It's not often we pat accountancy on the back so explicitly; but in the case of the auction-rate securities market, it deserves one. ARS are long-term bonds and preferred stocks that resemble short-term instruments because their interest rates are reset periodically — in as little as 7 days. The higher yields they offer led many corporate treasurers to use them to store idle cash.
But in the spring of 2005, accounting firms began issuing alerts about ARS, advising that such securities should be classified as investments, not cash equivalents. They also hinted that the ARS market had inherent liquidity problems.
That advice saved many companies from exposure to the current crisis involving the failing auctions of these securities. According to an Association of Financial Professionals' survey in 2007, one-third of respondents reduced the use of auction-rate securities after the major accounting firms voiced their concerns.
Meanwhile, though, the SEC had been aware of this market's flaws, arguably structural ones, for awhile. In May 2006, 15 broker-dealers settled with the commission over "industry-wide" violations in the ARS market. Those violations occurred between January 2003 and June 2004. Among the misdeeds: "asking customers to make or change orders in order to prevent failed auctions" and "submitting or changing orders, or allowing customers to submit or change orders, after auction deadlines." Legg Mason Wood Walker, which later became part of Citigroup Global Markets, was singled out in a separate order, for "intervening in auctions by bidding for its proprietary account to prevent failed auctions without adequate disclosure."
Now that the broker-dealers have stopped intervening, investors are scrambling for the crowded exits: American Eagle Outfitters Inc. ($388 million invested); HLTH Corp. ($95 million); Northgate Minerals ($72.6 million); and Sapient ($28 million) among them.
It's clear that the ARS market may have never operated efficiently if the banks hadn't been propping it up. A question then: why didn't the SEC either introduce structural reforms to assure liquidity, or shut the market down altogether? We hope to get some answers from federal regulators. In the meantime, to the accounting firms that sounded the alarm, kudos. |
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