Cash Management

Auction-rate Probes Go National

States get involved in searching for causes and consequences of damage from the deterioration of the once-reliable market.
Stephen TaubApril 21, 2008

From coast to coast, state and federal regulators are stepping up their probes of the auction-rate securities market.

New York Attorney General Andrew Cuomo subpoenaed 18 banks and securities firms, including a number of well-known large names, according to a report in Bloomberg News. The probe could lead to criminal charges, the wire service added, citing a person familiar with the investigation.

“We’re all getting complaints on a daily basis from retail investors and they all have the same the story: they were told by their brokers these were safe as cash and they’re not,’” Bryan Lantagne, the securities division director for Massachusetts Secretary of State William Galvin, told Bloomberg.

Massachusetts is participating in an ARS state task force with Florida, Georgia, Illinois, Missouri, New Hampshire, New Jersey, Texas, and Washington, according to the North American Securities Administrators Association.

Meanwhile, the inspections office of the federal Securities and Exchange Commission sent letters to the biggest sellers of ARS this month, seeking names of customers who purchased the notes and the identities of brokers who sold them. The regulator is interested in how Wall Street firms sold the bonds to investors and issuers, the wire service stressed.

“To have subpoenas and the threat of criminal investigations raised suggests that somebody has made up their mind that there really are abuses there,” Donald Langevoort, a former SEC, told the wire service.

Auction-rate securities 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 hit companies including 3M and US Airways, and forced some, including Bristol-Myers Squibb, into write-downs. Some issuers were forced to pay interest rates as high as 20 percent, Bloomberg noted.

In New York, Cuomo is asking for information about how investment banks convinced borrowers to issue ARS and how the banks decided when to stop bidding in mid-February, according to the wire service. It pointed out that for the past two decades, dealers regularly bought unwanted bonds at auctions to prevent failures for two decades.

Bloomberg noted that the subpoenas were issued under the Martin Act, which gives New York investigators the ability to file criminal charges.

It said the banks Cuomo subpoenaed include Merrill, UBS and JPMorgan Chase & Co.

This is not the first time investment banks have been accused of wrongdoing in the ARS market.

According to Bloomberg, in 1995 Lehman Brothers Holdings was fined $850,000 by the Securities and Exchange Commission for manipulating auctions conducted for American Express.

In addition, nearly two years ago 15 securities firms paid the SEC $13 million to settle claims of bid-rigging, according to Bloomberg, adding that the banks neither admitted nor denied wrongdoing. It also noted that the SEC also imposed new rules on the market after the settlement.