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ARS Gratia Artis? Brokerage Wins Auction Rate Securities Arbitration
Written: January 3, 2011

Grand Circle LLC (“Grand Circle”) largely provides travel services to the 50-year-old-plus community. As part of that niche market, Grand Circle had significant credit card usage, which was initially processed through Citizens Bank (“Citizens”) but was discontinued by that bank in 2005. 

Following the termination of its credit card processing through Citizens, Grand Circle entered into a new arrangement with First Horizon, which specialized in the airline and travel industries.

Collateralized Letter of Credit

First Horizon required a letter of credit to back the credit card accounts. Citizens provided that letter of credit to Grand Circle subject to its being collateralized with a brokerage account simultaneously opened with Citizens’ broker-dealer affiliate CCO Investments Services Corp (“CCO”).

Cast of Characters

Joseph O’Connor (“O’Connor”) was the CCO account representative in charge of Grand Circle’s account, which had investment objectives of income and preservation of capital.

Larry N. Fox (“Fox”) was the Assistant Treasurer of Grand Circle and he was responsible for opening the CCO brokerage account, authorizing trading in the account, and interacting with CCO and Citizens. Upon opening the CCO account, Fox transferred Grand Circle’s $10 million in bonds held by Wachovia into the CCO account.

Grand Circle's Investment Policy

Grand Circle’s Assistant Treasurer Fox informed CCO account representative O’Connor that Grand Circle wanted securities that were safe, liquid and AAA rated. Grand Circle’s investment policies were set forth in its Investment Policy (which Fox had drafted and was approved by the company’s Board of Directors). In part, the Investment Policy identified “AAA” rated Auction Rate Securities (“ARS”) as eligible investments with “no limit” as to the allowed percentage of the portfolio.

Grand Circle’s ARS History

Before opening its CCO brokerage account, Grand Circle had previously purchased approximately $18 million of ARS in brokerage accounts held with Royal Bank of Canada (“RBC”) and Wachovia.  Those prior purchases were based upon recommendations and advice received from individuals at RBC and Wachovia.

In contradistinction to RBC and Wachovia, CCO and O’Connor had no experience in trading in ARS. ARS were not on the list of securities that CCO brokers were authorized to recommend or solicit.

On opening the CCO account. Fox expressly inquired of both Citizens and CCO if Grand Circle could purchase ARS in the brokerage account because he wanted the better yield afforded by ARS. After checking with others in his office, O’Connor informed Fox that ARS could be purchased in Grand Circle’s account.

Various witnesses, tapes of the conversations, trade confirms, and account statements confirm that all of the ARS trades were unsolicited, and all were directed and ordered by Fox.

The Market Crashes

In 2008, the ARS market crashed.

Obviously, this is the point where the story takes a dramatic turn.  Hold on because the ride’s going to get bumpgy.

Although Fox instructed O’Connor to sell Grand Circle’s ARS positions,CCO was able to liquidate some but not all of the positions. Grand Circle investigated the possibility of selling the remaining ARS in the secondary market, but ultimately decided to hold on to the remaining securities until the ARS market recovered.

And at this point, we must assume that Grand Circle started with $X and wound up with considerably less than $X. Quite often the party with less bucks accuses the brokerage firm of conduct that caused the loss.

“It’s all your fault,” says the client.

“No, it’s not. It’s all your fault,” says the broker.

“You told me to buy that crap,” says the client.

“No, I merely entered the orders — you made the investments on your own,” says the broker.

Regardless of the reasons or the actual words spoken, Grand Circle and CCO clearly had a parting of ways.

FINRA Arbitration

In a FINRA Arbitration Statement of Claim filed in November 2009, Claimant Grand Circle sought at least $2.5 Million in damages arising out of the purchase of ARS in its  CCO brokerage account. In the Matter of the Arbitration Between Grand Circle LLC, Claimant vs. CCO Investment Services Corp., Respondent (FINRA Arbitration 09-06454, December 10, 2010) 

In explaining its decision, the FINRA Panel apparently viewed the case as one in which Claimant Grand Circle was alleging that it had been victimized by the unsuitability of the ARS investment.  However, the Panel rejected the attempt by Claimant Grand Circle to base its unsuitability claim upon the background and experience of Fox rather than the actual Claimant, which was deemed to be the more sophisticated, institutional investor Grand Circle. This effort to re-cast Fox in the role of the institutional Claimant was described by the Panel as ”misplaced.”

Further, the FINRA Panel characterized Claimant Grand Circle as having ”clearly stated Investment Objectives and a written corporate Investment Policy. ” Additionally, the Panel noted that Grand Circle’s account was non-discretionary and all of the trades were unsolicited by CCO. Similarly, the Panel found that the subject trades comported with Grand Circle’s stated investment objectives and its Investment Policy.

From a credit standpoint, the Panel allowed that Citizens Bank may have been remiss in taking long-term instruments as collateral for a short term, standby letter of credit. Nonetheless, that voluntary act by Citizens was not deemed tantamount to holding ARS out as cash or cash equivalents; and, further, the Panel noted that the ARS were not listed as cash/cash equivalents on statements issued by CCO’s clearing agent, National Financial Services LLC.

In conclusion, the Panel found that it was Claimant Grand Circle and not Respondent CCO that  made the decision to purchase ARS, which was based upon the advice and information provided by third-party investment advisors and by Fox.  Moreover, the Panel found that Claimant knew that Respondent CCO had limited knowledge and/or experience with ARS, and that CCO did not fail to disclose material facts about the ARS.  Finally, the Panel concluded that the ARS purchased were within the express Investment Policy of Grand Circle.


 
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