ARS-Auction Rate Securities: The Problems

Banks and broker-dealer investment firms purposely misled customers about the nature and increased risks associated with auction rate securities (ARS). The institutions told their customers that ARS were highly liquid investments comparable to cash or safe money-market accounts.

In the case of one banking institution, they reinforced the perception of liquidity by committing its own capital to support ARS auctions for which it served as sole or lead broker-dealer to ensure that those auctions did not fail. Wachovia also routinely purchased ARS from subsidiary A.G. Edwards’ customers between auctions, a service it referred to as par daily liquidity.

In late 2007 and early 2008, This bank became aware of the increased risk of auction failures but continued to market ARS to its customers as highly liquid investments. On Feb. 14, 2008, This bank followed the lead of other broker-dealers and decided to stop supporting auctions. Without broker-dealer support, ARS auctions failed and thousands of This bank's customers were left holding billions of dollars in illiquid ARS, without any practical means of redeeming, selling, or deriving value from them.

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This bank’s Financial Advisors did not adequately disclose that:

• Auctions could fail which would render customers’ ARS holdings illiquid
• An auction’s success may depend on a broker-dealer placing support bids in an auction
• The par daily liquidity service offered to A.G. Edwards’ customers could be withdrawn at any time

This bank is not the only culprit. The Securities Exchange Commission (SEC) announced final ARS settlements with Citigroup Global Markets, UBS Financial Services and UBS Securities, while Financial Industry Regulatory Authority (FINRA) reached final settlements with WaMu Investments and First Southwest Company. The SEC has reached agreements in principle with Bank of America, Merrill Lynch, RBC Capital Markets, and Other banks. FINRA reached agreements in principle with Mellon Capital Markets, City National Securities, Comerica Securities, Harris Investor Services, SunTrust Investment Services, SunTrust Robinson Humphrey, and NatCity Investments, Inc. Two dozen other broker-dealer firms are also being investigated.

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