Regulators Focus on Auction-Rate Securities

Prior to the recent financial crisis, auction-rate securities were often perceived by investors to be as safe and as liquid as cash. In February of 2008, however, that impression was shattered when the $330 billion U.S. auction-rate securities market collapsed.

The collapse came primarily as a result of a destabilized credit market. Auction-rate securities are long-term bonds, issued by corporations and other entities, with interest rates tied to the short-term market. The interest rates are determined during auctions held at 7, 28 or 35-day intervals.

In the early days of the financial crisis, there weren't enough bidders to reset the interest rates at auction and so the auctions failed, according to a May 20, 2009 Investopedia article. Investors were then forced to retain their securities until conditions normalized. In some cases, this forced retention meant that investors had to pay as much as 20% after a failed auction, according to an August 7, 2008 Reuters article.

Since 2000, the major underwriters of auction-rate securities have included: Citigroup, UBS, Goldman Sachs, RBC, Morgan Stanley, Lehman Brothers, JPMorgan, Wachovia, Merrill Lynch and Bank of America.

Over the past two years, regulators (including the enforcement arm of the Commonwealth of Massachusetts and the N.Y. Attorney General) have begun focusing on the securities, primarily out of concern that broker-dealers and other sales agents failed to properly disclose the securities' risks to investors.

"From the beginning of our investigation..., our objective has been to bring relief to investors stuck with illiquid auction rate securities...bringing justice to investors who were promised a cash-equivalent investment, while helping to further restore investor confidence," said New York Attorney General Andrew M. Cuomo, as quoted in a February 23, 2010 New York Times DealBook article.

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