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SEC's ARS Guidance Pending

WASHINGTON - The Securities and Exchange Commission may release guidance as early as this week that provides some relief to municipal issuers of auction-rate securities, a commission spokesman said yesterday.

The release probably will come this week or next, the spokesman said, after Robert Colby, deputy director of the SEC's Office of Markets and Trading, talked generally about the guidance at the National Association of State Treasurers' legislative conference here.

Colby also told the treasurers that one of the lessons from the subprime-induced turmoil in the financial markets may be that investors and other market participants should not be relying on credit-rating agency ratings as a measure of investment risk. Rating agencies suggest that their ratings are merely a measure of the probability of default, even though they have been widely used to delineate between investment-grade and other securities, he said.

Much of the discussion at the NAST meeting revolved around auction-rate securities, with Colby telling the treasurers that there have been failed auctions of about $80 billion of municipal auction-rate securities in recent weeks, according to news reports. Until now, the auction-rate securities market had grown to between $325 billion and $360 billion, with state and local governments accounting for $166 billion of the market, he said.

The auction failures have occurred because of a lack of sufficient interest in the securities by investors and have forced issuers to pay default above-market interest rates as high as 20%. The collapse of the market stems from the fact that most auction-rate securities are insured and most of the insurers with exposure to the subprime mortgage market have experienced actual or threatened rating downgrades.

In the past, dealers bid on securities to prevent failed auctions, but they have dropped this practice after the SEC last year forced 15 firms to pay more than $13 million in penalties to settle securities law violations for engaging in practices - liking bidding in auctions - that were never disclosed as a possibility in the offering documents.

More recently, a number of bond lawyers have warned issuers that if their original auction-rate securities documents did not disclose the possibility that they could bid on their bonds, then such bidding could open them up to charges of market manipulation from investors or federal regulators.

Market participants and federal lawmakers have been urging the SEC to find a way for issuers to buy back their securities in auctions on a temporary basis to avoid the high interest costs without running afoul of the securities laws.

Colby told the treasurers: "We are actively considering providing some form of relief for issuers of auction-rate securities. We should note that the [2007 enforcement] order does not prohibit broker-dealers from bidding from their proprietary accounts when probably disclosed. However, we understand that now certain of these dealers may be unwilling to accept bids from issuers in an auction because of the scope of the settlement. We're considering this relief in particular because of the excessive caution being exercised by the participating dealers in response to the commission's order."

"We're considering how to enable issuers to provide to short-term investors that want to sell their auction-rate holdings," Colby continued. "We would hope that this would ease the substantial financial burden on municipal issuers from the initial high interest rates and also facilitate an order exist from this market by issuers and conduit borrowers who seek to do so."

Colby noted that many market participants, lawmakers, and others looking for the "culprits" responsible for the market turmoil stemming from the subprime mortgage crisis have pointed to the rating agencies.

He called the rating agencies' rating performance of mortgage-backed securities "regrettable" and said the SEC is examining them to determine if they followed their procedures and methodologies or were influenced by conflicts of interest.

The SEC, he said, is looking at what steps it can take, within its limited regulatory jurisdiction over the rating agencies, "to increase transparency, integrity, and competitiveness in the rating industry" and "to address conflicts of interest."

SEC officials are concerned about whether the rating agencies, which were hired by broker-dealers to rate numerous offerings of mortgage-backed products, may have had an incentive to rate the products as highly as possible to keep the rating business, he said. Colby said the "deal flow" for these products was much greater than in the municipal or corporate markets.

Colby also said that ratings are "a tool that have a stated purpose, but that have been used much more broadly."

"If you listen to [the rating agencies] closely, they'll say all they're telling you about is ... the probability of a default," he told the treasurers. "They're not speaking of liquidity. They're not speaking to you of investment worthiness. So if there's one thing that's been clear, it's that the users of these ratings need to be more analytical about the [underlying] instruments."

The current market turmoil has shown that triple-A rated securities are not all going to perform the same, or to be priced similarly in the event of a market challenge, he said, adding, "I think going forward me, you, investors are not going to be able to use it for these broad purposes."

Colby's comments come as the SEC is exploring whether to continue to use ratings as proxies for investment risk in many of its rules, such as those governing money market funds and dealer net capital requirements.

Later during the conference, Washington Treasurer Michael Murphy told Rep. Paul Kanjorski, D-Pa. who was speaking to the group, that the treasurers would be adamantly opposed to any attempts by Congress to authorize the SEC to regulate municipal securities. Kanjorski said he still is considering creating an optional federal charter for the monoline insurers, which are currently regulated by individual states, because they have told him they want some kind of federal regulation.

Meanwhile, a congressional source who spoke yesterday at the National League of Cities' Congressional City Conference also held here said that Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, is concerned that issuers have been "sandbagged" by the monoline insurers. The insurers' downgrades have made it difficult for issuers to access capital markets, he said. The source asked for anonymity and stressed that he was only paraphrasing Frank's thinking on the matter.

Also, the committee announced the 12 market participants who will testify on three panels at its hearing on munis tomorrow. They include: Erik Sirri, director of the SEC's division of markets and trading; Eric R. Dinallo, the New York state insurance superintendent; Richard Blumenthal, Connecticut Attorney General; Ajit Jain, chairman of Berkshire Hathaway Assurance Corp.; three state treasurers, including Bill Lockyer from California; a representative of the Association of Financial Guaranty Insurers; a representative of Moody's Investors Service; and a member of the newly-formed Regional Bond Dealers Association.

Andrew Ackerman contributed to this story.

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