Capital Markets

Another Kick in the ARS

As troubles continue in the auction rate securities market, Massachusetts's securities regulator begins probing financial firms for information.
Tim ReasonFebruary 21, 2008

In the latest sign of trouble for auction rate securities (ARS), Massachusetts’s securities regulator has demanded information from nine financial services firms around the country regarding problems they have had with long-term investment schemes that invest in ARS.

ARS have long been considered a safe and liquid investment, and many companies record them as cash equivalents on their balance sheets. But in recent months, investors have spurned auctions where the securities are sold, calling their liquidity and par value with the dollar into question. The failure of the auctions has forced some companies, most notably Bristol-Myers Squibb, into the unusual step of writing down cash. Likewise, some investors have found it hard to unload their holdings, despite past assurances that the securities were highly liquid.

On Wednesday, William Galvin, Secretary of the Commonwealth of Massachusetts, sent a letter to nine firms asking them to provide samples of disclosures the firms had made regarding closed-end funds that invest in ARS, to describe any problems they had experienced with redemptions from closed-end funds, and to state their plans for coping with any funds. The firms receiving the letter, which was obtained by, were Eaton Vance, Evergreen Investment Management, Allianz Global Investors, John Hancock Advisers, MFS Investment Management, Nuveen Asset Management, Pioneer Investment Management, Blackrock Financial Management, and Calamos Financial Services. They have until March 7 to respond.

“We are seeking documents and information concerning the disclosures that have been provided to investors in closed-end funds that employ leverage through the auction rate markets,” the letter stated, adding that Galvin’s office “also seeks an explanation of how your firm is updating its shareholders given the recent auction failures.”

Galvin’s questions focused on whether the recent auction failures have made it difficult for investors to redeem their investments in closed-end funds. Galvin’s concern also is likely driven by the fact that the market failures will make it harder for municipalities to raise money. According to Moody’s Investors Service, roughly half of the estimated $328 billion ARS market is made up of tax-exempt (and some taxable) issues of state and local governments, not-for-profit hospitals, colleges and universities. Many long-term investors choose the funds because the securities are tax-exempt.

“The failures in these auctions cause many and diverse problems,” Galvin said in a statement, “but the impact on closed-end municipal bond funds can be daunting for the investor who has sought a safe and dependable harbor for life savings.”

Galvin, whose position as Secretary of the Commonwealth gives him the same regulatory oversight of securities that is typical of attorneys general in other states, has been actively pursuing firms involved in selling various structured products. Earlier this month, he sued Merrill Lynch over collateralized debt obligations (or CDOs) that the firm sold to the City of Springfield and that, according to Galvin’s complaint, “within months after the sale, became illiquid and lost almost all of their market value.” The market-value loss was also the result of failed auctions.

Despite Galvin’s concern over closed-end funds, Moody’s issued a report Wednesday noting that similar funds containing bonds and preferred stock were not in danger. “The credit quality of securities issued by closed-end funds is not likely be impaired,” said Moody’s vice president and report co-author Henry Shilling. The report noted that “the underlying credit quality of most securities in the ARS market remains strong in the short term,” although it added that “a prolonged disruption in the auction rate securities market could have negative ratings implications for some securities.”