Lehman Clients Demand $1.1 Billion in Auction Dispute (Update2) By David Scheer Jan. 18 (Bloomberg) -- Lehman Brothers Holdings Inc. faces a $1.14 billion claim from members of a New Jersey family, who say the firm mishandled their fortune by steering $286 million into investments that have become hard to sell. Brian and Basil Maher, two brothers who sold their family's marine container company last year, say Lehman ignored their requests to place the proceeds in short-term, liquid assets, according to an arbitration complaint filed yesterday with the Financial Industry Regulatory Authority. Instead, the Maher brothers say, Lehman put the money into so-called auction-rate securities that have been hit by the contraction in credit markets. The arbitration claim may be the largest filed against a U.S. brokerage since a surge in defaults on subprime mortgages last year prompted investors to shun high- yield debt. ``If Lehman had directions to do X and then they did Y, they could be liable,'' said Tamar Frankel, a law professor at Boston University who has written about investment industry regulation. Lehman, the fourth-largest U.S. securities firm by market value, disputed the Maher family's accusations. ``These clients had a professional investment consultant with whom we dealt,'' said Randall Whitestone, a Lehman spokesman. ``We believe we have meritorious defenses to this claim.'' The Mahers' complaint also names six of the New York-based firm's employees as defendants. Punitive Damages Sought The Mahers asked Finra arbitrators, who resolve disputes between brokerages and their clients behind closed doors, to require Lehman buy the $286 million in illiquid debt securities, which they describe as a loss. They are also demanding Lehman pay three times that amount, or $857 million, in punitive damages, plus legal costs and interest. Essex Equity Holdings USA LLC, a company controlled by the Mahers, is also a plaintiff in the case. ``Fundamental to this was an agreement with two objectives, to preserve the capital and provide liquidity,'' said family spokesman Anthony Cicatiello. After Lehman employees showed the Mahers a sample portfolio that met those criteria, ``they didn't do what was in line with that.'' Panel's Discretion Even if the Mahers prevail, arbitrators may not award the full amount they're seeking, according to Frankel, the Boston University professor. ``It depends on what they think the market practices are,'' she said. ``They may hit hard, or not at all.'' Lehman fell 2.6 percent to $53.25 as in New York trading, as concerns the U.S. economy will enter a recession drove down the Standard & Poor's 500 Index for a fourth straight day. The bank's stock has declined 19 percent this year. Investors received awards in about 42 percent of industry arbitration cases in 2006, when the system was run by NASD, Finra's predecessor, according to the most recent figures available on the regulator's Web site. Hearings are conducted by three-member arbitration panels that include a securities-industry representative. Auction-rate securities are typically bonds whose interest rates are reset by periodic bidding, usually every seven, 28 or 35 days. The auctions can fail if there aren't enough bids, leaving investors stuck with their holdings. In such cases, many bonds automatically compensate investors by paying higher interest rates. Blaming Brokers Investors surprised by the illiquidity of auction-rate securities often blame their brokers, said Donald Langevoort, a securities law professor at Georgetown University in Washington. ``My suspicion is that most investors are not even aware of auction-type securities,'' Langevoort said. Lehman was the 10th-largest senior underwriter of municipal auction-rate securities in 2006, with $970.4 million of the instruments, according to Thomson Financial data in the 2007 Bond Buyer Yearbook. It doesn't rank corporate auctions. The U.S. Securities and Exchange Commission sanctioned 15 firms, including Lehman, in 2006 for allegedly giving some clients information on rival bids for the securities. Lehman paid a $1.5 million fine in that sweep, without admitting or denying wrongdoing. It also paid $850,000 in 1995 to settle SEC claims that it manipulated auctions by improperly bidding for its own account. Terminal Business The Maher brothers, whose family has operated marine terminals for more than 60 years, began looking for ways to invest their funds in July, when they sold Maher Terminals LLC, the largest container operator at the Port of New York and New Jersey. The buyer was Deutsche Bank AG's RREEF Infrastructure unit. In their complaint, the brothers say they entrusted some of the proceeds to UBS AG, Europe's biggest bank, and $600 million to Lehman. They asked the firm to place the money for as long as two months in tax-exempt securities similar to municipal bonds, so they could explore long-term investment opportunities. UBS followed those guidelines, the complaint says. Lehman put about two-thirds of the money into taxable corporate securities, including auction-rate holdings, where about $286 million remains ``trapped'' after auctions began failing in August, according to the complaint. Lehman had helped create some of the investment products and in some cases sold securities to the brothers from its own inventory, the complaint claims. MBIA, Ambac Securities ``Large subsets'' of the portfolio were composed of corporate securities guaranteed by bond insurers MBIA Inc. and Ambac Financial Group Inc., and instruments that may be converted into preferred stock of those same companies, the complaint says. That left the brothers with ``an extreme concentration of risk,'' it asserts. Fitch Ratings today lowered Ambac's AAA rating two levels to AA, citing ``significant uncertainty'' about the company's business model. That throws into doubt ratings for $556 billion in municipal and structured finance debt guaranteed by the company. Moody's Investors Service said this week it may also cut the ratings of MBIA. The Mahers' complaint accuses Lehman and its employees of lapses including negligence, deception, breach of contract, making unsuitable investments and supervisory failures. ``Because of respondents' gross misconduct, claimants cannot use those funds and also are missing the valuable opportunity to invest those funds as they see fit,'' the claim says. There is ``no indication that liquidity will return to these securities.'' http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aDeP0vZPTHFY