In a move that will bloody a number of its customers, UBS (UBS) will mark down the value of auction-rate securities held by its customers. According to The Wall Street Journal the bank "began on Friday to lower the values of so-called auction-rate securities held by its clients, a move that will be a jolt to customers who had been told they were investing in a "cash alternative."

The action could drop the value of some of the paper by as much as 20%. Other banks are likely to follow UBS’s example

The auction-rate securities has held by individual investors, institutions, and some corporations who list them on their balance sheets as "cash equivalents". At the end of the first quarter,the public companies in this pool may have to take large write-offs for their holdings which will hit P&Ls.

There is a strong case to be made that the banks and brokerages which marketed auction-rate paper did so by saying that they were nearly as safe as cash. The auction-rate market traded well from 1985 until late last year. At that point troubled financial companies were not willing to keep the market liquid by buying excess securities from one auction and selling them in the next. This role as "specialists" kept the market operating smoothly.

There will almost certainly be a rash of lawsuits now from institutions and corporations. They will argue that the financial companies who "made the market" in auction-rate paper had an obligation to keep it trading if the securities were offered to investors as being as liquid as Treasuries.

If the auction-rate market continues to deteriorate, the lawsuits can go on as investors lose more with each passing quarter.

Douglas A. McIntyre

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