- The Washington Times - Sunday, May 23, 2004

NEW YORK (AP) — A sudden and unusual liquidation of a few bond trusts sold by Lehman Brothers Inc. and Morgan Stanley may cost some investors millions of dollars.

Trusts worth $430 million, backed by the debt from subsidiaries of General Electric Co. and Verizon Corp., were terminated this month after the subsidiaries stopped filing financial reports with the Securities and Exchange Commission.

Brokerage firms are telling some investors in a Lehman Brothers trust to expect up to a 16 percent loss, only months after their initial investment. By contrast, investors in one Citigroup Inc. trust will lose nothing, because the bank is making up their losses.

“It’s a little bit of a fiasco,” said Andrew Montalbano, a trader with Advest Inc. who sold shares of the trusts to investors.

The meltdown provides a window into the little-known world of the trusts. About $10 billion in bond trusts currently trade, Mr. Montalbano estimated.

Here is a hypothetical example of how the trusts, also called repackagings, work: A financial firm — a bank or brokerage such as Lehman Brothers — buys a chunk of corporate bonds, often $100 million or more. The firm will take bonds that pay, say, 7 percent interest and put them into a vehicle called a trust. The trust will issue shares at a lower interest rate, such as 6.75 percent.

The firm makes money on the difference between the interest it earns and the interest it pays.

The shares are attractive because corporate bonds often are traded in amounts too expensive for individual investors; straight bonds also are harder to trade than stocks. The trusts usually sell at $25 a share and trade on the New York Stock Exchange.

Another appeal of the trusts is they are seemingly safe. They pay a fixed amount of interest and “at the end of the day, you get your principal back, in full,” unless the backing company goes bankrupt, said Dennis Marin, president of Wedgewood Investors Inc. in Erie, Pa.

Some trusts started seeming riskier on May 4, when Verizon New York Inc. told the SEC it no longer would file reports separately from its parent company.

Filing has become more costly because of requirements under the 2002 Sarbanes-Oxley Act, and many companies are reducing expenses with consolidated filings. Some Verizon subsidiaries stopped filing in February 2003.

Under SEC rules governing the trusts, the underlying securities must come from a company that files directly with the SEC. When Verizon New York stopped filing, it triggered the termination of months-old $230 million Lehman Brothers trusts.

“It was stated in the prospectus that if Verizon New York stopped filing with the SEC it would force liquidation of the trusts,” Mr. Montalbano said. “We trusted that Lehman Brothers would do their due diligence and this wouldn’t happen. … Lehman did do their due diligence, it’s just that this never happened before.

“They’re never going to issue corporate-backed trusts off a subsidiary again,” he said. “And I’m never going to sell one.”

Lehman spokeswoman Kerrie Cohen said, “Lehman was required, by the rules set by the SEC, to dissolve the trust because of [Verizon New York’s] election to discontinue periodic reporting with the SEC.

“Lehman had no discretion in taking this action,” she said. “Lehman did not learn of the company’s decision to stop filing periodic reports until it was recently publicly announced, months after the transactions were completed.”

Other trusts backed by bonds from Verizon Maryland and GE Global Insurance also were terminated this month when those subsidiaries stopped filing separate financial reports to the SEC.

“This is just one of those loopholes or flaws in the structure that hurts investors,” said Eric Chadwick, vice president of Flaherty & Crumrine, a Pasadena, Calif., firm that specializes in debt securities.

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