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SEC Official Warns Against Below-Market ARS Bids

A Securities and Exchange Commission official yesterday warned market participants that the SEC might view below-market bids from issuers on their own auction-rate securities as possible market manipulation, but declined to say what a below-market rate would be.

Mary Simpkins, senior special counsel in the SEC's Office of Municipal Securities, told market participants at The Bond Buyer's conference on The Municipal Credit Crunch here that she could not provide any additional details beyond the SEC's March 14 guidance that lays out a general framework under which issuers may bid on their own securities.

"I don't think I have a good answer for you," she said, after she was pressed for a definition during a question-and-answer session by Robert Clarke Brown, treasurer of Case Western Reserve University, to provide a definition of the term.

Brown noted that Case Western’s auction-rate securities have historically closely corresponded with the interest rates on its variable-rate demand obligations. But it VRDOs are now resetting at rates of 2% or less while some of its auction-rate securities have failed six consecutive auctions, resulting in much higher penalty rates.

"What's the [rate] that I'm supposed to bid at so that I don't bid under the market?" asked Brown, who later told The Bond Buyer that he believes a reasonable bid would be between 25 and 50 basis points above the VRDO market.

Simpkins said the definition of a below market bid would depend on "a facts and circumstances analysis" and cited the language of the SEC's auction-rate securities guidance, which calls for issuers to disclose any steps taken "to avoid an auction leading to a below market-clearing interest rate, such as whether the rate(s) bid would not be less than an appropriate benchmark (for example, the relevant [Securities Industry and Financial Markets Association's] municipal swap index)." She also stressed that the guidance had been carefully negotiated among the SEC staff and that it may not be easy for staff to revisit.

Joseph Fichera, senior managing director and chief executive officer of Saber Partners LLC, who spoke on a separate panel, suggested that a spread of 50 to 100 basis points between the rates of auction rate securities and VRDOs would be an appropriate "liquidity premium" for the ARS.

Fichera also said the only way to revive investor confidence in the auction-rate market is to improve its transparency and bring in more investors to bid in the auctions, along with incentive-based compensation for bankers that would reward them for lowering issuers' borrowing costs.

Meanwhile, Simpkins tried to answer several other questions that she said market participants have privately raised with the commission since it released its guidance.

For instance, some market participants want to know if the commission staff believes it is acceptable for issuers who planned to self-bid in multiple auctions to disclose their intent in just one disclosure notice. No, she said, the commission wants disclosure ahead of each individual action.

Another question revolves around whether the guidance's disclosure requirements on the submission of bids applies to "sell" and "hold" orders.

"We told them we didn't think so, that it only applies to bids," Simpkins said.

Refering to the guidance's requirement that issuers disclose the details of the immediately preceding auction prior to the one in which they plan to self-bid, Simpkins said the commission has received questions about whether the SEC wants disclosure of the number of bids submitted to the broker-dealer or the number of bids submitted to the auction agent. Some dealers aggregate bids before submitting them to auction agents, she said.

"After thinking about this, we think the bids should be disaggregated," she said. "We've been told that it takes a bit more time to collect this information, but it's better for transparency if the bids are not aggregated and it's reported how many actual bids that there were."

The issue of market rates first emerged when Simpkins said that the commission has been asked whether the guidance means market participants should use only SIFMA's tax-exempt swap index, which is derived from yields in the variable-rate demand note market, to show that an auction-rate bid is a market rate.

"We did mean [they should use] that index because the thought was the auction-rate indices have been too volatile," she said, referring to SIFMA's ARS indexes.

Simpkins noted that the guidance does not apply to the secondary market. It only applies to primary-market auctions, not to transactions between auctions, she said.

Separately, John J. Cross 3d, an attorney with the Treasury Department's office of tax policy, who spoke on the same panel with Simpkins, addressed updated guidance that the department released Tuesday that gives issuers 180 days after they purchase their own auction-rate securities until the bonds are considered retired for tax purposes. If the bonds are purchased by Oct. 1, 2008, then they are treated as still outstanding for the six-month period.

"You could do a refunding by the end of that period. You could do a put to change the interest rate under the terms of the documents and the qualified tender, or on day 179, you could sell those bonds back out into the market," Cross said. "In each of those three examples, the bonds would be still outstanding."

By contrast, though, he warned that if issuers hold the bonds beyond 180 days, "they would die."

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