One of Shelby County’s largest employers is suing NatCity Investments Inc. to try to recover nearly $8 million in losses
on auction-rate securities.
Knauf Insulation filed suit in Shelby Superior Court in March, saying NatCity should repay the money in accordance with a settlement the bank reached with federal regulators in March 2009.
Investors nationwide have lost billions on auction-rate securities, which have been the subject of more than a dozen settlements with the Financial Industry Regulatory Authority.
“Knauf has enjoyed a long relationship with NatCity,” said Art Howe, a partner at Schopf & Weiss LLP, a Chicago business litigation firm representing the manufacturer. “It’s unfortunate that Knauf has had to go to court to get its money back, especially in light of NatCity’s settlements with national and state regulators.”
NatCity earlier repurchased some of Knauf’s auction-rate securities. But it maintains it doesn’t have to buy back the remaining $8 million because the company’s total auction-rate securities holdings—between NatCity Investments and National City Bank—exceeded the cutoff point of $10 million.
Knauf takes the opposite position, arguing that because its holdings with the bank and with the investment firm each were less than $10 million, it’s entitled to have all its securities repurchased.
“They’re splitting some very tiny hairs,” said Wayne Turner, a partner with Bingham McHale in Indianapolis representing National City.
Auction-rate securities, or ARS, are bonds whose interest rates are meant to be reset at daily, weekly or monthly auctions. Many financial firms marketed them as safe investments, equivalent to cash. But when credit markets seized up in 2007, auctions began to fail, freezing the $200 billion market and leaving investors without access to their money.
“This is merely one of many cases involved in ARS,” Howe said of his client Knauf. Another of his corporate clients, which he would not name, lost an amount in the “high” eight figures, he said.
Knauf’s lawsuit, which also names as defendants the FINRA and NatCity broker Randy Kord, was moved to U.S. District Court in Indianapolis last month.
Knauf is a German, privately owned firm with its North American headquarters in Shelbyville. The company employs about 500 people between two manufacturing plants there.
Howe would not comment on to what extent auction-rate securities losses affected Knauf’s bottom line.
The company plans to lay off about 100 workers starting in June, but the reason the company cited in its notice to the state Department of Workforce Development was decreased demand for building materials.
Cleveland-based National City was acquired in December 2008 by PNC Financial, based in Pittsburgh.
Under the settlement National City reached with FINRA in March 2009, the bank agreed to pay a $300,000 fine and buy back more than $23 million in auction-rate securities.
According to the agreement, the Cleveland-based bank sold $185 million in auction-rate securities from May 2006 to February 2008.
State and federal regulators have reached settlements with more than a dozen firms over the improper marketing of auction-rate securities.
FINRA alone has recorded 14 settlements with fines totaling nearly $5 million, and more than $2 billion in repurchases.
Indiana Secretary of State Todd Rokita recently announced settlements with a dozen firms, which agreed to repurchase more than $370 million in securities from Hoosier clients and pay fines totaling more than $3.5 million. National City was not involved in the Indiana settlement, though it reached an agreement in March 2009 with Missouri.
The Securities and Exchange Commission began investigating the auction-rate securities market in 2006, about two years before it collapsed.
The Knauf lawsuit, which draws heavily on conclusions reached in the FINRA settlement with NatCity, depicts the bank as beefing up its sales of the securities even as regulators were beginning to crack down.
The lawsuit shows that Warren Wise, Knauf’s senior vice president of finance, relied mainly on representations by Kord, a NatCity broker based in Indianapolis, who had been working with the company on its cash management since 1996.
Kord, the lawsuit alleges, suggested auction-rate securities were similar to variable-rate demand notes, where the company usually parked its cash.
The variable-rate demand notes, which are tied to money-market interest rates, had a seven-day or 35-day call period, and Kord incorporated that language in his description of the auction-rate securities.
“Kord regularly described [the securities] to Wise as ‘7-day’ or ‘35-day,’” the lawsuit states.
Kord, now working for PNC Financial in Indianapolis, referred questions to Turner. The Knauf complaint is the only one on Kord’s FINRA record since he became a registered broker in 1993.
According to the lawsuit, Kord recommended that Knauf purchase municipal auction-rate securities, and the company invested $1.5 million in September 2004.
Knauf sank more money into the securities after the risks became more widely known. The lawsuit notes that, beginning in May 2006, the SEC brought a series of enforcement actions against ARS underwriters, auction dealers and auction agents.
National City never informed Knauf about the enforcement actions, the lawsuit alleges, and auction-rate securities auctions began to fail in the summer of 2007. Yet NatCity continued to advise Knauf to buy the securities.
The company bought $3 million in Jefferson County, Alabama, sewer auction-rate securities in August 2007 and another $5 million of the same securities in January 2008.
Knauf acknowledges in its suit that National City bought back some auction-rate securities, but doesn’t disclose how much. Turner, National City’s attorney, said the repurchases totaled $8 million to $10 million and occurred around the time the FINRA settlement was negotiated.
He declined to explain the rationale for NatCity’s earlier repurchase, saying it was likely to come up in litigation.
After Wise learned of the FINRA settlement, he wrote to Kord demanding the repurchase of the remaining $8 million in auction-rate securities.
“As you know, I have been in contact with NatCity many times over the past few months about repurchasing these securities,” he wrote.
“Your response to my repeated requests for repurchase was that NatCity was prevented from repurchasing these securities due to an ongoing FINRA investigation.”•