Cash Management

Another Firm Gets Tangled in ARS Web

First Southwest settles with SEC after regulator claims that company intervened in auctions without adequately disclosing its positions.
Stephen TaubMay 28, 2008

A Texas broker-dealer has agreed to settle Securities and Exchange Commission charges related to its practices in the auction rate securities market during 2003 and 2004. Dallas-based First Southwest Co., without admitting or denying the findings in the SEC administrative proceeding, consented to the entry of an cease-and-desist order providing for a censure and a $150,000 penalty.

The SEC claims that between January 2003 and June 2004, First Southwest, without adequate disclosure, intervened in auctions by bidding for its proprietary account to prevent failed auctions and to prevent all-hold auctions (when all current holders decide to hold their securities without specifying a minimum rate). In those alleged instances when these practices affected the clearing rate of an auction, investors received a lower or higher rate of return on their investments, the SEC explained.

“To the extent that these practices affected the clearing rate, investors may not have been aware of the liquidity and credit risks associated with certain securities,” said the SEC order. The regulator said that by engaging in such practices, First Southwest purportedly violated rules that prohibit material misstatements and omissions in any offer or sale of securities.

“First Southwest Company is committed to ensuring that our auction rate practices meet the highest industry standards and that the firm is in compliance with SIFMA’s Best Practices for Broker-Dealers of Auction Rate Securities,” CEO Hill Feinberg, told “We have always supported the efforts of the Securities Exchange Commission to improve disclosure in capital markets and are pleased to have this matter resolved,” added Feinberg.

The commission emphasized that in determining the size of the penalty, it considered First Southwest’s cooperation and its relatively small share of the auction rate securities markets. “The Commission, however, also considered that First Southwest did not report its practices to the Commission,” it added.

ARS are municipal bonds, corporate bonds, and preferred stocks with interest rates or dividend yields that are periodically re-set through auctions, typically every 7, 14, 28, or 35 days. Auction rate bonds are usually issued with maturities of 30 years, but the maturities can range from 5 years to perpetuity.

ARS are often marketed to issuers as an alternative variable rate financing vehicle, and to investors as an alternative to money market funds. First developed in 1984, the ARS market has grown to well over $200 billion. Essentially, ARS are long-term investments typically marketed as alternatives to cash since their interest rates are reset at short-term intervals. Also, investors can choose to sell the securities. However, earlier this years a number of auctions failed due to the global credit crisis, forcing many investors to hold on to the securities, which have become illiquid.

In March, Morgan Stanley was sued by a client for “deceptively marketing” ARS as cash alternatives. At the time, the investment bank shot back in a statement saying that, “the challenges of the auction rate markets are industry-wide, and result from broader credit market conditions.”

Then in April, state and federal regulators launched investigations into the ARS market and possible wrongdoing by large investment houses. The main complaint from investors was that brokers sold the securities claiming that ARS were as safe as cash, which “they’re not,” noted New York Attorney General Andrew Cuomo, who subpoenaed 18 banks and securities firms in related probes.

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