States Consider ARS Enforcement Action

WASHINGTON — At least six state securities regulators are considering enforcement action against banks and broker-dealers that have failed to commit their “best efforts” to restore liquidity to institutional investors in auction-rate securities, according to David Massey, North Carolina’s deputy securities ­administrator.

Massey made his remarks as the state regulators gathered here for the North American Securities Administrators Association’s spring policy conference and warned the financial regulatory reform package being crafted by lawmakers falls short of needed reform.

NASAA president and Texas securities commissioner Denise Voigt Crawford said she is especially troubled that neither the House nor Senate bill does enough to address the conflicts of interest created by the largest rating agencies’ issuer-pays ­business model.

She suggested that more must be done to prevent rating shopping, in which an issuer only hires the rating agency that will give its securities the highest ­rating.

Massey, who is slated to succeed Crawford as NASAA president in the fall, declined to provide any details about the states or firms that may be involved in future enforcement actions involving auction-rate securities, citing the confidential nature of the agreements among the state regulators collaborating on the matter.

But the state regulators are deeply concerned about the economic fallout if companies are unable to access working capital stuck in ARS. Continued illiquidity could translate to layoffs or bring down the companies, he said, adding, “We view this as a big problem.”

Massey’s comments come after he announced in January that his office was beginning to work on a centralized ARS research center to collect progress reports on how Wall Street and other dealer firms fulfilled the “best effort” commitments they made in settlements with state regulators beginning nearly two years ago. Under those agreements, states generally agreed to forgo enforcement of firms’ ARS buybacks from institutional investors until the end of 2009.

While firms are widely believed to have fulfilled their commitments to provide liquidity to retail investors by early last year, it is not clear what efforts, if any, they have made at restoring liquidity to institutional investors, generally defined as investors with $10 million or more in investments.

Massey said his conversations with other state regulators and market participants suggest the best efforts have not translated into many ARS buybacks.

There are no publicly available statistics on the volume of ARS that remains in institutional investor hands, though several market participants have said it is mostly ARS backed by student loan debt.

A coalition of publicly traded, non-bank corporations that own billions of dollars of such securities has pushed for a federal liquidity backstop so they can sell the ARS and have money to invest in their businesses.

However, they do not appear to be making significant headway among regulators who are intent on unwinding, rather than expanding, the federal government’s economic recovery programs.

Separately, Crawford said that one way to improve the financial regulatory reform legislation would be to establish a “pooled system” in which issuers are assigned an agency to rate their securities, rather than allowing issuers to select an agency on their own, presumably the one that will rate their securities the highest.

“They obviously need to get paid, they need to be incentivized to do the right thing,” she said, referring to the rating agencies. “But it’s really hard to do that when you get to choose your rating agency.”

At least one member of the Senate Banking Committee who is working on the financial regulatory reform proposal, Charles Schumer, D-N.Y., made a similar “pooling” proposal last year that would require about one out of every 10 issues to receive a second rating from a random agency. But the provision was not supported by the Obama administration, nor was it included in the legislation.

However, there are other provisions in both the House and Senate bills that generally aim to limit rating agency conflicts of interest and to increase raters’ liability for issuing recklessly flawed ratings.

For instance, under the Senate bill, rating agencies would have to disclose their methodologies, their use of third parties for due-diligence efforts, and their rating track records. The bill also would create a new office of credit ratings at the Securities and Exchange Commission with the authority to fine the agencies, though it would not have its own compliance staff.

In addition, Crawford said that one of NASAA’s biggest concerns is that the latest Senate version of financial regulatory reform would merely require the SEC to study whether brokers that provide investment advice should be subject to a fiduciary duty.

An earlier draft would have imposed such a duty, similar to a provision in the legislation the House passed late last year, but was opposed by dealers.

Upcoming Events

Already a subscriber? Log in here
Please note you must now log in with your email address and password.