State Regulators Form ARS Probe Task Force

WASHINGTON - A group of state securities regulators investigating whether investment banks adequately disclosed the risks associated with the auction-rate securities they sold investors have formed a task force to share their information and expertise with other states trying to address investor ARS complaints.

The creation of the task force - which currently includes securities regulators from nine states and is being led by Bryan Lantagne, director of the Massachusetts Securities Division - was announced yesterday by the North American Securities Administrators Association.

"Given the number and nature of the complaints and the damaging impact this latest manifestation of the credit crisis is having on Main Street investors, state securities regulators have structured a coordinated approach to moving forward with our investigations," said NASAA president Karen Tyler, the North Dakota Securities Commissioner. "If violations are uncovered, then state securities regulators will seek appropriate remedies, including a much stronger commitment from Wall Street to provide their retail clients with an acceptable solution."

The task force is being formed as growing numbers of investors complain that they are now stuck holding auction-rate securities that they thought were safe, liquid and cash-like investments. It essentially will help provide states with means to share information and a road map on how to investigate the investor complaints.

Each state is to be assigned a bank or broker-dealer firm on which they will develop expertise, according to Lantagne.

"We've been hearing from our members that they're getting these [investor] calls on a regular basis. Many states have ongoing investigations, others are in the early stages of their investigations" and have had questions about how to obtain information and what kind of direction they should be taking, he said. "NASAA established this task force to basically set up a structure whereby states can contact a lead state on a particular firm."

Massachusetts, for example, will serve as the lead state on UBS Securities LLC and Merrill Lynch & Co., Lantagne said. The other states involved in the task force are Florida, Georgia, Illinois, Massachusetts, Missouri, New Hampshire, New Jersey, Texas and Washington. Lantagne said he could not say which firms they will each be focusing on because they may "either by statute, or policy, not [be able to] disclose ongoing investigations."

"It's really NASAA's way of trying to coordinate the whole process to bring the states together and make sure everyone has the same level of knowledge and expertise in the area as they move forward," he said.

The banks and broker-dealers most active in the auction-rate securities market generally had investors in all 50 states, Lantagne said. Some states have been in the dark about how to pursue investigations, he said. In other cases, complaints may cross state lines. An individual in Massachusetts, for example, may contact his or her state securities regulator about her mother who is in financial trouble as a result of auction-rate securities investments but is located in a different state.

While the states will be sharing information, Lantagne said he expects them each to continue conducting their own investigations. "Each state is a sovereign state and will pursue its own course of action," he said.

Asked if the states might band together on enforcement actions, he said, "This is a work in progress... We are still in the investigatory stages of this. How it develops over time remains to be seen."

The investor complaints mostly focus on liquidity, he said.

"Investors are telling state securities regulators that they did not know that their money was being held in auction-rate securities, and were not advised about the liquidity risks." Lantagne said. "States have heard complaints from a wide range of investors - young families saving for a first home, small business owners, retirees, and people with parents in nursing homes - whose lives have been detrimentally impacted because the money they thought was liquid is now tied up in this frozen market. Based on these investor complaints, this appears to be a pervasive problem."

Investors "had this instrument that they thought was cash that has now, somehow, morphed into long-term debt," he said.

Lantagne rejects the idea that auction-rate securities historically were safe and cash-like investments and could have continued to be characterized as such were it not for the subprime mortgage crisis.

"There have been problems in the past," he said. "It wasn't like this never happened and couldn't possibly happen."

The NASAA is urging investors with ARS complaints to contact their state securities regulators, and noted that contact information can be obtained at www.nasaa.org.

The states' ARS task force comes after New York Attorney General Andrew Cuomo subpoenaed firms for information about auction-rate securities earlier this week. He is seeking information dating back to 2003, about the time the auction securities market began developing.

The Securities and Exchange Commission's enforcement division and the Financial Industry Regulatory Authority also have asked banks and broker-dealers for information about auction rate securities.

The SEC requests, which were made in letters ranging from one-page to eight or nine pages, seek information dating back to November 2007, and seem to be focused to some extent on how the firms characterized, from the standpoint of risk or value, the auction-rate securities they held in inventory compared to the ARS they sold to investors.

One recent letter obtained by The Bond Buyer that the SEC sent to a mid-size firm asked the firm for detailed information about its customers who held auction-rate securities, including the registered representatives assigned to the customer accounts, and the quantity and "value of positions" for which the customer is the beneficial owner.

The SEC also asked for the "total value" of auction-rate securities held in the firm's inventory as of the end of the first quarter, as well as the amount of "haircuts" the firm took on those positions with respect to its net capital computations under commission rules. A haircut refers to the amount that a broker-dealer must deduct from its net worth in connection with each long or short inventory position it maintains in securities. The haircut is considered to be a reserve against loss due to a subsequent decline in the market value of the securities.

By contrast, FINRA sent firms auction-rate securities surveys ranging from two to eight or nine pages asking for information dating back to Oct. 1, 2007. The Bond Buyer obtained a copy of one of the shorter requests that asked for information about the amount of auction-rate securities held by customers of the firm and by the firm in its inventory. FINRA wanted breakdowns of the types of investors holding the ARS - retail, high net work, nonprofessional institutional and professional institutional. It also asked for the percentages of the types of ARS' held - municipal, student loan, corporate, equity preferred or other - by customers or in the firm's inventory.

The self-regulator asked firms if they were willing to offer margin loans to customers using ARS as collateral. It also asked how auction-rate securities were classified on customer statements. Were they classified as cash, cash equivalent, fixed-income securities, or municipals for example, the self-regulator wanted to know.

FINRA asked if the firm used internal training or marketing materials, sales materials, or advertisements when selling the securities and if the ARS were used as a cash-type product. It also asked for the number the firm received relating to ARS from Oct. 1, 2007 to the present. Finally FINRA asked if the firm ever served as auction agent at any time during that period.


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