WASHINGTON — The Financial Industry Regulatory Authority announced yesterday that it has fined HSBC Securities Inc. $1.5 million and U.S. Bancorp Investments Inc. $275,000 to settle sales-practice violations for municipal and other auction-rate securities the firms sold to retail customers.
The firms both accepted the fines without admitting or denying FINRA’s findings.
The $330 billion ARS market collapsed in February 2008 when dealers withdrew support for the auctions, shunning the securities because they were backed by insurance from downgraded bond insurers. The auctions failed when the banks stopped using their own capital to prop them up.
FINRA found that from May 31, 2006, through Feb. 28, 2008, HSBC retail brokers omitted material facts about the safety of ARS by recommending the securities as liquid and safe investments even after it became apparent to the firm by December 2007 that there was increased investment risk in the securities.
For instance, in a Dec. 19, 2007, conference call with HSBC brokers, a fixed-income desk manager and a sales manager continued to suggest that brokers recommend ARS to retail customers, describing the “spike” in yield on the securities at the time as “very advantageous” to customers, the self-regulator found.
Though one broker noted the possibility of a failed auction, the managers indicated that they did not believe problems in the credit markets would affect ARS, characterizing the more recent increases in inventory and yield as due to typical year-end activities by corporations to sell off positions, and unrelated to the underlying credit quality of the ARS, FINRA said.
After the conference call, a broker recommended to one of the managers that brokers inform clients about the possibility and consequences of a failed auction for ARS. But the next day an employee on the firm’s ARS trading desk was unsuccessful at obtaining the same manager’s permission to send an e-mail to clients with such a warning.
FINRA said the conduct violated the Municipal Securities Rulemaking Board’s Rule G-17 on fair dealing, because HSBC’s measures to notify its clients of the changing market conditions relating to ARS was inadequate.
The regulator also fined the firm for violations of the Rule G-21 on advertising and G-27 on supervision.
FINRA said that it took into account the voluntary actions by the firm to make most of its customers with illiquid ARS whole by late 2008. The firm has already voluntarily bought back $562 million of ARS at par, FINRA said.
But as part of the settlement, HSBC has agreed to offer to buy back ARS from any of its retail customers that did not take advantage of similar offers in the past and to commit its “best efforts” to provide liquidity to institutional investors within six months.
HSBC said in a press release that it is pleased to resolve the matter and that it was among the first institutions to voluntarily offer to repurchase at par from its customers all ARS sold at the firm. It also said that by July 2008 it had purchased more than 90% of its customers’ ARS holdings and in October 2008 offered to repurchase all of the remaining ARS held in those customers’ HSBC accounts.
Regarding U.S. Bancorp, FINRA said that from May 31, 2006, to Feb. 28, 2008, the firm failed to establish and maintain adequate supervisory procedures that were reasonably designed to ensure that it marketed and sold ARS in compliance with federal, FINRA, and MSRB rules.
For instance, FINRA found the firm failed to maintain procedures to ensure that its representatives accurately described ARS to customers during sales presentations and that they provided customers with adequate disclosure of risks, including that the auctions could fail and that their investments in the securities could therefore become illiquid.
FINRA noted that it was crediting the firm for taking voluntary actions in September 2008 to buy back at par all of the illiquid ARS held by its customer accounts at the time, plus accrued and unpaid interest. The firm bought $152.3 million of the securities.
As part of its agreement with FINRA, U.S. Bancorp agreed within 90 days to identify and make whole any customer who sold ARS in the 12 months before Feb. 27, 2009, at below par. It also agreed to arbitrate claims for “consequential damages” filed by investors who were eligible for buybacks.
Officials at the two firms could not immediately be reached for comment.
