was ill-informed (most likely) or the guy lied, but there was an imbalance of sell orders and the original underwriter, big brokerage houses and banks, were increasingly on the side of having to buy more. Unknown to me, these underwriters had been supporting the auctions for years, stepping in when there was an imbalance of orders to make sure the auction process functioned smoothly. Until they didn't. Which essentially was the end of the auction process, cause once liquidity dried up, and money could not be redeemed at will on a weekly basis, the auction process completely froze.

*I don't wish to reveal how much money I had tied into these things but suffice it to say I usually have notable cash balances and used these things extensively.

*Again, without getting into detail, I didn't handle these issue very well. Taken to the extreme, I felt - logically - that this could have essentially be the end of my business as I knew it. Granted, clients are supposed to have a 5 year time horizon when they sign up with me (written into the account agreement) but being blunt here - nobody wants their money completely illiquid. Nobody. In the end, I had some issues with a limited number of clients. But unlike someone working with ML or Barclay's or GS, my business has my name in the title, and I felt keenly responsible for getting us into this situation.

*After a long-drawn out process of due diligence, I finally determined that, by and large, the preferred notes were somewhat 'safe' in the sense of any principal issues because there was a mandated 200% coverage requirement. So if you had 500m in preferred notes, you had to have at least 500m in other assets. Once the coverage ratio broke 200%, companies were required to suspend all dividends until such time as they reached 200% again. In reality, every company I owned did a partial redemption to reach 200% again, usually within one month, which is a good thing because there was one closed end fund in particular who sustained horrific losses. In short, unless you had an immediate huge loss, which was exaggerated by the leverage of these notes, the notes would maintain their coverage.

*After a few months, some companies began to voluntarily redeem their notes under certain circumstances (either from debt refinancings or outright redemptions). Eventually, I had all but 1/8th of these notes redeemed in this manner, though the final redemptions for some groups took as long as this month. Meanwhile, these notes did generally pay well-above money market rates (at times, some substantially above), and because I was holding high cash levels for the past couple years, clients who owned these things - liquidity aside - financially benefited from the ownership. Liquidity aside.

*This does have an ending. This month the last of my client notes will be redeemed and I am hopeful that one note in my account will be liquidated upon approval of a merger. Otherwise, again without getting into specifics, I ended up solving the liquidity issue for any clients still in possession and to finally rid myself of this burden a day ago the notes were sold in the secondary market (taking a loss, but in an ironic twist of fate I believe the loss largely offsets an auction related to the notes I took last year in my personal accounts that, in pure happenstance, benefited my account).

So - some lessons and observations:

*I have always struggled with the issue of having cash in client accounts. All I can say now is - don't. If your overall performance is good, then cash levels are just one factor in that. For heaven's sake, don't get overly creative in looking for alternatives unless you are 100% cognizant of the risks involved. Remember - simple is always better. If you a good stock picker, focus on that to exclusion of all else. Period. Don't do what I did.

*These auction notes were grossly misrepresented by the fund companies that issued them. This isn't a surprise to all of us, but these companies are more interested in selling product than looking out for the benefit of their clients. There are always exceptions of course (see below), but most of them are scoundrels. Plus, as a warning, while doing my due diligence process on several occasions I got completely wrong information from the fund representative. As a rule, very few of them were knowledgeable enough to help me, and some were downright patronizing with their ignorance.

*I wanted to make special mention of Blackrock as the most unhelpful, rudest company I dealt with. I've never been treated this badly by a fund company before, and would never willingly do business with them again if there is an alternative.

*I do want to mention that Nuveen did a great job keeping everyone updated on their latest actions. While they may not have been as timely as I wished, they took pains to detail what they were doing each step of the way while providing detailed information on reset rates and the like. Granted, they misrepresented the notes in the first place, but the company took its fiduciary duty seriously when this become a problem.

*By and large, I can't say enough thanks to my client base, who stood by me during this issue and never added to my burden.

In short, after this month the nightmare is essentially over (fingers crossed). What a horrible, awful trip it has been.