Losses In 'Auction' Bonds

Debt Crisis Hits A Dynasty
Billionaire Mahers Rack Up Losses In 'Auction' Bonds

By Robert Frank | 14 February 2008

When M. Brian and Basil Maher sold their family's shipping business last July for more than $1 billion, they quickly put the money in a safe place. Or so they thought.

The two brothers handed much of it to Lehman Brothers Holdings Inc. with marching orders to make only the most conservative, cashlike investments. Within weeks, however, they had lost access to more than a quarter-billion dollars. "We didn't think we were taking risks," says Brian Maher, 61 years old. "We read about all the troubles in the credit markets and said, 'I'm glad we're not invested in that stuff.' It turns out, we were."

The Mahers rank among the earliest victims of "auction rate" securities, a once-obscure type of bond now sending shock waves through broad swaths of the U.S. economy. Auction-rate securities— an unusual type of long-term bond that behaves like a short-term bond— have become a keystone of modern finance. They are routinely used to fund everything from college student-loan programs to municipal road-and-bridge projects.

These bonds became popular with investors looking for cashlike investments, because they offered better returns than traditional money-market investments but were just as easy to buy and sell. Recently, however, that advantage has disappeared. The market for auction-rate securities has dried up amid fears about fallout from the subprime-mortgage crisis. This week, New York's Port Authority saw the interest rate on some of its debt jump to 20% from 4.2% amid disruptions in this market.

For the Mahers, the ordeal represents more than money. Their billion-dollar windfall was the fruit of a classic American success story— more than 50 years spent on the gritty docks of New Jersey, battling unions, the mob and fierce competition to build a shipping-port empire. Maher Terminals, the company founded by their father, operates one of the biggest container ports on the East Coast. When they sold the business, the brothers intended to use their money to launch new lives as entrepreneurs, investors and philanthropists. Now, while they're still very wealthy, they've had to scale back their plans. "No one could ignore the potential loss of $286 million," Brian Maher says.

Many rich investors like the Mahers are now discovering they hold exotic securities wrongly thought to be safe. As a result, the subprime-mortgage crisis that began with America's most financially strapped borrowers is climbing to the top of the wealth ladder, reaching into the pockets of America's millionaires. The brothers have filed a claim against Lehman, saying it mismanaged their money. The complaint, filed last month with the Financial Industry Regulatory Authority, which resolves disputes between investors and brokers, says Lehman ignored the Mahers' request to put the money in short-term, low-risk investments such as Treasurys and municipal bonds.

'Unprecedented Dislocation'

Instead, Lehman put more than two-thirds of their money into auction-rate securities. The Mahers are demanding that Lehman buy back the securities at their original value, plus interest. In a statement, Lehman said: "We cannot control the credit markets which have seen unprecedented dislocation, which unfortunately has affected most participants." The company says it believes it has "meritorious defenses" against the Mahers' claim.

The Maher fortune started in the early 1950s with Michael Maher, the son of an Irish immigrant in New York City's Queens borough, who worked as a longshoreman on the docks of Brooklyn and Manhattan to pay his way through law school. After serving in World War II, he returned home and, borrowing money from his sister, eventually established a terminal in Port Elizabeth, N.J., on a former piece of swampland. As the Manhattan and Brooklyn ports became crowded, Mr. Maher's port started taking off.

In the 1960s, he made another gamble that would ultimately cement the family's success. He invested heavily in building a facility that could load and unload "containers"— the giant metal boxes that are now the main building block of the global shipping trade. His rivals failed to adapt, and as containers revolutionized the shipping industry, Mr. Maher's business exploded. In his personal life, Mr. Maher remained thrifty. He drove a beat-up Volvo and carried a weathered leather briefcase.

"His life was the business," says Joe Curto, president of Maher Terminals and a 36-year employee. "He was on the docks at night, weekends, whatever it took." Michael's sons, Brian and Basil, inherited the obsession with shipping. As a boy, Basil Maher recalls marveling at dockland warehouses piled high with rubber, steel and fragrant coffee. The brothers' first jobs were as forklift mechanics and messengers. In 1992, their father handed the job of chief executive to Brian. But Michael Maher remained chairman until he died in 1995.

"Dad didn't ever retire," Brian says. With Basil as president, the brothers doubled the port's size to 450 acres. They helped open a new terminal in Prince Rupert, British Columbia, expanding their empire across the breadth of North America. In 2006, they began thinking about selling. Another era was dawning in the shipping business: Cash-rich global investors— private-equity funds as well as some foreign-government-associated investment funds— were on a shopping spree for ports, bidding up prices in the once-stodgy business as global trade boomed.

In a landmark deal early that year, the Gulf-state-backed Dubai Ports World bought the massive United Kingdom-based ports operator, P&O, for $6.8 billion. The sale touched off a bidding frenzy for other port operators. The Mahers were conflicted about cashing out. Their business was their life. The company was requiring increasing amounts of capital, and the Mahers shied away from large debt. With the acquisition wave pushing up port values, the family also faced the prospect of a huge estate-tax bill if either brother died. "All our wealth was tied up in the company," says Basil Maher, 56. So when one of Deutsche Bank's investment units offered to buy the company for more than $1 billion, the Mahers agreed to sell. The deal closed in mid-July.

Their only hobbies, in so far as they had any, are golf and trout fishing. In their daily uniforms of striped suits and starched white shirts, the brothers are uncomfortable talking about their personal lives or their wealth. They live in modest, Colonial-style homes near Short Hills, N.J., and both belong to the Baltusrol Club, a storied golf club in Springfield, N.J., founded in the 1800s.

Stock-Picking Foray

The brothers had no real investing expertise. Brian owned a few mutual funds. One of Basil's rare forays into stock picking left him with a $1,000 loss, "which was a lot for me at the time." Their plan was to park the money in a safe place until they could hire their own team of wealth managers. John Liu, the co-head of mergers and acquisitions at Greenhill & Co., who had advised the Mahers on the sale of the company, agreed as a favor to help them find professional managers.

Mr. Liu and the Mahers drew up a basic list of financial objectives. The first one, according to a letter the family sent the banks: "Preserve capital." The second was to "provide sufficient liquidity" and third was "capture a market rate of return based on [the brothers'] investment policy parameters and market conditions." To spread the risk, Mr. Liu also recommended three separate firms handle the temporary investments— Lehman, UBS AG and J.P. Morgan Chase & Co. All the accounts were "discretionary," meaning the banks could invest on the brothers' behalf, without prior permission, as long as the investments fit the written guidelines.

When their billion-dollar sale closed, the Mahers divided up the proceeds and wired the money to the three banks. UBS and J.P. Morgan invested in Treasurys, money-market funds and government bonds, the Mahers say. The investments with both banks have grown since July, they say. But when they saw an account summary from Lehman in early August, the Mahers were alarmed. It showed that two thirds of the account— about $400 million— had been invested in corporate securities with obscure names like Tortoise TYY I, or INC 2003-2.

Baffled by the codes, Mr. Liu says he phoned Lehman and learned that many were corporate auction-rate securities. Mr. Liu, who had only a vague understanding of the securities, asked Lehman for details. Auction-rate securities usually are long-term bonds with interest rates that are reset periodically (usually once a month) at an auction. Because the auctions happen so often, the bonds traditionally were much easier to buy and sell than other forms of long-term debt. Auction-rate securities worked well for over 20 years and were regarded by Wall Street as cashlike investments, since they were highly liquid and highly rated.

But if buyers stop showing up for auctions, they become tough to sell, or even to value. Mr. Liu says he came away from his conversation with Lehman unsure of the quality of the bonds' underlying assets. He consulted with the Mahers, and they agreed the bonds should be sold as soon as possible. Mr. Liu told Lehman to "unwind the positions and give the Mahers their money back." Lehman, however, had trouble selling. In early August, the market for auction-rate securities grew skittish as one auction for lower-grade securities failed.

Lehman had put the Mahers into most of their auction-rate securities a few weeks earlier, in July. It reinvested about $100 million of the Mahers' money in auction-rate securities in mid-August, the Mahers say. Lehman points out that the Mahers' own investment guidelines included "auction-rate certificates" on a list of 12 suitable investments. Lehman also says that the Mahers "had a professional investment consultant with whom we dealt," referring to Mr. Liu.

Mr. Liu points out that his expertise is in corporate merger advice, not personal investing. The Mahers' attorney, Michael Kim, says Lehman acted irresponsibly by putting so much of the Mahers' portfolio— two-thirds— into the instruments. "That's not responsible diversification," he says. Mr. Kim says Lehman may have sold the Mahers a portion of securities from the firm's own balance sheet, thus shifting Lehman's potential losses to the Mahers. Lehman says it couldn't have foreseen the auction failures in mid-August.

It's unclear what assets are backing the securities purchased by the Mahers. After the Mahers demanded that Lehman sell the securities, Lehman could bail out of only $114 million worth of the notes, due to the lack of buyers. The Mahers now hold the rest, which they purchased for $286 million. Mr. Kim says he doesn't know the current value of the securities, or whether they have any value. "As far as I'm concerned, if we can't get the money out, and we can't sell them, that's a loss," Mr. Kim says.

If buyers return to the auction-rate-securities market, the Mahers could sell their holdings and come out whole. The companies that issued the securities could also buy them back from the Mahers. In the meantime, the Mahers are collecting interest on the securities of more than 6%. For the time being, however, there is effectively no market for the securities they hold.

Company Write-Downs

Many companies, including 3M and US Airways, are already writing down the value of their auction-rate securities. Bristol-Myers Squibb in January took an impairment charge of $275 million because of auction-rate securities it held. Merrill Lynch & Co. recently bought back $13.9 million in debt securities that it sold to the city of Springfield, Mass. The Massachusetts secretary of state has since filed a civil lawsuit against Merrill charging the firm with fraud and misrepresentation. In their claim, the Mahers are demanding their $286 million back from Lehman, along with interest, and are seeking punitive damages of up to an additional $857 million.

Famous Last Words

As for what they learned about investing, "It's about trust," says Brian Maher. "We entrusted our money to Lehman believing them to be looking out for our best interests."

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